Driven by a good festive season, auto part makers likely to stage a strong show in Q3

The brokerage prefers Endurance Technologies, a proxy play to the domestic two-wheeler industry, and Craftsman Automation, due to expectations of strong growth and a superior capital efficiency, within its auto ancillaries basket.

LKP is cautious on cyclical businesses with elevated multiples.

Auto component makers are expected to outshine the rest of the automobile sector in the December quarter, on the back of strong festive season sales and the easing of woes such as a prolonged shortage of semiconductor chips, according to brokerage LKP Securities. The risk is widely spread and balanced, as the industry does not show interdependence with any of its segments, the brokerage added.

How much growth can you expect in the auto components segment?

Double-digit sales growth is likely to continue in the second half of the financial year, with a good performance in the October-December period, following 12.6 per cent year-on-year growth in the auto parts segment in the first half, said Rajesh Sinha, Senior Research Analyst at Bonanza Portfolio.

The auto ancillary segment continues to make investments for higher value-addition, technology upgradation and localisation to stay relevant to domestic as well as international customers, which will be the key growth trigger for the coming quarters, Sinha said.

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The analyst also pointed out that the auto parts industry is looking to invest $6.5-7.0 billion over the next five years for capacity addition and upgradation as compared to $3.5-4.0 billion spent in the last five years.

Revenue seen growing 20 per cent, margin may expand by 70 bps

Brokerage Nirmal Bang expects revenues of major auto ancillary companies to grow 20 per cent on a year-on-year basis and EBITDA margins to expand by 70 basis points. “Endurance is expected to grow by 31 per cent on a year-on-year basis on the back of strong two-wheeler volume, premiumisation and higher volume in the European market,” according to the brokerage.

LKP and Nirmal Bang track xx and xx stocks in the auto components space, respectively.

Stocks under Nirmal Bang coverage

Stocks	Rating	Target
Apollo Tyres	Buy	Rs 485
Balkrishna Industries	Accumulate	Rs 2550
CEAT	Buy	Rs 2689
Endurance Technologies	Accumulate	Rs 1561
Jamna Auto	Buy	Rs 133
Minda Corp	Buy	Rs 391
Suprajit Engineering	Accumulate	Rs 395

Stocks under LKP Securities coverage

Stocks	Rating	Target
Craftsman Automation	Buy	Rs 6098
Endurance Technologies	Buy	Rs 2124
Sona BLW	Buy	Rs 707
Suprajit Engineering	Buy	Rs 399
VST Tillers	Buy	Rs 4608

Auto ancillaries: A proxy to the auto sector

LKP Securities finds auto parts makers responsible for major supplies to the two-wheeler segment better positioned than the others from a year’s perspective. According to the brokerage, the growth prospects of the two-wheeler segment are bright on account of:

--Low base

--New launches

--Faster penetration

--Affordability

--Charging infrastructure for EVs

--Sentimental positivity

Also positive on auto ancillaries, analysts at Motilal Oswal Financial Services believes that the benefit of healthy growth in underlying industries coupled with cost efficiencies should also result in strong earnings growth during the quarter. The brokerage prefers Endurance Technologies, a proxy play to the domestic two-wheeler industry, and Craftsman Automation, due to expectations of strong growth and a superior capital efficiency, within its auto ancillaries basket.

Smallcap auto ancillary stocks show potential to zoom

According to LKP, Apollo Tyres, Exide Industries, CEAT and Balkrishna are trading higher than their fair value. Analysts at Nirmal Bang expect tyre makers to clock low-to-mid single digit growth rates and 473-basis-point EBITDA margin expansion due to raw material cost tailwinds. However, they expect the margins to contract by around 100 bps sequentially due to elevated raw material costs.

Stocks to avoid within the space

LKP is cautious on cyclical businesses with elevated multiples. The brokerage recommends avoiding tyre businesses, and battery businesses with relatively low pricing power and high capital intensity, currently operating at elevated EBITDA margins and trading at the higher end of valuation multiple trajectory.

Instead, it prefers businesses that have multiple business lines and offer cash flow visibility, with a presence across geographies, niche product segments, strong topline visibility, the capability to execute and sustain operating margin across OEM cycles, and to withstand input commodity cost volatility seamlessly.

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