Why Rebates Could Squeeze Automakers’ Margins

Among automakers, Bajaj Auto Ltd will be the first to announce September quarter (Q2FY23) results on Friday. Export markets are muted in the two-wheeler (2W) segment and Bajaj would bear the brunt of that. The share of relatively more profitable exports fell to 39% of Bajaj’s total 2W volumes in the second quarter, from around 63% in the first quarter.

Even so, lower prices for key inputs are likely to provide some respite on margins for all auto companies, including Bajaj. Data from Kotak Institutional Equities showed prices for commodities such as steel and aluminum in the second quarter were down 15-19% sequentially. Given this, auto stock investors would keep a close eye on margin performance this time around. Kotak expects gross margins to increase for some original equipment manufacturers in the second quarter. In addition, price increases by automakers would support margin expansion. In addition, the sequential increase in volumes in most segments translates into better operating leverage. Even then, an unfavorable product mix at some automakers could be a drag. For example, Mahindra & Mahindra Ltd’s tractor volume share fell to 34% in the second quarter from nearly 44% in the first quarter. The tractor business is high margin and will weigh on overall performance.

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Roas to recovery

A substantial improvement in margins due to lower raw material costs should be reflected from the third quarter, as the effect occurs with a lag. In addition, volume growth would also act as a lever for margin expansion with the alleviation of the chip shortage situation. However, amid the threats of a global recession, which is weighing on commodity prices, it may not be easy for automakers to accept steep price increases. In addition, a potential increase in vehicle discounts poses a risk to margins. This should be more prevalent in the entry-level passenger vehicle (PV) and 2W segments, where demand has yet to rebound strongly on a sustainable basis. Nomura Global Markets Research points out that Maruti Suzuki India Ltd rebates for certain models have increased sequentially so far in October. Increased discounts may negate part of the product benefit.

For 2Ws, demand picked up during the festive season, as evidenced by retail data for Navratri ’22 vehicles released recently by the Federation of Automobile Dealers Associations (FADA). 2W retail sales are up 4% from pre-covid (Navratri ’19) levels. However, the debatable question is whether this momentum will continue. “2W sales during Navratri have been good, but any slowdown during Diwali can lead to higher stock levels and lead to increased discounts. This will weigh on margins, but lower commodity costs would provide more cushion,” said Varun Baxi, analyst at Nirmal Bang Equities. Against this backdrop, investors should closely watch management’s comments on expected demand trends in the post-holiday 2Ws. the sluggishness of the rural market is a barrier to demand.

According to FADA, PV retail sales during Navratri 22 increased by almost 59% from pre-covid levels. They are expected to hold their own even after the festive season. The commercial vehicle (CV) segment is seeing strong replacement demand, which is expected to keep CV manufacturers such as Tata Motors Ltd and Ashok Leyland Ltd in good stead.

Meanwhile, the Nifty Auto index has gained 15% so far in CY22, as opposed to the Nifty 50 index’s 1% decline. announcements of electric vehicles by automakers, led to this outperformance. With stock prices soaring, valuations for automakers are reasonable and not exactly cheap, analysts said.

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