Demand is now back up to pre-COVID levels across sectors, including two-wheelers, passenger cars, and tractor segments. The sales recovery is led by the further opening of various regions (unlock-5), sustained rural demand, and inventory build-up ahead of the festive season. We expect an all-round improvement in margins in 2QFY21 driven by rising utilization levels (production is now running at 65-90% of capacity). Correspondingly, valuation multiple for auto companies continue to re-rate and are now trading at levels between mean P/E and +1 std deviation. Nifty Auto index is up a further 20% over the quarter (vs. 9% for the broader Nifty 50). We believe that stock price returns will be driven by retail trends in the festive season as well as expectations of supportive government policy (GST reduction, scrappage scheme). We have a BUY on Maruti (NS:MRTI), Hero MotoCorp Ltd (NS:HROM), and Endurance Technologies Cn Ltd (NS:ENDU) in the autos segment and prefer Gateway Distriparks Ltd (NS:GATE) in the logistics segment.
- Demand revival: Demand is now back up to pre-COVID levels across sectors including two-wheelers, passenger cars, and tractor segments. Even within CVs, demand for light trucks has risen sharply, though sales for heavy trucks remain below trend levels (though higher QoQ). The upsurge in sales is led by (1) gradual opening up of various regions under Unlock 5, (2) sustained demand from rural, led by good monsoons, and (3) inventory build-up ahead of the festive season as OEMs expect demand to be healthy
- Stock multiples have re-rated: Valuation multiples for auto companies continue to re-rate and are now trading between mean PE levels and +1 standard deviation above mean as the NIFTY Auto index is up another 20% in the Sep-20 quarter (vs. 9% for the broader NIFTY). Several factors have driven the rally, including (1) sustained recovery in volumes for rural segment/increased preference for personal mobility, (2) structural reforms announcement by the government for the Agri segment, and (3) expectations of supportive policy for the auto sector (GST reduction for two-wheelers, scrappage scheme for CVs). We believe that stock price returns will be driven by the retail trends in the festive season and policy support over the coming quarter.
- 2QFY21 earnings outlook – expect a recovery in margins: We expect margins to rebound in 2QFY21 as utilization levels have risen (to between 65-90% levels) and discounting trends have been under check. Further, the impact of rising commodity prices is likely to be felt with a lag of ~3 months.
- Logistics: Volumes for container rail operators have improved – CONCOR’s volumes are +21% QoQ. This is driven by a pickup in EXIM traffic as well as by market share gains by Indian Railways. However, the stock price of CONCOR will continue to be driven by news flow around privatization, while Gateway Distriparks will benefit from its recent fundraising/ deleveraging initiatives.
- Key recommendations: We remain positive on Maruti, Hero Moto, and Endurance in the auto/auto parts sector. These companies will benefit from the ongoing recovery in demand, given their market leadership position and broad-based presence (particularly in the rural segment). We recently upgraded Gateway Distriparks to a BUY post the recent rights issuance.