Why discounts could affect auto companies’ margins

Nevertheless, softening prices of key inputs is likely to provide some margin relief for all automakers, including Bajaj. Data sourced from Kotak Institutional Equities shows that commodities like steel and aluminum declined 15-19% sequentially in Q2. In view of this, investors in shares of auto companies will keep a close watch on the margin performance this time. Kotak expects gross margins to expand for some original equipment makers in the second quarter. Besides, price hike by automakers will support margin expansion. In addition, a gradual increase in volumes in most segments means better operating leverage. Still, the unfavorable product mix at some auto companies can be a damp one. For example, Mahindra & Mahindra Ltd’s tractor volume share fell to 34% in Q2 from around 44% in Q2. The tractor business is high-margin and will impact the overall performance.

The significant margin improvement on account of lower commodity costs is likely to be reflected from the third quarter as the impact comes with a lag. In addition, volume growth will also act as a lever for margin expansion while easing chip shortages. However, amid the threat of a global slowdown, which is impacting commodity prices, it may not be easy for automakers to hike large prices. Additionally, a potential increase in discounts on vehicles poses a risk to margins. It is expected to be more prevalent in the entry-level passenger vehicle (PV) and 2W segments, where demand is yet to improve strongly on an ongoing basis. Nomura Global Markets Research suggests that the discounts for certain models by Maruti Suzuki India Limited have increased sequentially so far in October. An increase in discount may negate a portion of the commodity profit.

For 2W, demand picks up in the festive season, as evidenced by the recently released Navratri ’22 vehicle retail data by Federation of Automobile Dealers Associations (FADA). Retail sales of 2W grew by 4% as compared to pre-Covid levels (Navratri ’19). The question, however, is whether this momentum will continue. “2W sales have been good during Navratri, but any slowdown during Diwali could lead to higher inventory levels and result in increase in discounts. This will impact margins, but will provide more relief from a fall in raw material prices.” A sluggish rural market is a deterrent to demand.

According to FADA, PV retail grew by around 59% versus pre-Covid levels during Navratri ’22. He is expected to continue on the field even after the festive season. The commercial vehicle (CV) segment is witnessing strong replacement demand and should be well-positioned by CV makers such as Tata Motors Ltd and Ashok Leyland Ltd.

Meanwhile, the Nifty Auto index has gained 15% so far in CY22, while the Nifty 50 index is down 1%. Improved prospects, multiple launches and electric vehicle announcements by automakers have led to this outperformance. Analysts say valuations of auto majors are reasonable and not cheap at all, with stock prices rising.