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We expect Q2FY20 to be yet another painful quarter for the automotive sector with a sharp 16% y-o-y drop expected in revenues. Volumes dropped in double-digits across automotive segments viz (2W, PV and CV) due to slowing economic growth, increased cost of ownership and inventory correction by OEM’s. Auto OEM’s are the worst hit with topline expected to drop 21%. Ancillary companies (due to replacement demand and increasing exports) are better off and would report a much lower 5% fall in topline. Negative operating leverage due to the steep volume drop coupled with increased marketing expenses would drag the margins and we expect sharp 240 bps y-o-y fall in OPM. EBIDTA is expected to fall 31% y-o-y while the net profit is expected to drop 29%. Volume woes are expected to sustain over the next three to four quarters due to slower economic growth, increased cost of ownership (safety and upcoming BS6 norms) and higher channel inventory.

<!--[if !supportLists]-->·         <!--[endif]-->Outlook: Volume pressures to sustain; earnings to remain under pressure: The automotive industry’s volumes growth is likely to remain under pressure over the next three to four quarters on the back of  slower economic growth, increased cost of ownership (increased road tax and safety and insurance norms) and higher inventory levels. Moreover, the automotive industry is likely to witness another steep increase in the costs (~10-12% price hikes expected) with the advent of BS6 norms (wef from 1st April 2020). Negative operating leverage due to volume pressures coupled with increased discounts would impact earnings before tax. OEM’s recent move to cut prices to spur demand can nullify the benefits of lower corporate tax rate. Earnings are likely to remain stressed with possibility of further downgrades. 

<!--[if !supportLists]-->·         <!--[endif]-->Valuation: Most of the auto OEM stocks are trading at P/E of 17-22x which is at the higher end of the long term historical average. With the possibility of earnings cut looming, the current valuations are unlikely to sustain. Nifty Auto index has underperformed over the benchmark indices since we turned cautious on the sector (refer our report dated 20th Feb 2019). Nifty Auto index has corrected by 8% since our report as compared to 5% gain in the benchmark Nifty. Given the earnings pressures, we retain cautious stance on the sector.             

<!--[if !supportLists]-->·         <!--[endif]-->Key risks: Any change in personal income tax and incentives / scrappage policy announced by the government would result in a meaningful demand revival and is a key risk to our call.

<!--[if !supportLists]-->·         <!--[endif]-->Leaders in Q2FY20: Exide Industries, Endurance Technologies, HeroMotocorp

<!--[if !supportLists]-->·         <!--[endif]-->Laggards in Q2FY20: Ashok Leyland, Maruti Suzuki

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