Strong recovery may continue for auto ancillary companies

Good export demand, likely Q2 uptick, low interest rates are positive

There’s an interesting divergence of opinions on the autoancillary sector. Some analysts and fund managers believe the sector is likely to continue a strong recovery. On the other hand, India Ratings & Research has issued an advisory saying there will be a contraction in the first quarter of financial year 2021-22 (Q1FY22). The longer-term prospects seem good.

The Q4FY21 results were very encouraging. For a sample of 73 auto-ancillary manufacturers, combined revenues rose 36 per cent year-on -year (YOY) to ~58,610 crore and PBDIT was up 84 per cent at ~7,551 crore, with PAT up 400 per cent to ~3,048 crore.

There are multiple companies with PAT expansions of above 100 per cent including Motherson Sumi, Sundaram Clayton, Bosch, Minda, Shriram Pistons, Jay Bharat Maruti, Craftsman Auto, L G Balakrishnan, Jamna Auto, etc.

The forgings and castings industry, which is also connected to the auto value chain, is also doing better with 38 per cent turnover expansion and 97 per cent rise in PBDIT. Operating margins are up around 3 per cent for many companies. Both industries have seen an expansion in employee costs and a fall in financing costs. Both trends are healthy since they indicate hiring.

Their fortunes are tied to the automobile industry, and there, too, we see improvement. Revenues for 11 listed companies rose by about 36 per cent, PBDIT was up 58 per cent, and PAT 148 per cent. Auto sales are consumptionrelated and consumer confidence is critical.

One positive is low interest rates — it is good for the entire value-chain as the sector is working capital intensive. It is also a demand-push factor since vehicles are financed. A cause for concern is input costs, which are rising because of the global bull market in commodities. This has forced majors like Maruti and Hero to hike prices, which could hurt demand. Higher fuel prices also hurt demand.

Then, there are base effects to consider — Q4FY21 was almost normal, while Q4FY20 was hit by 10 days of lockdown. And in Q1FY21, April and May were washouts. The second wave affected April and May 2021, but not as badly as in the previous year. Hence, the base effects are positive.

India Ratings & Research estimates working capital requirements were higher for ancillaries in Q1FY22 as they needed to hold high inventories to avoid supply chain disruption in the second wave. Capacity utilisation declined from 90-95 per cent in March, to 55-60 per cent in May. However, demand should pick up in Q2.

Export demand remains strong. Assuming no major disruptions by a third wave, revenues should grow at 18-22 per cent through FY22. Other analysts believe India’s auto ancillary sector has consolidated its market share not only in India, but also in globally, where they are competitive at scale. If Q1 is disappointing for the sector, and it is a temporary effect, it may create an opportunity for investors to enter at lower levels.