The automobiles sector is expected to face commodity cost inflation which will be offset by price hikes, lower discounts, cost-cutting, and operating leverage, according to a report by Motilal Oswal Institutional Equities.
The report said spot prices of base commodities saw a sharp increase (15-40 per cent) over 2QFY21. "Considering 3-6 month contracts, we expect the impact of base commodity prices to reflect in the P&L from 3QFY21 onwards. Base commodity price inflation would have a 350-400bp gross impact over the next 2-3 quarters," the report said.
Precious metals (platinum, palladium and rhodium) are facing a double whammy of a huge increase in usage due to BS-VI compliance and a sharp rise in prices. This is particularly true for rhodium where spot prices are higher by 28 per cent/70 per cent over 1HFY21/FY20 on an average.
While cost inflation is fairly large, OEMs are focusing on more than offsetting the same through price increases (of 1-6 per cent in 2Ws, Tractors, and PVs), lower discounts (100-400bp across segments), cost-cutting (80-100bp), and operating leverage (150-170bp).
"Putting all negatives and positives together, we expect EBITDA margin to improve to 13.3 per cent by FY23E (v/s 10.5 per cent in FY20 and 12.7 per cent in FY19) as the impact of commodity cost inflation is more than offset by benefits of price increases, lower discounts, cost-cutting initiatives, and operating leverage," the report said.
With a likely pick-up in volumes (higher asset turns), margin improvement, and lower CAPEX intensity, the brokerage expects a sharp improvement in FCF generation over FY21-23E. "For our Auto OEM (excluding JLR) universe, FCF conversion (percentage of PAT) is estimated to be at 100-125 per cent over FY21-23E (as against 20 per cent/33 per cent in FY20/FY19)," it said.
Analysis of past cycles suggests that valuations expand as the cyclical recovery sustains, laying the foundation for the next upcycle. Current valuations reflect an early to mid-cycle recovery, with scope for a further rise if the volume expansion sustains.