Tax cuts not enough to lift sentiment on auto: Jefferies

Brokerage Jefferies said it expects sharp cuts to FY20 earnings estimates of auto companies despite the recent corporate tax cut bonanza. Downgrading Maruti Suzuki to hold after the recent run up in share price, the brokerage said the auto sector is still in the middle of a down-cycle, which have lasted an average of 7-11 quarters. M&M is its top pick among auto stocks Here's why Jefferies sees more earnings cuts in the auto space and continues to remain cautious on the sector:TRIGGERS FOR FURTHER EARNINGS DOWNSIDEThe brokerage said high operating leverage amplifies the impact of weaker-than-expected volumes. Jefferies has cut FY20 earnings estimates across its coverage by 1-49 per cent, and its estimates for the year are now 4-58 per cent below consensus. “With inventory levels still high ahead of BS-6 transition in April, 2020, wholesale volumes will remain muted in the second half even assuming a reasonable festive season on retail basis,” it said.WHERE ARE WE IN THE AUTO CYCLERs Jefferies said down-cycle in the auto industry is currently in its third quarter for tractors and light commercial vehicles (LCVs), and in the fourth for medium and heavy commercial vehicles ( MHCVs) and two wheelers. Historically, downcycles have lasted an average of 7-11 quarters but a wide range of 4-23 quarters means timing the recovery can be tricky, the brokerage said.CAUTIOUS ON TWO-WHEELERS, MHCVSWhile Jefferies is cautious on the auto sector overall, it continues to avoid two-wheelers and MHCVs. High cost increase of 10-15 per cent post BS-6 norms from April 2020 will remain an overhang on volume and margins even in FY21.The brokerage expects a sharper recovery in passenger vehicles (PVs) and tractors. “We expect a sharper recovery in petrol PVs where BS-6 risk is low, down-cycle is more advanced and base is particularly helpful. We also expect a recovery in tractors where BS-6 is not a factor and normal monsoon this year should help,” it said.RECOVERY PROSPECTSJefferies said it remains on the lookout for signs of a turnaround given the stage of the downcycle. However, channel checks with dealers do not indicate any recovery yet even in retails, though much of the festive season is still ahead and the next few weeks could be crucial. Major government policy measures such as cut in personal income tax could also trigger a recovery, said Jefferies.MARUTI SUZUKI DOWNGRADED, M&M IS A BUYThe brokerage said the recent run up of 25 per cent in Maruti Suzuki India's stock from July lows and stretched valuation as a result of that leave room for limited upside to its price target. Jefferies has lowered price target on the stock to Rs 7,000 from Rs 7,100.Jefferies said it would wait for better entry points or for better visibility of a sharp recovery. The brokerage has retained its buy rating on Mahindra & Mahindra given the inexpensive valuation and no BS-6 impact in tractors.

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