The chosen few
The auto ancillary industry segment has more than 100 listed companies in India. Barring the top 12-13 companies by market cap, the rest are all small caps in a technical sense (below market cap of 12,000 Cr). Scale is very difficult to come by in this segment, but those that manage to scale well continue to do so for many years.
This has been our fundamental thesis in the auto ancillary segment. We prefer businesses that have a healthy proportion of revenue coming from the replacement segment and a management that is able to successfully execute on category expansion over the years. Our coverage is limited to a few businesses here for these reasons, else there is no shortage of ideas within the industry. Just that one will need to be tactical and agile in entry and exit; else the cyclicality of the industry will dilute stock returns once the tide turns.
Q4 results have been a continuation of the trends we have seen over the past few quarters –
- PV segment doing well in urban India
- 2W segment (bikes specifically) struggling, more so in rural India
- CV appears to be going into a good cycle
- EV story is likely to see much better adoption in the 2W segment, since charging infra there does not need much infra unlike the PV segment
- EV penetration within new sales has crossed 5% within 2W, however measured against the existing installed based of ICE vehicles it continues to be miniscule
- Today we have many more businesses having an EV ready roadmap, leading to the market giving these a better terminal value
Suggested reading – Q4 Conference call transcript of Exide Industries, they have given a clear roadmap of how they expect the Li-Ion battery ecosystem to evolve. Goes to show how less the analyst community and the broader investor community (we included) understands the mechanics of this emerging segment.
In our opinion, the best businesses here continue to be Uno Minda, Balkrishna Industries, Bosch in terms of business quality. In terms of stock preference (considering valuation, risk reward and specific stock cycle), we would rather take out best on the battery makers and Suprajit Engineering within our universe. Endurance Technologies continues to be an interesting business but for their heavy reliance on Bajaj Auto (~40% revenue).
We might look to increase coverage within this industry to cover a few electronic component makers from here. However, we don’t think the overall portfolio can afford to have more than two names from the auto & auto ancillary pack, unless something drastically changes about our assessment of this sector. The sector is never short of technological advances but very few players manage to put a price tag on the product development they manage to do. See for yourself how many businesses make > 15% EBITDA margin and ROCE > 20% across cycles. OEM’s are happy to procure components from specialized component makers but will rarely allow them to make healthy margins or healthy return ratios. That’s just the nature of the industry.
We continue to track the developments in EV infrastructure and believe that unit economics will become steady over time. India will finally have two large players (at the least) who are putting their skin in the game in building gigafactories that can produce lithium Ion cells locally rather than import them. We believe the trajectory of Amara Raja Batteries and Exide Industries is something every serious investor should track, given the valuation these businesses trade at.