Auto component companies with a technological edge, global scale advantage or an identified and exploitable niche have better prospects in the current market, says Espirito Santo Securities. It has recommended Balkrishna Industries, Bosch and Motherson Sumi

Auto sales in developed markets are slowly recovering and the worst appears to be over in Europe, with emerging markets still holding up. So, the outlook for auto component exports is improving in India. Further, it is expected that demand from the replacement market will only increase over time. These are the observations of analysts at Espirito Santo Securities on the auto component industry.

Espirito Santo expects that auto component companies with a technological edge, global scale advantage or an identified and exploitable niche have better prospects in the current market. The analysts highlight the following stocks as its picks to play these three themes: Balkrishna Industries, Bosch, and Motherson Sumi.

The global landscape for OEMs (original equipment manufacturers) is becoming increasingly competitive leading them to set up manufacturing facilities in emerging markets like India to take advantage of lower costs. Along with the domestic market, these facilities will also cater to the export market. For instance global OEMs like General Motors, Volkswagen and Ford have manufacturing facilities in India to cater to Indian as well as overseas markets. Hence this is another source of incremental demand for the auto component sector.

The current sluggishness is a cyclical blip in a structural boom, says the brokerage. India has recently crossed the $3,500 per capita income (PPP) consumption threshold, and the exports and replacement market will only support the growth.

On the improving prospects of exports, Espirito Santo observes that as the Indian component players achieve scale and experience they are improving on quality and reducing defect rates which will give growing confidence to US, German and other top auto players to increase imports of parts from India.

According to Espirito Santo, technological edge and a consistent track record of innovation are important in establishing and maintaining a competitive advantage in auto components. However, in the Indian context most firms are just moving up the curve to become globally competitive, and hence innovation and technology will not be the key driver, with the exception of the global firms such as Bosch and Wabco, whose Indian listed entities benefit from the technological edge at the parent level. Bosch is seen as benefiting from a strong technology based competitive advantage, exploiting a dominant share in changing fuel injection technology in India.

The other category to look out for is companies with adequate critical mass that would be difficult to replace in the categories they are present in, and where size is yielding a cost advantage and operating leverage. Also, as demand of global autos recovers these companies should see operating leverage play out in margins.  Motherson Sumi is the pick to play the margin improvement trend as global auto sales recover, says Espirito Santo.

A dominant position in a niche category is another area to focus on in the auto component industry, and according to the Espirito Santo, Balkrishna Industries is a small but relevant player in a niche category of Off Highway Tyres (OHT) with limited competition as: it is too small to be a focus area for large global tyre companies; and it has the cost advantage given low cost of Indian plants. The company can sustain superior profitability given the mix of cost arbitrage, distribution and brand strength. It should also benefit from falling prices of the key raw material natural rubber.

The analysts of Espirito Santo have a ‘buy’ recommendation for the stocks of Bosch, Motherson Sumi and Balkrishna Industries in the Indian stock markets.