Indian Autos:What does increase in commodity prices in August mean for Auto sector?

The rise in prices for key commodities like steel and aluminium in recent weeks hasworried many Auto investors. Steel prices are up ~8% in the past one month andaluminium is up 6% in the same period. Commodities are 15-20% of the value of acar/2W (approximately) and as discussed in our note Looking beyond the ‘expensive’PE multiple on 16 August 2017, current earnings and valuations have little scope toabsorb negative surprises. In our view, a rise in commodity prices in August is not arisk to FY18/19 earnings as average 2Q prices are still inline with 1Q. However,commodities have been a significant headwind in the past one to two years and afurther increase could admittedly be negative for Auto sector earnings.

    We believe at this stage the net impact is limited on 2Q/2H FY18 margins: Asmentioned, most auto companies have seen a significant impact on margins in thepast one to two years due to increases in commodity prices. For instance, Maruti’smargins came off from ~17% in 2Q FY17 to ~14% in 1Q FY18, with a ~200 bps hitfrom just commodities. However, we believe the recent commodities price increasemay not be an incremental headwind for margins as the average 2Q/3Q prices arestill stable and inline with 1Q. Commodity prices actually declined in July, beforeincreasing again in August, leading to stable average prices over the quarter. Pleaserefer to Figures 1 and 2 for the commodity index movements for 4Ws and 2Ws. Also,helping the index is the offsetting decline in prices for plastics and rubber vs theincrease in prices for steel and aluminium in August.