India Automobiles: Buy Tata Motor, Ashok Leyland; Sell Maruti: Macquarie Research

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Sector outlook 
India Automobiles: Buy Tata Motor, Ashok Leyland; Sell Maruti: Macquarie Research

Moderate growth expectation amidst cost concerns: Auto sales volume has increased by
28% YoY in the nine months ended December 2010, mainly due to rising disposable income
and buoyancy in the economy. We expect moderate industry growth next year in view of
higher base effect and rising interest rate. We believe auto sales would increase by 17% YoY
in FY12E, down from ~27% in FY11E. Further, profitability of the OEMs would be impacted
by ~150-200bps due to rising costs of key inputs like steel, aluminium and tyres. Due to high
competition in cars and the two-wheeler space, we expect advertisement and selling
expenses to remain elevated, which will further put pressure on margins.

􀂃 Competition intensifying in two wheelers. Motorcycles will continue to grow on the back
of increasing rural penetration and stable urban demand. We expect two-wheeler sales
growth to remain strong at 18%, however it will come off from >25% in last two years,
mainly due to a higher base. Scooters will likely grow at 20% in FY12E, despite capacity
constraints due to strong urban demand. HMSI’s aggressive plans of launching an
economy bike (10% cheaper than the lowest priced bike in the market), coupled with
expansion of its dealership network will increase competition in the domestic market.
Exports may also get impacted by ingress of cheaper Chinese bikes in the African market,
which is the largest market for India manufacturers.
􀂃 Prefer UVs over cars in passenger car segment. The passenger car market has grown
by ~28% in 2010, due to rising disposable incomes, easy availability of finance and a
variety of new models launched in the compact and the mid segments. We believe the
momentum will continue in FY12, albeit at a lower pace, due to interest rates tightening.
The long waiting periods on recently launched models and strong pipeline of upcoming
launches (~50), gives confidence of 17% volume growth in FY12. We expect Utility
vehicles to grow by 13% in FY12E on the back of rising tourist arrivals, improving business
sentiment and new launches in the MPV space. Competition in the high volume A2
(compact) segment is set to intensify as new players like Nissan, Ford and Volkswagen
ramp up capacities. Passenger car players may face profitability pressure due to partial
pass through of increased raw material costs as competitive remain high and higher selling
expenses on new launches.
􀂃 Strong outlook for commercial vehicles, but risks are rising. We expect domestic CV
industry to grow by 15% in FY12E supported by continuous growth in economic activity
and growing consumption expenditure. We believe domestic LCV goods segment will clock
the best growth rate of 20% due to growing consumption led demand, favourable business
environment and easy financing for the first time buyers. Domestic M&HCV goods
segment is likely to register 12% growth on the back of increasing industrial and
agricultural activity, infrastructure development and improved transporter profitability.
M&HCV buses segment is likely to grow at 10% as inter city passenger transport through
luxury buses increases. M&HCV buses segment will also get boost from improving road
infrastructure. Key risks to the CV segment growth are 1) diesel price hike due to rising
crude oil prices and 2) interest rates hardening. Both these factors may impact profitability
of transporters’ and can limit CV manufacturers’ ability to increase prices without risking
loss of demand.



Sector Top Picks
Top Buy Recommendations
Tata Motors (Outperform; TP: Rs1,500; Potential upside: 22%)
􀂃 JLR margin is sustainable at ~15%. We expect slight margin decline this quarter from
16.6% reported last quarter as raw material prices are renegotiated. We believe ~15%
margin is sustainable for JLR given improved realisation on better product and region mix,
initiatives on increasing low cost sourcing and rationalisation of components.
􀂃 Leverage to reduce below 1.0x: Tata Motors net automotive debt to equity reduced to
1.73x in 2Q’FY11 from 1.96x in 1Q’FY11. Taking into account the US$750m raised
through QIP issue in October, the company’s net debt to equity would stand reduced to
~1.16x. With strong operating cash flows and possible stake sale in unlisted subsidiaries,
we believe that leverage will fall below 1.0x by 4Q’FY11E.
􀂃 New models and CV products to benefit domestic business: Company is slated to
launch a new Safari and sub-1 tonne LCVs in 4Q’FY11, which we believe will boost its
volume. We expect CV business to grow at 15% over the next 2–3 years as investment
cycle picks up and profitability of freight operators improve.
Key Near-Term Catalyst
􀂃 Monthly sales numbers. 3Q FY11 Earnings, to be announced in the first week of February
2011, will provide comfort on sustainability of JLR margins.

Top Buy Recommendations

Ashok Leyland (Outperform; TP: Rs91; Potential upside: 47%)
􀂃 Volume growth to remain robust: Increasing industrial production, high agriculture
output and a pick-up in the investment cycle should support volume growth of 22-24% in
the current year and ~15% in the next 2 - 3 years. With demand improvement expected in
key South Indian market, multi-axles and tractor trailer segments as well as exports,
Ashok Leyland’s M&HCV sales should rise to 96k units in the current fiscal year, in our
view, and should increase by 15% to over 110k units in FY12E.
􀂃 Price hikes to support margins: Ashok Leyland has taken price hikes for BSII compliant
vehicles by ~7% and prices for BS III by 3% in FY11 We believe these price hikes will
support its margins. Also, we believe CV manufacturers have better pricing power due to
improved profitability of fleet operators and robust demand in freight generating sectors,
which will support their margin.

􀂃 U-truck to support demand: The recently launched U-trucks are seeing good demand
due to better technology and performance capabilities. With pick up in the investment
cycle and increase in expansion plans of businesses, sales of U-trucks will likely gather
traction in the following quarters.
􀂃 Benefits from Uttarakhand plant to sustain margins: From just 2,500 units in 1H’FY11,
the company plans to increase production from Uttarakhand plant to12,500 units in the
remaining six months and hopes to reach 4k units per month by March 2012. The
company expects to save at least ~Rs35k per vehicle produced at this new plant due to
tax benefits and faster ramp-up of component suppliers.
Key Near-Term Catalyst
• Ashok Leyland’s Q3 FY11 results scheduled on Jan 22, 2011.


Top Sell Recommendations
Maruti Suzuki (Underperform; TP: Rs1,250; Potential downside: -5%)
• Competition threat is getting real. Toyota launched its competitively priced ‘Etios’ and
received bookings of more than 15,000 in the first month, compared to ~9,000 units of
‘Dzire’ sold in a month. Further, players like Ford, Nissan and Volkswagen are ramping up
their capacity faster and we believe the competition is likely to get hotter as they increase
production next fiscal year. Thus, we see threat to Maruti’s profitability due to its limited
ability to pass through raw material cost inflation on rising competition and higher
advertising and selling expenses arising from new launches.
• Royalty payments set to increase from 5.3% on new launches. With higher proportion
of new models and appreciating yen, royalty as % of sales is bound to increase from the
current level of 5.3%.
• Market share loss expected as new capacity to start in 3Q’FY12. Among new planned
capacities, Mansar B (250k) will start operations in 3Q’FY12 and Manesar C (250k) is
scheduled to commence production from FY13. With scheduled launch of ~50 new
models in 2011, we expect Maruti to see a decline in market share due to capacity
constraints since production expansion is unlikely before Oct – Nov 2011.
Key Near-Term Catalyst
• Maruti Suzuki’s Q3 FY11 results scheduled on Jan 29, 2011.


Top Switch Idea
Switch to Tata Motors from Maruti Suzuki
• Margin sustainable for Tata Motors. Margins of Tata Motors should be supported by
leadership position and lesser competition in the commercial goods carrier segment. With
the launch of technologically superior and premium priced Prima trucks, profitability will
improve further. Product mix has also improved further due to launch of new higher end
models and better regional mix (higher sales from China). As Chinese assembly line
completion expected by the end of 2011, realizations will receive further boost. On the
other hand, Maruti Suzuki will see margin degradation in the next couple of years, mainly
due to 1) Increase in royalty expenses on account of new model launches and 2) Jump in
selling and advertising expenses on escalating competition.
• Tata Motors – attractively valued compared to Maruti Suzuki: Strong revival in sales
due to recovery in domestic and international markets coupled with aggressive cost
cutting measures undertaken at JLR, We estimate ~23% EPS CAGR for Tata Motors over
the next two years. At ~8x FY12E PER and 5.6x FY12E EV/EBITDA the stock appears
attractively valued. On the other hand, we expect 11.4% earnings CAGR for Maruti
Suzuki over the next two years due to margin compression on account of increasing
competitive intensity as well as higher selling & distribution and royalty expenses. Maruti
shares are currently trading at 15x FY12E PER and remain expensive compared to Tata
Motors.