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The auto sector is among the core economy sectors, contributing to about 7% of the GDP and holding the lion’s share of manufacturing GDP. The auto and auto component industries generate employment to 35 million people, both direct and indirect. 

Therefore, it stands to reason that its fortunes are tied to the core economy. Auto and component players have had a rough 2-3 years and are not just related to Covid. But different factors point to a clear revival in this space. Moreover, the auto sector is in itself undergoing a transformation in design and technology.

It is on these two legs that we have built our PrimeInvestor Auto++ smallcase. This smallcase puts together auto companies, auto component players, and other diversified companies that are involved in the design and technology transformations unfolding in the industry.

PrimeInvestor Auto++ smallcase

What hurt demand

The auto sector has had a troubled 2-3 years, across segments of passenger vehicles, 2-wheelers, and commercial vehicles. A shift to the new BS-VI emission norms by April 2020 necessitated capex investment, product price hikes and phasing out of older non-compliant vehicles. Higher insurance costs raised the cost of ownership for consumers. Slow economic growth additionally hurt, especially in segments such as CVs and 2-wheelers. Input cost increases upped the pressure on companies. while semiconductor chip shortage impacted the passenger vehicle sales.

Then, of course, companies had to grapple with the long Covid-led impact. Prolonged lockdown, decline in rural income especially over the second wave, hit to the mid-to-lower-income consumer segment in terms of income and spending power, and supply chain hiccups swept across the sector. FY-19, therefore, was something of a peak in terms of auto segment sales.  

Stock markets, accordingly, ignored the auto sector. The Nifty Auto index has underperformed the Nifty 50 from about early 2019 onwards. In the last 4 calendar years, the auto index has fallen short of the Nifty 50, as shown in the graph below.

But this bleak scenario is set to change with several factors signalling the revival of the automotive industry in FY23 even as a transformation in the industry is under way.

Market cognizance

Markets have already begun taking note of the potential change in the sector’s fortunes. From an underperformer, the Nifty Auto index is starting to do better than the Nifty 500.
The chart below shows the Nifty Auto index has been underperforming the Nifty 500 for a long period of 3 years however it started to narrow the gap down  in the past few months.

Zooming further into the past three months the Nifty Auto has clearly decoupled and started outperforming the Nifty 500 Index.

Several auto component players have also seen stock prices rally. The Nifty Auto index is also narrowing the gap by which it has trailed the Nifty 50 for nearly 3 years now.

So what’s driving the fortunes of the auto sector and how does our portfolio play it?

Revival

The auto sector splits into multiple segments. While all are not firing at this time, key segments are starting to pick up - commercial vehicles (CV) and passenger vehicles (PV). These hold good implications for longer-term sustained growth.

  • CV sales closed FY22 on a strong note with year-on-year growth of 26%, a momentum that has carried into the first two months of FY23. Replacement of ageing vehicle fleets and firming up of freight rates are pushing the revival in CV cycle. What can keep up the impetus is the continued demand from the logistics sector, opening up of the economy and growth as well as Govt spending on infrastructure. Even with the jump in FY-22, CV sales are still 38% below the peak recorded in FY-19 leaving a long runway for recovery and growth.
  • On the consumer side, PV sales recovered towards the close of FY22 and momentum seems to be getting back in the first 2 months of FY23. Within PVs, though, it’s the SUV segment that has seen recovery and not the small car segment – suggesting that it is the more affluent consumer segment which is driving demand for now. Though PV sales registered year-on-year growth of 14% in FY22, SUV sales grew 40% while small car sales declined 5%. Sluggish 2-wheeler sales also suggest that entry-level consumers appear to be putting off purchases for now. 

However, a broader economic recovery can help bring back demand in 2-wheelers and the small-car PV segment too. Companies do appear upbeat on improvement in rural incomes, aided by normal monsoons and rising agri-commodity prices. Prices of inputs such as steel may also correct or slow the momentum in their rise, with commodity prices starting to cool off globally and government initiatives helping reduce margin pressures.

What can also hold the broader auto sector in good stead in the medium term is the government’s production linked incentive (PLI) scheme for the sector worth Rs. 26,000 crore. The scheme aims to take the contribution of the sector to our GDP to double digits from the 7% now. It has received overwhelming response from companies with planned capex outlay of Rs. 75,000 crores, coming from both OEMs and component makers over the next 5 years.

Transformation

Even as revival gathers steam, there are other trends shaping up in the industry that bode well for companies associated with the larger auto industry. EV adoption is leading to software defined architecture in future vehicles with more advanced driver assisted systems (ADAS). Automotive plants are going for higher levels of automation. Even auto ancillaries are increasing the level of automation they adopt. 

Therefore, companies aiding this growth and transformation are also emerging as pillars of future growth.

PrimeInvestor Auto++ smallcase

We’re playing the auto sector along two lines – the demand recovery that will see better sales numbers for Original Equipment Manufacturers (OEMs, or auto manufacturers), in turn boosting component makers and the transformation through EV adoption, other technologies and automation.

The PrimeInvestor Auto++ smallcase portfolio therefore splits into 3 main segments:

  • Auto ancillaries catering to both domestic and global markets
  • OEMs across segments
  • Companies that provide the auto sector with the technology to take it to the next level of growth and transformation.

This thematic portfolio is an opportunity to get in at the start of the upswing. It’s better-suited to invest through lumpsums, and not SIPs. You can best phase investments in a few tranches given the overall market volatility. This apart, this portfolio will be longer term by nature but its cyclical nature means that the portfolio may eventually need to be liquidated to lock profits once the auto cycle turns. We will be alerting you on this. Separately, we will as usual be rebalancing the portfolio every quarter to book profits when needed or add stocks as opportunities unfold.

Finally, note that this is a thematic portfolio that suits high risk-takers and not more moderate-risk investors.

PrimeInvestor Auto++ smallcase by PrimeInvestor

FAQs on PrimeInvestor Auto++ smallcase

What is the universe of stocks considered in Auto++ smallcase?

The Universe comprises auto ancillary companies, auto OEMs and technology companies that drive the transformation of the automotive industry.

How are the stocks screened?

Key parameters are used to screen stocks in the universe to assess their prospects to make it to the shortlist and from there into the portfolio. These include, but are not limited to:

  • Net earnings growth (last 5 years)
  • ROCE (5 year average)
  • Return on Assets
  • Debt to equity ratio
  • Valuation

These parameters help assess fundamental strength. Qualitative assessments are done based on each segment for ancillaries, OEMs, and diversified companies.

How are the stocks weighted?

Earnings growth, business fundamentals, financial track-record, earnings volatility, balance sheet health, market capitalization and valuation are the key factors considered while fixing the individual stock allocation in the portfolio.

How often is the portfolio rebalanced?

When a stock in the portfolio goes beyond our valuation comfort zones, or external events reduce the potential growth for the stock, or we spot fresh opportunities, we will rejig the portfolio. We follow a quarterly rebalancing schedule. The portfolio may also be rebalanced between quarters when needed based on external events.

Some stocks in the portfolio have run up sharply. Should those be avoided?

No. PrimeInvestor Auto++ smallcase portfolio is a weighted basket of stocks and is meant to be bought as a portfolio and not as individual stocks. Holding them as a portfolio will help reduce risk and optimise return. Our rebalancing and weights will consider stock valuations and prices to optimise returns, book profits or exit when needed.

What is the tax impact on the portfolio?

The taxation is the same as tax on individual stocks. Stocks sold within a year will be taxed at 15% on capital gains and those held for more than a year at 10% (after the first Rs 1 lakh in long-term capital gains). Apart from this, you will be paying tax on dividend income (treated as other income) received from this portfolio, at your tax slab. TDS shall also be deducted on such dividend income at applicable rates unless you are submitting Form 15G/15H.

What is the cost involved in buying this portfolio?

On the research side, you will be paying PrimeInvestor a quarterly or annual fee as mentioned on the smallcase portfolio page. On your brokerage platform, you will incur brokerage cost, securities transaction tax (STT) and demat charges, similar to buying and selling of any stock.

What returns should we expect from this portfolio?

The aim of this portfolio is to generate returns that beats the Nifty Auto index over the long term. However, this portfolio will go through ups and downs and may not beat the index at all times. As a diversified portfolio with much higher weights on ancillaries and smaller-cap stocks than the Nifty Auto index, it can fall more sharply in turbulent times. Do not expect positive or even double digit returns year after year. We do not provide any assurance or guarantee of returns on the portfolio.

How should I invest in this portfolio - through lump sum or SIP?

As a themed portfolio, we prefer that you invest lumpsum in this portfolio. However, if your investment amount is high and in several multiples of the minimum amount then you can consider spreading your investment over a few months.

Is there a cap or maximum amount that I can take exposure to?

There is no maximum limit to this portfolio. However, as a themed portfolio, it is good to restrict this to 5-10% of your overall equity portfolio.

Does PrimeInvestor offer other Smallcases?

Yes, PrimeInvestor offers a diversified Core & Satellite ETF Smallcase and a thematic Financial Disruptors smallcase.

This Smallcase portfolio has delivered negative or poor returns since I bought it. Can I get a refund?

No, there are no refunds. Equity investing is risky and themed portfolios are riskier still, and will see declines from time to time. These are suitable only if you can stay invested over the long term. If you cannot tolerate sharp falls, it’s best to skip this smallcase and go for our Core & Satellite ETF smallcase.

Early subscription offer! Get 20% off on PrimeInvestor Auto++ smallcase if you subscribe before July 15, 2022. Use the coupon code PRIMEDRIVE.

PrimeInvestor Auto++ smallcase by PrimeInvestor

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Please note that any specific queries on any of our recommendations will be answered ONLY through email. If you are a subscriber, please mail contact@primeinvestor.in.  Only general queries or discussions will be answered through the comment section of the blog. For full details, please refer to this post – How to communicate with PrimeInvestor.

2 thoughts on “PrimeInvestor Auto++ smallcase”

  1. Chaitanya Rayabharam

    Hi Team,

    Thank you for the article. In one of the previous article you had recommended UTI transportation and logistics fund. Is the current smallcase also similar in nature and what would be the benefit of choosing the smallcase over the fund if the planned holding duration is around 2-3 years.

    Regards,
    Chaitanya

    1. One this is a more focussed one and not a broad mandate like the fund. It consists of auto comp, auto and a few auto solutions players (from capital goods or technology). two, we have screened this – apart from fundamentals and revival – on those that will survive in disruption. That is not an objective of the fund. The fund route is suitable only for those who do not invest in stocks. Vidya

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