We expect sharP cuts to FY20e EPS across most auto OEMs as we head into the earnings season-our estimates are 4-58% below consensus. We downgrade Maruti to Hold given limited upside post 25% rally from recent lows even assuming 46% FY21e EPS growth. We stay cautious on 2-Ws & MHCVs due to BS-6 overhang in FY21e. Reiterate Buy on M&M.
Sharp cuts ahead to FY20e EPS
Despite the recent corporate tax cut, we cut FY20e estimates by 1-49% across our coverage as high operating leverage amplifies the impact of weaker than expected volumes. While some cuts are expected and have to be assessed in the context of divergence between wholesales & retails ahead of BS-6 transition, we believe the extent of cuts and implied ask rate for FY21e, even assuming recovery, will surprise the street.
Where are we in the cycle?
The auto down-cycle is currently in its 3rd (Tractor, LCVs), 4th (MHCVs, 2w) and 5th (PVs) quarter across segments. Historically, downcycles have lasted an average of 7-11 quarters but a wide range of 4-23 quarters means timing the recovery can be tricky. The extent of volume decline has surprised negatively so far, particularly in 2-Ws and PVs.
Expect improvement in FY21e but BS-6 remain an overhang
Shift to BS-6 from April, 2020 which will lead to 10-15% cost/price increase in 2-wheelers, CVs and diesel PVs is an added overhang this time. Nevertheless, given the low base, we now expect some volume recovery in FY21e even in these segments though margin risks exist. We expect a sharper recovery in petrol PVs where BS-6 risk is low. We also expect a recovery in tractors where BS-6 is not a factor.
Downgrade Maruti to Hold
Despite our positive view on recovery prospects for PVs, recent sharp up move in Maruti (up 25% from July lows) and resultant stretched valuations (42/29x FY20/21 P/E), even factoring in a sharp recovery, limit upside to our price target of Rs 7,000 (prev. Rs 7,100).
Stay cautious on 2-W, MHCVs
We continue to avoid 2-wheelers and MHCVs where high cost increase (10-15%) post BS-6 will remain an overhang on volume/margins even in FY21e. Reiterate Buy on M&M given inexpensive valuation and no BS-6 impact in tractors.
Catalysts to look out for
We remain on the lookout for signs of a turnaround. Our channel checks with dealers do not indicate any recovery yet even in retails, though we note much of the festive season is still ahead and the next few weeks could be crucial. Major policy measures such as a cut in personal income tax could also trigger a recovery.