Wednesday, Aug 10, 2022
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With Falling Commodity Prices, Maruti, M&M, Tata Motors Become Attractive For Investors

Auto shares have massively outperformed the Nifty 50 index as the measure of auto shares on the – Nifty Auto index has surged nearly 11% in first quarter of the current financial year

The welding arm on the automobile production line is being welded
The welding arm on the automobile production line is being welded Shutterstock

Automobile manufacturers have been on a price hike spree since January last year citing an uptick in commodity and other raw material prices. The country's largest car maker Maruti Suzuki hiked the prices of its cars five times since January last year. In April this year, Maruti Suzuki India hiked car prices across models by 1.3 per cent (ex-showroom price) in Delhi citing an increase in various input costs.  

Likewise, Tata Motors also increased the prices of its commercial and passenger vehicles. Earlier this month, Tata Motors increased the prices of its commercial vehicles in the range of 1.5-2.5 per cent. In April, Tata Motors hiked the prices of its passenger vehicles by 1.1 per cent. Since 2021, Tata Motors has undertaken five price hikes and has, on average, increased the price of its cars by 6.6 per cent. 

The country's largest sports utility vehicle maker, Mahindra & Mahindra, has raised car prices twice this year. In April, Mahindra & Mahindra undertook a price hike of 2.5 per cent on its range of vehicles. Resulting in an increase of Rs 10,000 to Rs. 63,000 on the ex-showroom prices across the range. 

Automakers were struggling with shortage of semiconductors and rising metal prices in international markets and the situation got worse after Russia invaded Ukraine, disrupting supply chains. Ukraine was one of the largest makers of neon gas which is used as a raw material in making microchips.  

Metal prices also shot up as the economic revival after the opening up of economies was quick which led to increased demand for metals. 

However, in recent months, base metal prices have fallen sharply as fears of the global economy going into recession grew after central banks across the world started raising interest rates to control the spiralling inflation. 

The US Federal Reserve last month increased its benchmark interest rate by 75 basis points which was the biggest rate hike in nearly three decades. 

In recent months, copper has fallen sharply, along with other metal prices like aluminium, zinc, and steel. Copper fell to its 16-month low last week. The fear of a fast-moving US Federal Reserve pushing the country into recession is upending prices across assets and commodities.  

The carmakers have faced acute cost pressures due to steel prices that were rising till recently.  

Meanwhile, auto shares have massively outperformed the Nifty 50 index as the measure of auto shares on the National Stock Exchange – Nifty Auto index has surged nearly 11 per cent in the first quarter of the current financial year compared nearly 10 per cent drop in the benchmark Nifty 50 index. 

 

 

Mahindra & Mahindra is the top gainer among the auto stocks with the stock surging 35 per cent in the first quarter. TVS Motor Company, Ashok Leyland, Hero MotoCorp, Eicher Motors and Maruti Suzuki have also rallied between 12-34 per cent in Q1. 

Chart
Source: Ace Equity

Mahindra & Mahindra shares have been on investors buying list after its latest sports utility vehicle XUV 700 saw strong demand amid a long waiting period. 

Will Car Makers Use This Opportunity To Reduce Prices or Enrich Their Margins? 

After the companies started increasing car prices in January last year their operating profit margins began to contract sharply. For example, Maruti Suzuki’s operating profit margin declined to as low as 6.71 per cent in the September quarter of last year, data from Ace Equities showed. However, it improved 10.85 per cent in the March quarter but still remained below the pre-Covid-level.  

Maruti Suzuki used to clock an average margin of 15 per cent while it surged to 17 per cent in the financial year 2018. 

Likewise, Mahindra & Mahindra’s margins squeezed to 12.76 per cent in the March quarter compared with 15.52 per cent during the same period last year. During the pre-Covid era, Mahindra & Mahindra used to clock an average margin of 18 per cent. 

Tata Motors’ margin dropped to 3.29 per cent in the December quarter from 8.99 per cent (year-on-year). Its operating profit margin touched a high of 10.83 per cent in the financial year of March 2019. 

Car prices are unlikely to come down and companies will take this opportunity to improve their margins, says Deven Choksey of KR Choksey Securities.  

“Prices of metals have come down now but the companies were carrying inventory since the last couple of quarters at higher prices and it will last for another one or two quarters at higher prices. My reading is that the September quarter will also have higher cost of raw materials because when a company supplies to original equipment makers (OEMs) they hold materials in factory and that is where the cost is going to be higher and benefit from lower inventory cost will come in the second half if at all if it comes,” he adds. 

Choksey is bullish on the auto sector as chip shortage is out of the way, raw material cost is falling, demand scenario remains buoyant, and valuations have corrected. His top picks in the sector include Tata Motors, Bajaj Auto and Ashok Leyland. 

When auto companies were raising prices their margins were also getting compromised and now with costs coming down their margins will go back to normal as there is high demand for commercial and passenger vehicles, says AK Prabhakar, head of research at IDBI Capital 

Mahindra & Mahindra is his top pick in the auto sector despite a 35 per cent rally in the first quarter.
 

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