For autos, Gloom St isn’t over yet

Margins seen under pressure, profits lower

MUMBAI: Sales numbers for auto companies for the quarter ended September 2007 (Q2) are already out and largely indicate that the performance of most of the major players is likely to be subdued with toplines flat, margins under pressure and net profits lower in Q2.

And that’s no surprise for the markets. The BSE Auto index has underperformed the BSE Sensex in the past one year.

Analysts feel the auto industry’s financials for Q2 will more or less reflect the trends seen in Q1.

“The sales volumes continue to decline due to the higher interest rates, the seasonal effect of the monsoon and the high base of last year,” said a September 17 report by Sharekhan.

Balaji Jayaraman and Anosh Koppikar of Morgan Stanley said in their report dated September 18, “The decline in sales have led to a cut in production and are paving way for disappointment in the earnings scenario.”

Positively, analysts are optimistic about the performance of passenger cars. “Cars will perform well as there is a huge underlying demand for cars,” said an analyst.

Maruti has been a favourite of analysts. Its A2 segment, comprising Alto, Zen Estilo, Wagon R and Swift, has registered a 23% growth in Q2 year-on-year, marginally below analysts’ 24% estimate.

Additionally, exports have grown by 86% during Q2, helped by good orders for Zen Estilo from Indonesia. In the A3 segment, includes SX4 and Esteem, sales grew by 68%.

Maruti’s sales were helped by consumer discounts, which it intends to offer in the ensuing festive season as well. Analysts estimate operating margins to show a flattish trend due to losses at its Manesar plant.

Tata Motors, on the other hand, is expected to report a flat growth in revenues. Slower movement of goods (freight traffic) on account of monsoons, stagnant freight rates and higher base of last year has affected the heavy and medium commercial vehicle segments, which enjoys relatively higher margins.

The launch of Magic and Winger (passenger LCVs) may mitigate the bad performance to some extent. Sales of passenger cars, too, have been impacted due to lack of new products and aggressive competition. Car sales for Q2 were down by 5%.

Most analysts expect Tata Motors to report a decline of around 20% in profit after tax.

For Mahindra & Mahindra (M&M), Q2 revenues are expected to grow around 20%. M&M will benefit from the re-launched Bolero, good sales of Scorpio and the newly launched Logan car.

Truck sales are linked to lending rates as well as freight rates and hence most transporters tend to delay their purchases in a high-rate scenario.

This will also affect Ashok Leyland’s numbers in Q2. Overall revenues are expected to remain flat for Ashok Leyland.

Notably, contrary to the industry trend, profit margins are likely to be higher for Ashok Leyland. Analysts attribute this to cost reduction measures, improvements in productivity and product mix (high proportion of fully built vehicles and buses in sales), and better realisations.

Two-wheeler companies are likely to be the worst hit in Q2 led by a drop in motorcycle sales. Sales of entry-level motorcycles (100cc) are bearing the brunt of higher cost of credit and product fatigue. Entry-level motorcycles account for nearly two-thirds of the total two-wheeler sales.

Analysts estimate Bajaj Auto’s numbers for Q2 to decline by a greater margin than those of Hero Honda. Bajaj derives 50% of its motorcycle volumes from 100cc vehicles and this is expected to take a toll on its performance.

Its launch of ‘XCD’ and the festival season should save the day for the company, going forward. Q2 saw a good response for ‘XCD’, following which Bajaj is contemplating a capacity expansion to 75,000 units from 50,000 earlier.

Hero Honda is no exception. The company had postponed production at its new plant in Uttaranchal to April 2008 on account of poor demand.

However, its performance in Q3 is likely to be better as it plans to introduce two new bikes this month to capitalise on the festive season.

Meanwhile, analysts maintain that stock prices have already factored in all the expected bad and good news. Hence, a re-rating of auto stocks seems unlikely from the current levels.

One of the reasons is the high oil prices, which may prompt the government to hike fuel prices, resulting in an increase in inflation levels.

If that happens, RBI is likely to keep interest rates at higher levels to contain inflation rather than go for a cut.

Additionally, Deutsche Bank analyst Srinivas Rao said in the India Equity Strategy report,

“The inventory drawdown in two-wheelers is still not complete and the decline in commercial freight rates suggests analysts’ estimates for the industry may not have bottomed out yet.”

According to the report, in 2009, product launches will coincide with an improvement in demand, which will bode well for the industry.

Assuming that, Rao has shifted the industry’s position from underweight to overweight.

Analyst Viren Bajalia of IDBI Capital said, “except for two-wheelers, we are bullish on the industry. Commercial and passenger vehicles will perform better as interest rates soften. New launches will drive fortunes for auto companies in the days to come.”

In the two-wheeler segment, said Bajalia, the increase in capacities may not be matched with an equivalent rise in demand and if that happens, it will affect the two-wheeler companies adversely.

Positively, the approaching festive season and expected higher sales augur well for the industry.

In short, the near-term prospects are already factored in, whereas hopes are building up that the next year will be good. That leaves little on the plate of the auto majors, at least for the time being.