How to Analyse Automobile Sector Companies and Identify Investment Opportunities

Hello, I am Umesh Tripathi, and we are learning the concepts of Fundamental Analysis. In this video, we are going to learn how to analyze investable companies in the automobile sector, including OEMs and auto components. We will talk about the overall automobile sector in India, especially the leading players. We will also talk about the performance metrics and the challenges faced by automobile companies in India. Here, we will discuss the demand drivers and external factors which can affect the overall automobile industry, and we will talk about how to analyze companies in the automobile sector when it comes to investing decision-making.

As far as the overall automobile sector is concerned, the sector is mainly comprised of OEMs plus auto component manufacturing companies. Basically, OEMs are the Original Equipment Manufacturers, and auto components companies are called auto ancillary companies. Let’s take a simple example: a company that manufactures cars this company is regarded as an OEM because it is manufacturing the original equipment, i.e., cars; and auto-component companies are the companies which actually provide auto parts to this particular car manufacturing company. Here, a certain company could be Motherson Sumi Wiring India, which provides wiring-related components to a car manufacturer. Tata Motors can be an OEM, as it is itself a car manufacturing company.As far as the overall market of the automobile sector is concerned, India is the third-largest automobile manufacturer in the world. It includes passenger vehicles, commercial vehicles, two-wheelers, tractors, and EVs. India has the largest two-wheeler market globally. It is the third-largest car market in the world by volume and contributes about 7.1% to India’s GDP and nearly 49% of manufacturing GDP. The automobile sector generates direct and indirect employment for over 37 million people, and India is a major exporter of vehicles to the emerging markets in Africa, South Asia, and Latin America.

If we talk about top players, among OEMs we have Maruti Suzuki, Tata Motors, Mahindra & Mahindra, Bajaj Auto, and Hero MotoCorp as some of the top OEMs of the Indian automobile sector. Whereas for auto components i.e., auto ancillary companies examples include BOSCH, Motherson Sumi, Sundaram (Sundaram-type firms), Bharat Forge these are top auto-components manufacturing companies.

The market size of the overall automobile sector is around ₹10 lakh crore, according to FY 2024 data, which is 7% of India’s GDP. 
Export contribution here is around 15% of total exports. If we look at the segment-wise breakdown for FY 2024–25: two-wheelers hold about 75% market share; passenger vehicles hold about 17%; commercial vehicles hold about 4%; and three-wheelers hold about 3%.

Key performance metrics when it comes to analyzing automobile-sector companies in India are basically around revenue generation and profit margins. Here, revenue and profit growth year-on-year are very important metrics whenever we are doing analysis. Along with that, healthy EBITDA margins have to be around 10–20%. Return on Capital Employed is again an important metric greater than 15% in the ideal situation. Volume growth is an important metric mainly for the automobile sector where we track how many units are sold in a certain time period. And capacity utilization is another metric when it comes to overall assessing automobile companies.

Along with this, supply challenges are one of the key challenges for automobile companies in India. We recently saw in FY 2023 that chip shortages occurred, because of which the OEM productions were impacted. Here, basically, there is high dependency on the global supply chain for key components, and moreover high input costs of raw materials used by automobile manufacturing companies impact the supply chain. For example, in 2021–2022, prices of steel, rubber, and aluminum surged, due to which overall supply in the automobile sector was affected. For the overall growth of the automobile sector, there are key demand drivers and external factors which impact the overall supply and demand of these companies. Whenever income grows or urbanization happens, demand mostly rises for automobile companies’ products. Infrastructure spending also significantly increases demand, especially for automobiles. And a strong preference for personal mobility has been observed particularly after 2020, post-COVID, people started preferring personal mobility more, which increased demand for vehicles.

Along with this, there are some external influences due to which automobile-sector companies are impacted: certain regulatory norms like BS4, BS6 and EV incentives; fuel prices (which majorly influence the shift to EV and CNG); export markets like Europe, Africa and other regions; and technological shifts. Mostly, as we are shifting to EVs nowadays, in such cases sales of other vehicle types are, to some extent, impacted. Now, let’s talk about how we analyze automobile-sector companies. The first important thing is to do segmental analysis. Segment-based analysis is very important basically, we understand what companies make by doing segment-based analysis. We saw that in the automobile sector, some companies manufacture two-wheelers; some focus only on auto manufacturing; some manufacture three-wheelers; some manufacture commercial vehicles; some manufacture passenger vehicles; some manufacture trucks; and some manufacture buses. So this segment-wise case study of companies becomes important when analyzing auto-sector companies.

Basically, looking at segments: in two-wheelers you have Hero MotoCorp, TVS Motor; in passenger vehicles you have Maruti Suzuki, Tata Motors; in commercial vehicles you have Ashok Leyland, Eicher Motors; in electric vehicles you have Tata Motors, Ather; and for auto-component manufacturing companies mostly the auto ancillaries Motherson Sumi, BOSCH, Bharat Forge, etc. Different segments bring different risks and opportunities at the same time, so we have to do thorough analysis of these kinds of segments when we are analyzing auto-sector companies.

Along with this, there are important key metrics when it comes to evaluating automobile-sector companies. Here, revenue growth, EBITDA margin, profit-after-tax margin, Return on Capital Employed, debt-to-equity, and free cash flow these are the major financial metrics which we have to analyze while analyzing automobile-sector companies. If revenue growth is 10% or more, then it is good for the company we are analyzing. EBITDA margin: 10–15% for OEMs; 12–20% for parts manufacturers. 
Profit-after-tax margin profitability after all expenses should be greater than 5% for OEMs. ROCE should be 15% or more. Debt-to-equity: for healthy firms, it is desirable that debt-to-equity be 1 or less; but in most OEMs and auto manufacturers, since manufacturing vehicles entails high cost, companies are mostly seen with debt, so their debt-to-equity often stays above 1. 
Free cash flow: positive free cash flow is ideal for investment decision-making. Whenever we are analyzing automobile companies, we must pay attention to volume and market-share trends alongside the financial metrics. We need to analyze monthly or quarterly units sold how they currently are and what the trend has been, and we need to keep tracking market share. 
Basically, if a company is gaining market share, it means it has pricing power, and its sales and ultimately profitability are expected to increase over the next few months or quarters. Along with this, the product pipeline and R&D focus of the company are very important. We should research the EV readiness of the company whether the company is ready for the EV transition or not. 
Assume a company we are analyzing is still manufacturing parts primarily for legacy solutions related to diesel engines; then, in the next 5–10–20 years, as the transition happens and almost 60–70% of vehicles on the road move to electric mobility, that company which remains focused on diesel will gradually become obsolete in a sense its sales will reduce and ultimately profitability will decline. So we must focus on this as well. For component firms, we mostly have to assess whether they cater to ICE (Internal Combustion Engine) plus the EV markets as well. As an example, Eicher Motors has been planning to roll out electric bikes, which helps investors gain confidence in this company for future mobility. Along with this, export dependency matters for automobile companies. Basically, if a company exports more, higher exports generally mean better forex earnings and natural risk hedging. 
For example, a component manufacturer like Motherson Sumi earns about 75% of its revenue from exports. Along with this, capacity expansion and capex are especially important for automobile companies. They indicate the future demand visibility of the company. While analyzing automobile-sector companies, we have to analyze recent capex announcements versus revenue growth. Another important factor is raw-material and supply-chain exposure. OEMs procure materials for manufacturing vehicles; hence, OEMs are mostly vulnerable to prices of steel, rubber, and semiconductors. We have to keep an eye on these as well while analyzing auto-sector companies. Basically, we have to analyze their inventory days and working-capital cycle.

Along with this, management quality and strategy are also key factors when analyzing automobile-sector companies. 
We should review management commentaries and their vision for EVs, exports, and overall technology shifts they are planning for the next few years. While keeping these important points in mind, we also have to analyze promoter shareholding in a particular company and check whether there has been any recent pledging by promoters of their shareholdings and if pledging has occurred, understand the reasons behind it.

As we discussed, there are a few important valuation ratios which can be different across industries, but in the automobile sector the main ones are Price-to-Earnings, EV/EBITDA, and Price-to-Book. P/E tells us valuations versus earnings. EV/EBITDA is better for capital-heavy businesses. Price-to-Book is useful for component manufacturers.So, let’s look at a checklist for investable auto companies: market share should be stable and growing; margins should be greater than 10%; ROCE should be at least 15% or more; EV and tech readiness should be present in the companies; there should be a strong pipeline and R&D investment in the automobile companies we are analyzing; and valuation should be reasonable compared to peers. Along with this, company debt levels should be low or moderate. All in all, the auto sector is large, diverse, and transforming fast. EVs, technology-enabled vehicles, and exports offer major opportunities. So, focus on the financial health of the company, market share and innovation, and supply-chain resilience when deciding whether to invest in automobile companies or not.

That’s all in this video. 
See you in the next video.

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