Rely on auto sec­tor

With many stocks hit­ting 52-week lows, this could be a good time to en­ter. But be pre­pared to hold for two-three years


Slug­gish car sales through the fes­tive sea­son were fol­lowed by flat sales in Novem­ber and de­clines in De­cem­ber. Var­i­ous rea­sons for the down­turn have been cited, rang­ing from poor ru­ral de­mand, to high fuel prices, to high equated monthly in­stal­ments.

But there is con­sen­sus that the in­dus­try is fac­ing “chal­leng­ing” times. Note that the base ef­fects are hard to ad­just for, be­cause au­to­mo­bile man­u­fac­tur­ers faced ex­treme sales volatil­ity in 2017 due to the GST launch.

The in­dus­try has a long value chain — prob­a­bly the long­est over­all. It sources pri­mary ma­te­ri­als (met­als, rub­ber), sec­ondary ma­te­ri­als (plas­tics), high-end elec­tron­ics and com­put­ers. It pro­vides em­ploy­ment to peo­ple with var­i­ous skill-sets, rang­ing from min­ers to man­age­ment grad­u­ates, fi­nan­cial whiz-kids and movie stars.

Re­ces­sions are cycli­cal and, given that long value-chain and the em­ploy­ment the in­dus­try gen­er­ates, it’s hard to be­lieve that GDP can grow at over 7 per cent, when the auto in­dus­try is feel­ing chal­lenged or fac­ing re­ces­sion­ary con­di­tions.

How­ever, the most in­ter­est­ing ques­tion for an in­vestor is the im­pact on price as the bot­tom­line de­te­ri­o­rates. There are a fair num­ber of listed com­pa­nies in the sec­tor, with decades worth of track records and in most cases, strong and stable man­age­ment. A re­ces­sion is un­likely to drive them out of busi­ness though it may mean sev­eral quar­ters of earn­ings down­grades, or losses.

It’s very likely that the Oct-Dec 2018 (Q3, 2018-19) re­sults will be dis­ap­point­ing for this sec­tor. It is also very likely that this cur­rent quar­ter, and the next will be dis­ap­point­ing. Some­where down the line, the sec­tor will re­cover from the cur­rent slow­down.

What sort of price pull­back should in­vestors be look­ing for? This is im­por­tant for those who are al­ready ex­posed to the sec­tor since they will have to be braced to with­stand some pain. It is also im­por­tant to some­body who is look­ing to take fresh po­si­tions and would ide­ally seek to do so when prices have slid close to a bot­tom.

There are a few im­por­tant points to note. Just look­ing at price-earn­ings ra­tios can be de­cep­tive. Dur­ing re­ces­sions, prof­its can evap­o­rate very quickly and a com­pany can rapidly run into the red. Sim­i­larly there can be sharp earn­ings growth when the cy­cle turns up.

This means valu­a­tion by priceto-earn­ings (PE) can pro­vide counter-in­tu­itive sig­nals. Dur­ing an up­cy­cle, you are likely to find pe­ri­ods when the PE drops even though the share price climbs be­cause earn­ing growth ac­cel­er­ates so much. Con­versely, dur­ing down­turns, earn­ings can drop so fast that the PE goes from low to high to mi­nus in the space of a month.

Purely in terms of price, 50-75 per cent re­trac­tions from the high price of a pre­vi­ous cy­cle to the bot­tom of the down- cy­cle are quite com­mon. In­deed, we’ve seen 65-70 per cent re­trac­tions in the last year in Tata Mo­tors, 40 per cent re­trac­tion in Eicher, and about 35 per cent in Maruti, Bajaj Auto and Hero Mo­tors. There’s ev­ery chance that there could be fur­ther dips if Q3 re­sults are poor and guid­ances are slug­gish.

We have also seen a fair amount of cor­re­la­tion within the sec­tor in that stock prices tend to move in the same di­rec­tion, al­though there are ob­vi­ous dif­fer­ences in the per­for­mance of in­di­vid­ual com­pa­nies. In ad­di­tion, auto-an­cil­lar­ies have sim­i­lar cycli­cal swings and cor­re­la­tions.

When the next up­cy­cle starts, a 200 per cent re­turn is also com­mon and more than that is also pos­si­ble. Hence, cycli­cal as it may be, the auto sec­tor along with its an­cil­lar­ies can pro­vide multi-bag­ger re­turns.

Is this a rea­son­able time to start buy­ing auto stocks? Many of them hit 52-week lows in De­cem­ber and Jan­uary. Most are within 10-20 per cent of their 52-week lows. There is still a down­side but this could be a rea­son­able time to start ac­cu­mu­la­tion.

But be pre­pared to av­er­age down and be pre­pared to hold for a two-three year pe­riod. The big listed busi­nesses will see their ups and downs, and it could be mostly the lat­ter in the re­cent fu­ture. But they won’t go out of busi­ness and if his­tory is any­thing to go by, this is among the most re­li­able of sec­tors when it comes to big re­turns on the cycli­cal up­swing.

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