In this sector, we will be discussing how to analyze the automobile sector and which parameters to look at specifically for the automobile business. So, let’s get started!Business Model of Automobile Business:
Key Characteristics of the Automobile Sector:
- Automobile companies earn revenues through manufacturing and selling automobiles, and spare parts and by providing after-sales services.
- Segments to which the business cater proves important for the companies. A commercial vehicle is highly dependent on economic growth, the tractor is dependent on monsoon and 2 wheelers & passenger vehicles are dependent on consumer income sentiments.
- The major expenses in this business include volatile raw materials. This forces the players to manage their expenses tightly. They maintain margins by passing through the costs to customers.
- Though the automotive industry is majorly dominated by large players, it is still a highly competitive playground. The profitability of an auto manufacturer is majorly dependent on operating efficiency and capacity utilization.
Automobile Sector Analysis Example- Hero MotoCorp:1) Utilization Rate (%):
- Capital intensive
- High Competitive Intensity
- The majority of the customers are price sensitive
- Regulatory and policy risks due to emission norms and safety standards
- Significant investments in R&D and marketing
2) Revenue Breakup:
- This ratio tells about actual vehicle output as compared to potential vehicle output in a given time.
- The ideal range of the utilization rate is higher the better. As of FY22, the utilization rate of the company is 52%.
3) Inventory Turnover Ratio:
- This is the breakup of revenue between the vehicles business and spare parts business of the company. The spare parts business has a higher profit margin.
- There is no ideal range. But the spare parts have higher margins compared to the vehicle business. As of FY22, the company is having a revenue break up of 86% and 14%.
4) Debt to Equity Ratio:
- Inventory turnover is the rate that inventory stock is sold, used, and replaced. The inventory turnover ratio is calculated by dividing the cost of goods by the average inventory for the same period.
- A higher ratio tends to point to strong sales and a lower one too weak sales. For Bajaj Auto, it is 24.33 and for TVS Motor Company it is 16.18 in FY22. The same is 18.45 for Hero MotoCorp.
5) Operating Profit Margin (%):
- The ratio compares the company's total liabilities to the shareholder’s equity.
- The debt to Equity ratio of the company is 0.02.
- For the company, the Lower the better. It is among the best in the industry for Hero MotoCorp.
6) Return on Capital Employed (ROCE):
- This is calculated by dividing operating income by its sales.
- The company’s operating profit margin is 14% as of FY22.
- Higher the better. Hero is third highest after Eicher Motors and Bajaj Auto.
7) Price to Earnings (P/E) Ratio:
- This is calculated by dividing net operating profit by the capital employed in the business.
- The ROCE of Hero MotoCorp is 20.7% as of FY22. While Bajaj Auto has a ROCE of 24.7%.
- Ideally, the ROCE should be higher for automobile companies.
Moats available in the Sector:
- The ratio of the price compared to the earnings per share.
- Currently (as of 22nd September 2022), the P/E ratio of the company is 21.09. The 5-year Median P/E for the company is 18.62.
What Should Investors Do?
- Strong vendor network
- Strong brands and associated customer loyalty
- Diversity of offerings across price points and segments
- Extensive sales and service network
- Technological Tie-ups
- Shifting productions according to demand dynamics
- Innovation and regular analysis of products that satisfy customer needs
- Geographical manufacturing diversification
The Automobile sector is one of the important sectors of the Indian economy which has good prospects supported by the emergence of Electric Vehicles as well. The sector is also supported by many other key tailwinds but has many headwinds and challenges which an investor should carefully assess before making any investment decision in an automobile company. One should follow due diligence before making any investment decisions.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.
Originally Published On:https://blog.investyadnya.in/what-are-the-important-parameters-of-the-automobile-sector-how-to-analyse-automobile-sector/