What’s New in PrimeInvestor Auto++ smallcase?
9 July ’23

Rebalance update: 9th July, 2023

Our Auto++ portfolio has completed a year since its launch in June 2022 and has notched up +40% returns in this period. In the last rebalancing, we had mentioned that the stock movement in the auto sector is yet to get broad based. That’s happening now with OEMs and ancillaries participating in the rally.

The ailing 2-wheeler space has also begun to witness activity, with Bajaj Auto and Hero MotoCorp launching Triumph and Harley bikes, respectively, at affordable prices. So far, these brands were beyond the reach of a large chunk of premium bike aspirants leaving the space entirely in the hands of Royal Enfield.  But that is expected to change with these launches.

There is more evidence of a broad-based growth in the auto sector this fiscal. Between FY22 and FY23, the sector’s recovery just took it back to previous highs (2018 sales) in terms of number of units while growth was yet to take off. The uneven recovery in economy, as reflected from better performance of premium bikes and SUVs, also delayed sales growth. This appears to be changing for the better now.

In this rebalancing, we:

• Exited an Automobile Manufacturer to secure gains 
• Reduced weights in few stocks to book some profits
• Added 2 stocks where we see potential.

Exits

We exited a multinational motor company in our latest rebalance. The stock has returned 40% since we added it to our portfolio and this is an opportune level to realise the gains. Also, this stock is a very volatile due to a complex mix of businesses and wide geographical presence. For example, it gets hurt whenever China sales suffer as one fourth of its sales coming from China. It also took a knock during Brexit. So, we are taking a call to exit it with decent returns to make way for stocks with higher potential.

Allocation Changes

Increased exposure to a two wheeler components supplier. The Triumph and Harley launches have given a sentiment boost to the 2-wheeler segment. The company is a common supplier of components to all three premium players for some of the high-end components such as inverted front forks. Premiumisation in the 2-wheeler segment, be it ICE or EV, is likely to benefit the stock due to the newer and higher technology areas that it has ventured into in the last few years.

Reduced weightage of a multinational automotive manufacturer from 7% to 6%. In We are deliberately taking some weights off this stock after a recent rally. 

Reduced weightage of two auto ancillary companies from 7% to 1% and to 6% from 8%. We think it is time to take some money off these players after a strong up-move in the last one year.  They have also delivered stellar earnings growth in the last one year led by sales growth as well as margin expansion. Though there is still room for optimism in these players, our weight adjustment is to limit the impact on the portfolio in case of any quarterly earnings setbacks. 

New Additions

We added two stocks which manufacture parts & components for the auto sector.

Stock A was a poor performer after it peaked in August 2015. It was a case of valuation peak-out In a high growth stock in 2015 at nearly 35 times earnings. Profit growth stagnated since 2016, up until  2022 even as revenue more than doubled during this period. But market valuations are a matter of PAT growth. We are seeing revival signs now while valuations are exactly half (at 16 times) of what it was at its peak in 2015. The current valuation is also at a depressed EBIDTA margin of 13% Vs is historical average of 15-16%. Hence, we are adding this stock. 

It is a similar story  for artificial leather manufacturer Stock B, which was in the limelight in 2014. Commodity price corrections, Chinese imports, auto sector slowdown, etc. played a spoil spot on growth while rich valuations lead to a valuation peak out in stock price. But now, with the auto sector revival and the government’s policies to support domestic industries, the fortunes of this artificial leather maker is reviving. It is already catering to US and European automakers including Mercedes and BMW. The company is awaiting more government support to play a check on Chinese imports and is anticipating that a favourable outcome on this front would help it grow profitably on other user industries such as footwear, furnishing and personal accessories apart from auto.

Investment Rationale

When a stock in the portfolio goes beyond our valuation comfort zones, or external events reduce the potential growth for the stock, or we spot fresh opportunities, we will rejig the portfolio. We follow a quarterly rebalancing schedule. The portfolio may also be rebalanced between quarters when needed based on external events.

The auto sector is among the core economy sectors, contributing to about 7% of the GDP and holding the lion’s share of manufacturing GDP. The auto and auto component industries generate employment to 35 million people, both direct and indirect. Therefore, it stands to reason that its fortunes are tied to the core economy. 

Auto and component players have had a rough 2-3 years and are not just related to Covid. But two factors are now unfolding in this space that makes a case for investing in this segment.

Revival In Demand

The auto sector splits into multiple segments. While all are not firing at this time, key segments are starting to pick up – commercial vehicles (CV) and passenger vehicles (PV). These hold good implications for longer-term sustained growth.

CV sales closed FY22 on a strong note with year-on-year growth of 26%, a momentum that has carried into the first two months of FY23. Even with the jump in FY-22, CV sales are still 38% below the peak recorded in FY-19 leaving a long runway for recovery and growth.

PV sales recovered towards the close of FY22 and momentum seems to be getting back in the first 2 months of FY23. Within PVs, though, it’s the SUV segment that has seen recovery and not the small car segment – suggesting that it is the more affluent consumer segment which is driving demand for now. Though PV sales registered year-on-year growth of 14% in FY22, SUV sales grew 40% while small car sales declined 5%.

Sluggish 2-wheeler sales also suggest that entry-level consumers appear to be putting off purchases for now. However, a broader economic recovery can help bring back demand in 2-wheelers.

Transformation

Even as revival gathers steam, there are other trends shaping up in the industry that bode well for companies associated with the larger auto industry. EV adoption is leading to software defined architecture in future vehicles with more advanced driver assisted systems (ADAS). Automotive plants are going for higher levels of automation. Even auto ancillaries are increasing the level of automation they adopt. Therefore, companies aiding this growth and transformation are also emerging as pillars of future growth.

Bullish on India’s Auto Sector?

1. PrimeInvestor Financial Research Pvt Ltd is a SEBI-Registered Research Analyst having SEBI registration number INH200008653. PrimeInvestor Financial Research Pvt Ltd, the research entity, is engaged in providing research services and information on personal financial products. These Research calls are prepared and distributed by PrimeInvestor Financial Research Pvt Ltd with brand name PrimeInvestor.

2. PrimeInvestor Financial Research Pvt Ltd, its partners, employees, directors or agents, do not have any material adverse disciplinary history as on the date of publication of this report. 

3. The analysts hereby certify that all of the views expressed in this research report accurately reflect my/our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. We, or our relative, or PrimeInvestor Financial Research Pvt Ltd do not have any financial interest in the subject company. We, or our relative, or PrimeInvestor Financial Research Pvt Ltd do not have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. We, or our relative, or PrimeInvestor Financial Research Pvt Ltd do not have any material conflict of interest. We have not served as director/ officer, etc. in the subject company in the last 12-month period.

4.  PrimeInvestor Financial Research Pvt Ltd has not received any compensation from the subject company/ companies  in the past twelve months. PrimeInvestor Financial Research Pvt Ltd has not been engaged in market making activity for the subject company/companies.

6.  In the last 12-month period ending on the last day of the month immediately preceding the date of publication of the research call, PrimeInvestor Financial Research Pvt Ltd has not received compensation or other benefits from the subject company of this research report or any other third-party in connection with this report.

7. Research analysts of PrimeInvestor Financial Research Pvt Ltd may be investors in the smallcase portfolios managed by PrimeInvestor Financial Research Pvt Ltd.

For detailed disclosures, please click here