Auto stocks: Right time to buy cheap?

Auto stocks were under a huge selling pressure in Sept-Oct, dragging Nifty Auto index down to a correction. Rising insurance costs, increasing interest rates, and volatile commodity and fuel prices made the investors jittery ahead of the earnings, which also came out muted at large. In November, auto stocks have exhibited some strength led by good price-volume action in stocks like Maruti Suzuki and Eicher Motors (up 16% and 19%, respectively, from their recent lows). However, as per the CAN SLIM methodology, it is important to wait until the stocks display strong earnings and breakout from a strong base pattern.

Below chart describes the technical standpoint of the top auto stocks:

 

  Previous Low Close (As of Nov 26) % above previous low % from 200-DMA % from 50-DMA
Maruti 6500.00 7565.00 16% -11.80% 2.10%
Ashok Leyland 101.65 108.90 7% -18.10% -6.70%
Tata Motors 164.60 182.00 11% -35.80% -10.50%
M&M 715.00 747.60 5% -11.10% -7.30%
Eicher Motor 20001.15 23890.00 19% -13.50% -0.30%

Strong Macro Background

Auto stocks had a dream run post demonetisation in 2016 and 2017. The rally was driven by strong overall economic growth and higher volume growth across the industry. Industry leaders gave hefty returns to investors last year.

Indian auto industry is the fourth largest (in terms of volume) in the world with two-wheeler segment contributing the most with a market share of 81% followed by passenger vehicle segment with a share of 13%, and commercial vehicle and three-wheeler segments with a contribution of 3% each, respectively. The industry is expected to grow 3.5–4x to $260–300B, which would contribute to over 12% to the country’s GDP. With incremental focus, the automobile production and sales in India clocked a CAGR of 7.1% and 7%, respectively, during the period FY 2013–2018.

The adoption of electric vehicle (EV) will become a crucial growth driver for the industry as a whole. Most of the companies have started focusing on it, and indigenous players like Mahindra and Tata have launched new electric cars and Hyundai will launch its first electric vehicle in India in 2019.

New Product Development/New Models to Drive Growth

Continuous innovation and new product design, especially in the PV segment, is a key to success for the auto companies. New launches get good traction in the market and with some successful launches in compact SUVs and UVs recently the industry as a whole is expanding its market share in PV and CV segment.

Weak Macro-Environment Drags Recent Performance

Weaker macros like a general correction in the market, muted festive season, rising finance cost, and fuel prices have resulted in a subdued demand for the PV segment. The erratic rainfall this year weighed badly on the tractor sales as a result of which CV segment was also negatively impacted.

The reported net profit of companies also suffered from increased raw material prices (commodity prices).

Company Q2 Sales (Y/Y) OP. Margin (Bps)
Ashok Leyland 26% 50
Maruti Suzuki 3% -160
Tata Motors 2% -290
M & M 6% -150
Eicher Motors 11% -120

 

Rising Commodity Prices and New Insurance regulation: A Matter of Concern

Automotive manufacturing has a substantial exposure to Aluminium, Copper, and Zinc. Prices of these metals have been rising at a faster pace supported by a pickup in demand and supply constraints. Global supply has been held back by restrained capacity addition, trade sanction against metal exporters, and policy actions in China. According to the World Bank, the price indices for metals and minerals are expected to rise 9% in 2018. During the period May 2017-2018, the prices of Aluminium, Copper, and Zinc grew 25%, 27%, and 23%, respectively.

The rising prices of raw material have dented auto companies as it accounts for 60-74% of the total revenue. This has impacted the gross margin for most of the auto companies in FY 2018. Barring The The new third-party insurance regulation which requires coverage for all new cars and two-wheelers mandatorily for a period of three and five years, respectively, is expected to dampen the interest of potential buyers.

Below are a few stocks which could be kept in the watchlist but only be added after the breaks out.

Technical Commentary

For the last few years, the rally in auto stocks was driven by strong overall economic growth and higher volume growth across the industry. Industry leaders gave hefty returns to investors last year. But the selloff in Q2 FY 2019 dragged almost all auto stocks below their 50- and 200-DMA.

Ashok Leyland is trading 5.5% and 17.2% below its 50- and 200-DMA, respectively. Post the announcement of the resignation of its CEO, the stock dived into very weak price strength and have seen heavy distribution.

Eicher Motors showed resilience post Sep-Oct sell-off and retook its 50-DMA line in November. The stock has shown good accumulation in the past 2-3 weeks, which is a good sign, but the price-strength still remains poor at 45.

Maruti Suzuki has shown improvement in accumulation in the month of November and successfully retook its 50-DMA. It is currently trading 2.8% above 50-DMA but 12% below its 200-DMA.

Mahindra & Mahindra has seen heavy distribution in the last 2 months. Its 50-DMA line breached 200-DMA on November 12, hinting downward momentum.

Tata Motors is the worst performer on the technical front. The stock has exhibited consistent downward momentum in the last one year along with heavy distribution. The stock trades at an extremely weak price strength ratio and the number of institutional funds invested in it have reduced significantly.

 

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