The big story in the last few months has been the fall in automobile sales in India. The situation has become tight that banks are refusing to fund dealer inventories and companies are forced to offer unprecedented discounts to sell cars. What is this auto industry story and how is it impacting the GDP. Let us look at in 3 phases. Firstly, let us look at how the auto numbers have performed and the reasons for the same. Secondly, we will look at the significance and correlation of auto and the GDP. Lastly, we will look at how the auto stocks have performed using the Nifty Auto index and stock market in general.
Why are auto sales numbers falling so sharply?
A cursory look at the auto chart is enough to show how the auto sales numbers have been falling over the last one year. On a monthly basis, the auto production and off-take numbers have been falling by anywhere between 20-30% on a YOY basis. The situation has become so grave that most leading auto companies are forced to shut down production for weeks to balance demand and supply. Here are some of the reasons.
Uncertainty in terms of growth, income levels and jobs is resulting in weak demand for cars. People prefer to postpone their car purchase decision. A report by CSFB pointed out that the postponement is now as high as 1 year.
Petrol prices have shot up to beyond Rs.80/litre. When prices of crude oil had shot up to $85/bbl, the petrol price had crossed Rs.90/litre. Unfortunately, when the crude prices fell, the petrol prices did not fall in tandem.
Funding is perhaps the biggest issue. After the IL&FS fiasco and the Dewan Housing default, the NBFCs are finding it hard to source funds to lend. Also, the cost of funds has one up by up to 200 bps in some cases and that is not great news for auto companies. Demand has suffered in a big way at these higher costs of borrowings.
Lastly, there is also a structural issue which we cannot ignore. The rise of hail cabs like Uber and Ola have made quality transport accessible to people. Also, infrastructure in the form of metros and better roads is changing cities for good. All these factors are impacting auto demand in a big way.
If you look at the chart above, the average auto demand is down 25-30% on a monthly basis and that is what is driving the pain in the industry.
Correlating auto sales numbers and GDP numbers
The GDP number for the June quarter came in at a multi-year low of 5%. In October, the RBI downgraded the GDP growth to 5% while rating agencies like Fitch and S&P went as low as 5.5%. We will have to await the GDP growth number for September quarter, which will be announced on November 30th. Government sources are already pegging GDP at below 5% for the September quarter. If that were to happen, then full year GDP growth of even 6% would be extremely difficult. One way to understand GDP slowdown is via auto sales. As the chart above shows, there is a direct correlation between auto sales and GDP. Here is why this correlation is so high and important.
Auto and ancillaries, put together, represent the single largest manufacturing value in the Indian economy. In fact, this sector accounts for more than 50% of all manufacturing in the Indian economy, which explains the chart pattern above.
As the chart above shows, on a long term basis, fall in auto demand has proved to be the turning point for GDP. The lower shift in GDP was exactly predicted by the auto sales almost a year ago.
Finally, auto is an important barometer of consumption from the demand and supply side. On the demand side, auto demand is the best proxy for durables demand, which measures the extent of consumption confidence. On the supply side, auto sector directly and indirectly employs nearly 5 million people. It is estimated that if auto demand does not revive then close to 1 million jobs may be lost. That explains the caution among consumers.
How have auto stocks performed?
If you look at the chart above, it is clear that from the lows of 2009, the NSE auto index has been rallying up with few breaks. However, post mid 2018 when the liquidity issues first began, the auto stocks have been on a constant downtrend. Stock prices have been an important lead indicator of the macro challenges for the auto sector. Since the beginning of the 2019, auto has been one of the worst performing indices and is almost at the levels it was last seen in 2016. P/E ratios, have however, come down from a rich 40X to 23X.
The turn in auto sales is an indication of turning points in economic cycle which is reflected in the GDP growth. But if we check the stock prices of auto companies, stock market has been ahead in factoring the expected turn in auto sales. And of course, it is the stock market that discounts everything well in advance.
Nevertheless, the question is whether the auto sector performance is an indicator of stock market cycle? Albeit, auto sector is an indication of economic cycle, it will take some period of time for the stock market to converge to economic cycle. This we can see in the Nifty 50 chart that is presented below in comparison to Nifty Auto Index.
From the above chart comparison we can see the Nifty Auto Index peaked out in January 2018 at a time when Nifty 50 a broader index continuing its rally. Thereafter both the index are moving in opposite direction reflecting the deviation of stock market in general to auto sector index.
At the backdrop of the fact that Indian economy is currently sluggish, the next question that arises is when will the stock market start reflecting the economic slowdown. Before trying to find an answer to this let us remind our self that timing the market is the worst thing an investor can do and hence instead of thinking when? let us think how to focus on investing regularly and patiently instead.