Government efforts to tame inflation - shot in the arm for domestic automobile sector!

What's Buzzing

The central government has cut excise duty on petrol and diesel by Rs 8/litre & Rs 6/litre, respectively, over the past weekend. Media reports also suggest that It has also imposed higher duties on steel exports and at the same time reduced custom duty on key raw materials for steel manufacturing thereby intending to control metal prices for user industries within a broader aim to control inflation domestically.

Context

The domestic automobile sector has been under persistent pressure in the recent past on account of sharp rise in input costs mainly metals and crude derivatives. Q4FY22 results marked the turning point, wherein most OEMs had successfully passed on the raw material costs increase to their end customers though calibrated price hikes. However, management commentary was wary of further input costs inflation denting margins in the near term. The ancillary players, however, on the other hand, are still not yet out of the woods and are still reporting muted to neutral quarterly performance in Q4FY22.

Our Perspective

We view this development as a positive for the entire sector from both demand as well as cost perspective. On the demand perspective, decline in retail fuel prices will help spur automobile sales especially in the 2-W category and entry level passenger car segment wherein demand is more elastic to fuel prices. Decline in fuel prices also helps reduce the costs of doing business especially in terms of lower logistics costs. On the other hand, decline in metal prices especially steel will help in keeping the raw material costs under check for the sector with beneficiaries being Tractor, CV, 4-W and 2-W space in this sequence. With recent outperformance in the Nifty auto index (down 2% YTD vs. Nifty index which is down 8% YTD) and currently trading in the close vicinity of 11,000 levels, we sense the present measures to control inflation to act as a right catalyst to take the index higher, primarily tracking expectations of better volume growth and profitability for the sector, going forward. Our preference within the segments is tilted in favour of the passenger vehicle and commercial vehicle space, primarily tracking need for personal mobility and cyclical upswing in the CV space led by greater infrastructure spend by the government and private capex cycle revival, respectively. Our top bets in the auto OEM space include M&M, Tata Motors and Ashok Leyland while the same on the auto ancillary front would be Minda Corporation, Automotive Axles, Bharat Forge and Ramkrishna Forgings among others.