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Auto ancillary stocks, once favoured for their promising structural tailwinds, have now entered a phase of valuation correction and performance reassessment. According to Ambit, while the auto ancillary (Anc) sector offers multiple growth levers, it continues to lag original equipment manufacturers (OEMs) on key financial metrics such as cash flow generation and return on capital employed (RoCE).

In its latest report, Ambit noted that auto ancillaries are benefitting from a broad set of growth drivers including rising content per vehicle, international expansion, premiumization, and India’s cost advantage. The sector is also witnessing structural tailwinds from evolving emission and safety regulations, increased localization, and diversification into non-auto segments such as industrial and electrical components.

“Auto Ancs have multiple growth avenues, including content increase, entry into new products/markets, and leveraging M&A. Premiumization, regulatory changes and EV adoption are driving higher component demand,” Ambit said. It added that tech synergies and offshoring opportunities further enhance the sector’s long-term prospects.

However, Ambit underlined that auto component manufacturers have not fundamentally outperformed OEMs in terms of revenue, EBITDA, or PAT growth. Ancillaries also have higher capex intensity and weaker working capital cycles, resulting in lower free cash flow (FCFF) and elevated debt levels. “Scope to improve profitability, terms of trade or RoCE appears limited,” the report said.

Despite long-term growth visibility, fundamental challenges continue to restrict earnings quality. “While Ancs may see faster growth ahead, their structurally weaker balance sheets and limited room for operating leverage make them financially vulnerable,” Ambit observed.

Ambit identified three key external risks for the ancillary segment — tariff pressures under USMCA, European Union demand weakness, and intensifying Chinese competition. These are particularly critical as many Indian ancillaries are heavily reliant on exports to North America and Europe.

The brokerage also pointed to the risk of EV-led disruption, especially for component makers with higher exposure to internal combustion engine (ICE) parts. That said, Ambit believes these challenges may pave the way for new opportunities, such as EV-specific component exports and offshoring to India from stressed European vendors, albeit with longer gestation periods.

Ambit noted that Domestic Institutional Investors (DIIs) have continued to maintain an overweight position on auto ancillaries, attracted by higher growth potential and rerating-led gains. This positioning had paid off until early 2024. However, post the recent correction—primarily triggered by tariff risks—the valuation gap between ancillaries and OEMs has significantly narrowed.

In contrast, Foreign Institutional Investors (FIIs) have largely stayed underweight on auto ancillaries, preferring the relatively more stable and cash-generating OEMs, Ambit said.

Ambit’s relative evaluation framework assesses six auto ancillary stocks based on business fundamentals, financial strength, and valuation metrics. Based on this, the brokerage recommended a ‘BUY’ on Endurance Technologies (ENDU), Motherson Sumi (MOTHERSO), and Samvardhana Motherson International (MSUMI). It downgraded Bharat Forge (BHFC), Sona BLW Precision Forgings (SONACOMS), and Happy Forgings (HAPPYFOR) to ‘SELL’.

“Our pecking order in Auto Ancs is ENDU (BUY) > MOTHERSO (BUY) > MSUMI (BUY) > HAPPYFOR (SELL) > SONACOMS (SELL) > BHFC (SELL),” Ambit said.

Within the overall auto space, Ambit continues to recommend reducing the overweight allocation that many institutional investors currently maintain, suggesting a neutral stance going forward. Among all auto stocks, Ambit’s top three BUYs are Mahindra & Mahindra (MM), followed by Endurance (ENDU) and Motherson (MOTHERSO). It also added Tata Motors (TTMT) to its preferred picks.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.

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