What are the Important Parameters of the Auto Ancillary Sector? How to Analyse Automobile Business?

In this sector, we will be discussing how to analyze the auto ancillary sector and which parameters to look at specifically for the automobile business. So, let’s get started!

Business Model of Auto Ancillary Business:

• Auto Ancillary companies earn revenue through manufacturing components required for vehicles and selling them to Original Equipment Manufacturers (OEMs), aftermarket, and export segments.
• Segments to which the business cater proves important for the companies. Auto Ancillaries which cater to commercial vehicles see a lot of cyclicality in the performance due to the underlying nature of their customer’s industry.
• Working capital management, i.e. managing the inventory and the receivables is one of the key aspects of the auto ancillary business.
• A mix of OEM and aftermarket business is usually a great combination for the company. As majorly the OEMs are bigger players there, there is no room for much price negotiation. Hence, aftermarket segments give better margins to the companies.

Key Characteristics of the Auto Ancillary Sector:

• Capital intensive
• Cyclicality due to the Auto sector
• High Competitive Intensity, especially with the unorganized sector
• Regulatory risk majorly in emission and safety standards
• Foreign currency risk.

Auto component Sector Parameters Analysis Example- Balkrishna Industries:

1) OEM & Replacement Mix:

• This parameter tells about the percentage contribution from the OEMs and Replacement market.
• For Balkrishna Industries, the Replacement figure is 69%, and OEMs: 31% as of FY22.
• There is no ideal range. The replacement market provides better margins than the OEMs.

2) Geographical Diversification:

• This is the breakup of revenue based on the various geographies the business sells its products in.
• The revenue Mix of the company as per geographies as of FY22 stands as follows: Europe: 54%, Americas: 17%, India: 17%, and Rest of the World (ROW): 12%.
• There is no ideal range. A good presence in different geographies protects from a downturn in a single region.

3) Inventory Turnover 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.
• As of FY22, the company’s Inventory Turnover Ratio is 6.36
• A higher ratio tends to point to strong sales and a lower one too weak sales. It is 5.58 for MRF.

4) Debt to Equity Ratio:

• The ratio compares the company’s total liabilities to the shareholder’s equity.
• The Debt to Equity ratio of the company as of FY22 is 0.20.
• Lower the better. The debt to equity ratio is lower than the industry average for BKT

5) Operating Profit Margin (%):

• Operating Profit Margin or OPM is calculated by dividing operating income by its sales.
• As of FY22, BKT’s operating profit margin is 29.5%.
• For OPM, it is considered as higher the better. BKT has the highest OPM among the tyre companies.

6) Return on Capital Employed (ROCE):

• ROCE is calculated by dividing net operating profit by the capital employed in the business.
• For FY22, the ROCE of the business is 24.2%.
• Like OPM, ROCE is also considered higher the better. The ROCE of MRF is just 7.26%.

7) Price to Earnings (P/E) Ratio:

• The ratio of the price compared to the earnings per share.
• Currently (as of 22^nd September 2022), the P/E ratio of the company is 26.27. The 5-year Median P/E for the company is 28.45.

Moats available in the Sector:

• Strong relationships with OEMs
• Strong presence in the aftermarket segment
• Geographical Diversification
• Technology intensive products to create reliability
• Technological Tie-ups with foreign players
• Varied product diversification to become a one-stop shop for the OEMs
• Segmental and client diversification
• Constant upgradation and innovation in components

What Should Investors Do?

The Auto Ancillary sector which is largely dependent on the automobile sector performance can experience decent to good growth in line with the growth prospect of the automobile industry. An investor should carefully assess the parameters of the auto ancillary sector as discussed above as the sector possesses challenges of automobile sector as well as the factor of its own as well. 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.