Mutual funds gung-ho on auto even as doubts persist on recovery

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Domestic mutual funds are throwing their weight behind automobile shares hoping the sector will stage a strong revival after a three year downtrend.

In May, equity mutual funds’ holding in automobile stocks hit a 39 month high of 7.1 percent driving their overweight stance on the sector higher by 160 basis points, according to brokerage Motilal Oswal Financial Services.

May also marked the second consecutive month in which mutual funds raised their holding in the sector after having reduced it in prior three months.

The turn in sentiment for the sector comes after a three-year slowdown that has seen earnings of some leaders such as Maruti Suzuki India and Hero MotoCorp decline by more than 10-20 percent from their levels in 2018-19.

The economic slowdown prior to the pandemic, the pandemic itself and rising costs and supply chain issues in 2021 had turned investors against the sector.

The recent increase in optimism for the sector comes on the back of changing outlook for automobile companies as analysts believe that the worst may be behind the sector given renewed optimism for recovery in rural demand and easing supply chain issues.

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The Nifty Auto index has fallen 0.4 percent so far this year as compared to the more than 10 percent fall in the benchmark Nifty 50 index.

“We remain positive on the automobile sector and expect sustained demand recovery moving forward,” brokerage Axis Securities said in a recent note.

Demand revival?

Axis Securities highlighted that low volume base of 2021 and new product launches could drive demand going ahead for passenger vehicle segment.

Moreover, rising activity in the industrial and construction sectors as well as improving freight availability and increasing demand for e-commerce will drive sales of commercial vehicles in 2022-23, Axis Securities said.

Slowdown in the rural economy throughout 2021-22 due to stagnating farm income and rising cost of living has been one of the major reasons for the sharp decline in volumes for automobile manufacturers in the country.

That said, brokerage Spark Capital in a note said that all signs in the rural economy are pointing towards a bumper kharif crop but any demand revival is threatened by the sharp decline in yields from rabi crop for farmers due to intensive heat waves this year.

Edelweiss Securities, too, believes that cyclical revival in volumes will be challenged by the potential slowdown in the domestic economy due to high inflation and uneven recovery from the pandemic as well as rising interest rates.

“This time, the risks from the headwinds have become apparent right at the onset of a volume recovery. Traditionally, the headwinds have led to demand slowing,” Chirag Shah of Edelweiss Securities said in a note.

Chipping away

The semi-conductor shortage has also been a limiting factor in the growth of the domestic automobile industry.

Commentary from some automobile manufacturers suggested that availability of chips have improved in recent months allowing production levels to rise. “The chip-supply constraints have gradually improved over the last few months. It is improving steadily at the moment. This year will be better than last year,” Maruti Suzuki India’s Chairman RC Bhargava told Moneycontrol in a recent interview.

However, Intel’s Chief Executive Officer Pat Gelsinger warned that the ongoing semi-conductor shortage will run well into 2024 due to lack of manufacturing tools and high demand.

“That’s part of the reason that we believe the overall semiconductor shortage will now drift into 2024, from our earlier estimates in 2023, just because the shortages have now hit equipment and some of those factory ramps will be more challenged,” Gelsinger told CNBC in April.

Shah of Edelweiss Securities concisely summed up the current status of the sector: “The automobile sector is at a crossroad facing headwinds and tailwinds. An intense tug of war between the two is likely to emerge. Traditionally, headwinds have won the tug-of-war.”

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