MOSL: AUTOMOBILES-Bottom out plays – look for volume visibility/op leverage; MSIL/EIM best bets offering both
Automobiles: Bottom out plays – look for volume visibility/op leverage; MSIL/EIM best bets offering both
After 12 months of dwindling demand, there have been initial signs of green shoots from the ground. Although the upcoming BS6 transition could lead to volatility in volumes, we are hopeful of a ‘business as usual’ scenario from 2HFY20. In our view, the best risk-adjusted way to play this theme would be to focus on companies offering (a) higher probability of volume recovery and (b) high operating leverage. From this perspective, we believe MSIL and EIM are best positioned for a sustained recovery, led by company-specific drivers and the least impact from the BS6 transition. Apart from operating leverage, both these companies offer scope of a gross margin improvement. A sustained volume recovery could drive a mean reversion of profitability by FY22, leading to earnings upgrade. Valuations are reasonable considering they are based on early cycle earnings of FY21/22.
- Auto OEMs have been hit by a sharp fall in volumes over the past 12 months, with 10-38% decline across segments (ex 3Ws) in 9MFY20. Consequently, their capacity utilization declined sharply by 15-34pp in 1HFY20. The fall was particularly pronounced for EIM (-34pp) and MSIL (-32pp) as they had added capacity in 1HCY19.
- Despite pressure on volumes across OEMs, the gross margins were stable (and above 10-year average) for the MOSL Auto OEM Universe (ex JLR). Gross margin for our OEM Universe was at ~29.9% in 1HFY20 (-100bp from FY18 levels). However, the impact of operating deleverage (due to a sharp decline in utilization) was fully reflected in the sharp decline of ~300bp in the EBIT margin in 1HFY20 (over FY19) to ~6.3% (v/s LPA of ~8.3%).
- EBIT margin eroded the most for AL (-410bp), MSIL (-660bp), EIM-S/A (-700bp) and TTMT-S/A (-870bp) – in line with the magnitude of the drop in demand/capacity utilization.
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