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For 3QFY2011, we expect our auto universe to post a strong
net sales growth of ~27% yoy, aided by robust ~26% yoy volume
growth (due to increased production by most players to meet
high festive demand) across product segments. Revenue growth
is expected to be led by Maruti (strong domestic volume offtake
due to the festival season), Mahindra & Mahindra (M&M, robust
tractor sales due to the festive season and post-harvesting
period), Hero Honda (HH, healthy volume growth) and Bajaj
Auto (BAL, increased capacity and low base effect). We expect
Ashok Leyland (ALL) to emerge as a laggard in terms of revenue
growth as commercial vehicle (CV) sales moderated during the
quarter due to pre-buying ahead of emission norm changes
from October 2010 and production constraints of
BS III vehicles. For most companies, the focus continues to be
on volume growth. Going ahead, near-term volume growth
would be tapered off due to the high base effect of 2HFY2010
and an increase in financing cost; while in the long run, we
expect sales momentum to continue, aided by healthy consumer
sentiment, rising income levels, easy availability of finance and
success of new product launches.
Rising raw-material costs pose margin pressure
The auto industry is expected to face margin pressure as input
costs spiraled during the quarter. Prices of major raw materials
such as steel, aluminum, plastic and rubber witnessed average
increases of ~6.5%, ~15%, ~16.5% and ~65.2% yoy,
respectively, during 3QFY2011. However, cost-reduction
initiatives, improved operating leverage and price increases will
dilute the impact of input cost inflation to some extent. We expect
the operating margin of our auto universe to contract
substantially by ~300bp yoy, reflecting higher input costs; while
net profit margin is expected to decline by ~150bp yoy. Players
are expected to register a yoy decline in net profit for 3QFY2011
on a yoy increase in input cost. On a sequential basis, net profit
is estimated to decline by ~10% qoq, owing to a sequential
increase in input cost.
Interest rate, fuel price and commodity price trend
Financing plays an important role and industry trend suggests
that there is a negative correlation between auto finance rates
and auto volume growth. Auto finance rates declined by
200-250bp in FY2010, which supported robust growth during
the period. A swift revival in underlying vehicle sales volume, a
benign finance environment and an increase in finance
penetration and loan-to-value (LTV) ratio are the key factors
responsible for the industry's growth. However, the beginning
of monetary tightening by the RBI has pushed interest rates up,
thereby increasing the cost of ownership for consumers. Further,
the government's policy of deregulating petrol prices to control
the fiscal deficit has led to a substantial increase in petrol prices
since June 2010. Petrol and diesel prices were hiked by
`8.59/litre and `5.36/litre in CY2010. This should have a direct
impact on ownership cost and freight operators' profitability,
and could moderately impact auto volume growth in the medium
term. For 3QFY2011, commodity prices in general have
witnessed an upward trend, with prices of key raw materials,
steel and aluminum, increasing by 6-15% yoy. Rubber and lead
prices also rose by ~65% and ~4% yoy during the quarter.
Further, around 10-12% yoy increase in average international
crude oil prices during 3QFY2011 has had an impact on
transportation costs for all the companies in our auto universe.
Auto index outperforms the Sensex
The auto index posted gains of 7.4% during 3QFY2011 versus
2.2% gains for the Sensex, outperforming it by 5.2%. The upturn
in volume witnessed in 1HFY2011 continued during 3QFY2011,
albeit at a slightly lower pace, on the back of positive consumer
sentiment and healthy festival demand. Further, advanced
buying in anticipation of the expected price increases from
January 2011 due to higher input costs also boosted volume
growth to a certain extent during the quarter. The auto sector
has turned out to be a star performer since FY2010, while,
going forward, concerns over rising input cost, higher cost of
finance and rising inflation could act as headwinds for the
industry's volume growth. Heavyweights, Tata Motors and M&M
outperformed the auto index by 11.6% and 4.7%, respectively,
during 3QFY2011. However, other heavyweights such as Maruti,
HH, Bajaj Auto and Apollo Tyres underperformed in 3QFY2011.
CV growth to moderate on a high base effect
CV sales, which have a strong correlation with domestic GDP
and industrial production, were caught in a cyclical downturn
over FY2008-09. CV volumes witnessed good recovery in
FY2010 and registered 38.6% yoy growth YTD in FY2011.
However, CV sales moderated during 3QFY2011, given that
the pre-buying ahead of the changes in emission norms had
resulted in strong sales growth in 1HFY2011. With positive
traction in the GDP, which is estimated to register a CAGR of
~8.5% over FY2010-12E, we expect CV demand to remain
buoyant. Moreover, healthy freight rates, ease in finance
availability and government thrust on infrastructure investment
are expected to boost the growth momentum further. However,
this growth momentum is expected to witness a slowdown on
account of the high base effect and as such we estimate the CV
sector to register a CAGR of ~14% over the next two years.
Tata Motors recorded a healthy growth of 23.2% yoy in CV
volumes, aided by 17.2% yoy and 27.7% yoy growth in M&HCV
and LCV, respectively.
Passenger vehicles (PV) - Maruti ahead of competition
PV volumes witnessed strong 25.6% yoy growth YTD in FY2011,
aided by buoyant domestic demand. Domestic demand was
supported by sustained positive consumer sentiment, easy
availability of finance and new model launches. Exports,
however, declined by 1.6% yoy YTD in FY2011 as PV majors
concentrated on meeting the strong demand in the domestic
market. Moreover, robust volume growth, low penetration and
a low-cost manufacturing base have been attracting global auto
majors to India, who have started launching products for the
Indian market. During CY2010, General Motors, Volkswagen,
Nissan and Ford launched Beat, Polo, Micra and Figo,
respectively, in the dominant A2 segment, thereby escalating
competition for the market leader Maruti. However, Maruti
recorded a robust 28% and 27% yoy increase in volumes during
3QFY2011 and 9MFY2011, respectively, supported by strong
volume traction in the A2 and C segments. Going ahead, we
expect volume momentum in the PV segment to continue but at
a slightly modest pace. We estimate the PV segment to register
a CAGR of ~15% over FY2010-12E.
Two-wheeler segment's momentum continues
The two-wheeler segment registered robust 29.2% yoy growth
YTD in FY2011, aided by 26.4% growth in the dominant
motorcycle segment and 49.2% yoy growth in the scooter
segment. Hero Honda reported robust 28.5% yoy growth in
the domestic market in 3QFY2011, indicating strength of its
market reach and better performance by the rural market. At
the same time, backed by a series of new launches and low
base, BAL reported a 17.8% yoy increase in motorcycle volumes
in 3QFY2011. We believe though the substantial ownership
base of two-wheelers results in reduced headroom for higher
growth and increases dependence on replacement demand to
sustain volumes, rural markets will register better growth on
demand arising from the relevant rural population. This is
expected to help two-wheeler companies maintain their growth
momentum and register a ~13% CAGR in volumes over the
next couple of years.
Auto ancillaries to track the auto sector
The auto ancillaries sector, which depends on OEMs for growth,
was stuck in the midst of sluggish growth in the domestic market
and a recession-hit global export market in FY2009. However,
revival of domestic auto volumes in FY2010 supported recovery
of the players during the period. Growth of the Indian auto
component industry is directly linked to growth of the auto sector
and has more than 65% of its domestic sales to OEMs. Thus,
recovery of auto sales volume in FY2010 would help the OEM
segment to register a ~13% CAGR over FY2010-12E. Further,
an overall increase in vehicle population (recorded a 10% CAGR
over FY2000-10E) is expected to support consistent growth in
replacement demand of auto parts and register a ~8% CAGR
over FY2010-12E. Broadly, the sector is expected to deliver good
yoy earnings performance in 3QFY2011 on improved volumes
and better operating leverage.
Among battery manufacturers, we expect Exide to post ~27%
yoy growth aided by increased capacity of two-wheeler and
four-wheeler batteries by ~35% and ~13%, respectively, during
the quarter. Tyre manufacturers are likely to post a sharp decline
in profitability due to a significant increase in raw-material prices,
especially natural rubber. Natural rubber prices increased by
~65% yoy in 3QFY2011. We expect Apollo Tyres to report a
~550bp yoy contraction in operating margins for the quarter.
Outlook
Going ahead, driven by strong economic recovery, we expect
the auto sector, which includes PVs, CVs and two-wheelers, to
register good growth in the domestic market and decent growth
in the export market over FY2010-12E. We estimate overall
auto volumes to register a CAGR of ~13% over FY2010-12E,
aided by improved business environment for the sector.
Over the longer term, comparatively low penetration levels, a
healthy economic environment and favourable demographics
supported by higher per capita income levels are likely to help
auto companies in sustaining their top-line growth. Core
business performance of auto companies improved in FY2010
and visibility restored, with substantial 25% yoy and 29% yoy
growth witnessed in volumes in FY2010 and YTD FY2011,
respectively. Thus, while this quarter's performance is likely to
be robust on a yoy basis, we expect auto companies to report a
sequential spurt in revenue on better volumes. Most stocks have
been positive in the last one year due to better visibility for the
sector. We remain positive on the long-term prospects of the
Indian auto sector. We prefer stocks with attractive valuation
and where strong fundamentals could deliver positive
earnings surprises.
Among auto heavyweights, we prefer Maruti Suzuki and M&M.
Among ancillary stocks, we maintain our positive stance on
Apollo Tyres, Ceat and Fag Bearings, which are available at
reasonable valuations.
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