Auto OEM or Auto Ancillaries

Buying on auto OEM will at times comes with auto ancs, certain parts that are more visible and reflect brand are manufactured in house. These kind of OEMs will involve the operation of ancillary. Automobile sector is a capital intensive and asset heavy business which needs constant upgradation and expenditure to stay in the game. Commodity price risk, demand fluctuations, consumer preferences are all threats to both the suppliers and the automobile manufacturers. As of the present conditions, the auto sector is heavily investing in EV infrastructure and peripherals to churn the existing marketing mix, but consumers prefer natural gas variants of the vehicles to be the next best substitute for IC engines due to the rise in crude oil, gasoline price and lack of charging infrastructure.

In which auto sub sector can an investor focus?

Deal making and Bargaining power

When it comes to hiring a supplier the company looks for cost per unit and timely deliveries. Being a brand established and constantly searching for demand will be a tougher job than providing what the Original equipment Manufacturers ask for. Because of this reason part suppliers are available in excess and still entrepreneurs are entering the space because of technological advancements that reduce costs. The OEMs can comfortably switch to new ones for a cheaper price. The OEMs have the upper hand in most of the deals except specific cases with Bosch, Balkrishna Industires, etc.

Revenue mixture

As a main concern auto ancs has clients most of them in offshore. Sona BLW which manufactures bevel gears and other power train products has a large portion of revenues from foreign orders. Now investors need to concentrate on the uncertainty of orders and that pose an international risk. India, evolving as a manufacturing hub, OEMs flock to outsource parts for cheaper costs. Hero Moto Corp purchases almost all the parts from suppliers to maintain an asset light business model increasing the free cash flow. Another major reason is when the cycle is up for Indian automobile companies the suppliers are focusing on export manufacturing, this would push them out of the trend.

Stretched valuations

The price that is offered by the market is too high for an investor to accumulate or make a new allocation and have been richly valued for a long time. Other side the manufacturers are stable competitors and are still available at reasonable valuations. As EV is playing out well, two wheelers lead the front. Bajaj Auto, Hero Moto Corp, TVS motors being the two wheeler manufacturers are well placed to accumulate. The underlying business of the two subsectors is totally different to compare but a product company that faces consumers should be trading higher than the service providers. The people who actually do the work has to be valued more than who support them. The well known listed players in the ancillary business are trading at an average of 50.

Recommendations for educational purpose (Read well and invest):

Original Equipment ManufacturersAuto Ancilliary
Maruthi Suzuki Ltd.Bosch Ltd.
Tata Motors Ltd.Sona BLW Precision Forgings Ltd.
Mahindra & MahindraFiem Industries Ltd.
Ashok LeylandSJS Enterprises Ltd.
Eicher MotorsMotherson Sumi Systems Ltd
Hero Moto Corp.MRF Tyres Ltd.

Company Size

Most of the companies that supply parts to the end producers are small capitalized businesses. What the small cap stocks lack is the collection efficiency, large parts of the working capital gets stuck with the receivable account. This can fairly be taken because OEMs dictate terms because of supplier availability. More than 80% of the listed suppliers fall under the 5000 Cr cap, which is segmented as the small cap stocks. At present the subsection of commercial vehicles is hit the most (School buses, office buses, etc.). The net profit numbers might look rosy, but the operating cash flow lags due to the ineffcient collecting system.

A perfect fit is Eicher motors Ltd. whose sales has been diminishing gradually and the uptick can only be expected if industries and companies reach pre covid functionality. This poses a threat to the suppliers of Eicher. To avoid cash crunch, companies delay payments to their suppliers on previous orders.