India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Auto Sector
Macro headwinds, rural India a safe haven
Growth likely to slow on higher inflation and interest rates
After two years of above-trend growth and rising headwinds of inflation and higher
interest rates, we expect sector growth to moderate. We lower our estimate for
passenger vehicles (PV) growth for FY12 from 19% to 15% and two-wheeler (2W)
growth from 17% to 14%. Our preferred picks in the sector are Mahindra &
Mahindra (M&M) and Hero Honda given higher exposure to rural demand.
Rural demand to remain strong; 2Ws and Tractors to be key beneficiaries
We expect rural demand to remain strong in FY12 driven by: 1) strong growth in
rural income (due to high food inflation and strong agri growth); 2) continued
stimulus to the rural economy in the form of higher Mahatma Gandhi National
Rural Employment Guarantee Act (MGNREGA) allocation and high credit
growth; and 3) continued investment in rural infrastructure. We believe these
factors will continue to drive strong demand for 2Ws and Tractors in FY12.
Upgrade Maruti to Buy on compelling valuations
We upgrade Maruti to a Buy from Neutral as we believe the margins are bottoming
out for the company and valuations have turned attractive. The stock has
underperformed the market by 8% and declined 13% in the past three months.
Prefer M&M and Hero Honda as beneficiaries of rural growth
We remain bullish on M&M given its: 1) leading tractor franchise; 2) significant
exposure of the utility vehicle (UV) business to rural demand; 3) positive impact of
strong tractor growth on product mix and margins; 4) we also expect the
Ssangyong acquisition to be significantly accretive for M&M. We raise our price
target for Hero Honda from Rs1,950 to Rs2,250 as we raise our earnings driven by
lower royalty payments. About 64% of Hero Honda sales are from rural and agrilinked
areas.
Summary
In the near term, we think the auto sector is set to face challenges with
continued high inflation raising the prospect of strong monetary tightening
by the central bank. We believe rising inflation and interest rates will
adversely impact volume growth for the sector, particularly in urban areas.
We reduce our 2W growth forecast for FY12 from 17% to 14% YoY and PV
from 19% to 15% on account of stronger-than-expected growth in FY11 and
a likely slowdown in demand due to increasing inflation and interest rates.
However, we remain sanguine on rural demand driven by: 1) strong growth
in rural income (due to high food inflation and strong agri growth); 2)
continued stimulus to the rural economy in the form of higher MGNREGA
allocation and high credit growth; and 3) continued investment in rural
infrastructure.
We expect 2Ws, where we believe almost half the demand stems from rural
areas, to benefit from this surge in rural income in FY12. We expect Hero
Honda with its large rural presence to benefit from this trend. We raise our
12-month price target for Hero Honda from Rs1,950 to Rs2,250 as we raise
our FY12/13 earnings by 16%/9% driven by lower royalty payments.
We upgrade Maruti from Neutral to Buy rating. We believe potential
headwinds of: 1) slowing growth; 2) near-term margin pressure; and 3)
higher competition, are now largely in the price. We, however, believe the
margins are bottoming out and valuations have turned attractive.
We maintain our Buy rating on M&M with a Rs910 price target. With the
government proposing to link MGNREGA payout with inflation, it is likely
to put upward pressure on rural labour cost. This could be a positive driver
for tractor demand. Continued investment in rural infrastructure is increasing
opportunities for non-agri (construction) use of tractors, further supporting
this growth.
We also maintain our Buy rating on Bajaj Auto, despite a cut in estimates as
we believe the correction is overdone. The company is likely to benefit from
positive 2W growth with new launches and expansion of distribution reach.
We lower our price target from Rs1,775 to Rs1,550.
Will inflation impact auto
demand?
We believe the sector is slightly in uncharted territory with persistent high
inflation returning after a long time. Inflation, both WPI and CPI, has been well
behaved for most of the last decade despite the strong growth that the economy
saw between FY04-FY08.
However, now the CPI index (for industrial workers) has been hovering at close
to or above the 10% mark for more than two years. WPI has been more volatile.
We leave the inflation and central bank policy question to our esteemed
economist, Philip Wyatt. Philip has written several detailed pieces on inflation
over the past couple of years (refer to ‘India: The inflation enigma explained’
dated 26 November 2009 and ‘India: Inflation Zenith’ dated 2 July 2010).
To summarise, Philip continues to hold the view that the central bank is unlikely
to tighten further and inflation should continue to trend down to the 6-7% range
by March 2011.
However, we try to examine the implication of high inflation in terms of the
demand outlook for auto companies going into FY12.
Two wheelers—less impact as rural demand
remains strong
While there have been some concerns on the CPI (industrial workers) basket
being outdated, we use this as a better measure of consumer level inflation than
WPI. The chart indicates a sharp slowdown in 2W demand in 1997 with the CPI
peaking around January-February 1997 and another sharp slowdown in H2’98 as
the CPI rose rapidly from 5% to 20%. Post that, CPI levels have been fairly
benign till FY08. Inflation has risen rapidly in recent years; however, 2W
demand has been robust.
However, we believe one needs to look at this in conjunction with economic
growth during the period. Given GDP growth did not really falter in 1998, the
slowdown in the auto sector in H2 FY99 looks likely to be due to high inflation
FY08 downturn
While CPI levels were not very high in FY07, we however note that some
anecdotal evidence attributes increasing defaults and therefore, a pull-back in
financing to the 2W sector from November 2006, to rising food inflation. The
increase in consumer financing over the period FY03 to FY07 helped consumers
upgrade to entry-level bikes, leading to increasing proportion in motorcycle
demand. However, the default among these customers started to increase from
late FY07, prompting banks to pull back on financing to the sector. The segment
has continued to decline as financing never returned in a big way for these
customers.
Epicentre of 2W demand shifting to rural
The industry demand base has steadily moved in favour of rural demand with
smaller cities (Tier 3&4) and rural areas likely to be the incremental driver for
growth.
We believe industry split is now ~50:50 for rural vs. urban and likely to increase
further in favour of rural given a large rural population (71% of total), where
income growth is likely to drive growth for the 2W sector. The 2W penetration
level (27% vs. 55% in urban, Source: NSHIE, NCAER, CMCR analysis, 2004-05
numbers, shows % of households that own 2Ws) is still very small, leaving
substantial headroom for strong growth.
We believe increased food and agri inflation will be positive for rural incomes
and will therefore improve affordability for 2Ws, leading to increasing demand.
We believe that urban demand could potentially be impacted negatively due to
high inflation. We slightly reduce our volume estimates for the industry in FY12
to 14% from our prior estimate of 17%.
Passenger Vehicles (PVs)
We believe interest rates rather than just inflation may be a more relevant
determinant of PV growth. Interest rates have risen sharply over the last few
months so we believe GDP growth trajectory will be a more important driver for
PV demand.
If GDP growth slows, we are likely to see a sharp slowdown in PV demand.
Though we do not expect GDP growth to slow down in the near term, we are
however moderating our growth expectations to 15% for FY12 from 19%.
Rural demand to be strong in
FY12
We expect rural demand to play a strong role in FY12, and support demand for
the auto sector. We expect 2Ws and tractors to be the key beneficiaries of this
strong growth. We expect rural demand to remain strong, driven by:
1) Strong agri growth and high food inflation, translating into higher rural
incomes;
2) Strong stimulus to the rural economy with increasing MGNREGA
allocation;
3) Investment in rural infrastructure from the government.
Strong income growth in rural India
The finance minister recently announced agri GDP growth is expected at 6% in
FY11 (Economic Times, 8 January 2011). This, coupled with high food price
inflation, is likely to result in strong growth in rural incomes. Despite weak real
growth, nominal agri GDP growth has kept close to overall nominal GDP
growth for the country over the past few years.
Mahatma Gandhi National Rural Employment Guarantee
Act (MGNREGA)
The government has continued to increase allocation towards MGNREGA since
its launch in February 2006. The scheme guarantees at least 100 days of wage
employment to one person per household in rural areas for unskilled manual
work. There has been a substantial increase in the wage rates under MGNREGA
to the extent of 54% from Rs65/day in FY07 to Rs100 in 2010. Recently, the
government announced that wages under the scheme will be linked to inflation
with effect from 1 January 2011, leading to a ~17-30% hike from the current
Rs100/day. We believe 2W are likely to remain the biggest beneficiary of
increase in rural incomes.
Implications: 1.Wages under the MGNREGA scheme can be taken as a base
rate and a substantial increase in the same will cause an increase in wage
expectations across rural India. We believe this will lead to an increase in
demand for tractors as farmers will find it beneficial to purchase a tractor vs.
employing an expensive workforce.
2. MGNREGA also increases the spending power of rural India, leading to a
general rise in consumerism.
Investment in rural infrastructure
There have been increasing government efforts including and not limited to
construction of roads and improving rural housing, irrigation facilities, and
electricity supplies to develop rural India.
Pradhan Mantri Gram Sadak Yojna (PMGSY) aims to improve road
connectivity in rural areas. The scheme was started in 2000 and since then
has added 2,74,000 km of new roads. Recently, World Bank approved
US$1.5bn credit and loan for PMGSY.
Bharat Nirman policy (BNP) is focussed on overall infrastructure
development of rural areas. Under the Bharat Nirman policy of 2009, the
government will connect all villages that have a population of 1000 (or 500
in hilly/tribal areas) with a road by March 2012. In Table 6 below, we give
further details of the policy.
Hero Honda and M&M key beneficiaries of rural
demand
We identify 2Ws to be the biggest beneficiary from the uptick in rural
development. Hero Honda has strong exposure to rural demand with ~64%
of sales coming from rural areas and agri-related towns. We also believe the
industry pricing environment remains positive and Hero Honda margins have
potentially bottomed out.
We also expect tractor demand to remain healthy given strong wage push
inflation in rural labour cost, continued investment in rural infrastructure,
and strong agriculture credit growth. We estimate Mahindra tractor volumes
to grow 15% YoY in FY12 after a strong 20% YoY growth in FY11. M&M
UV portfolio is also significantly exposed to rural demand with its leading
Bolero brand. We expect demand for M&M UVs to remain robust in FY12.
We prefer Hero Honda over Bajaj Auto at current levels
We are positive on the 2W industry and are positive on the two largest players,
Hero Honda and Bajaj Auto. However, we prefer Hero Honda over Bajaj Auto
at current levels. We believe rural India will lead the growth of the 2W sector in
FY12 and we identify Hero Honda to be the major beneficiary given its strong
rural presence.
In addition, we are more positive on margin expectations for Hero Honda in
comparison to Bajaj Auto as the 2W industry pricing environment remains
positive. Bajaj could however see margin pressure due to rising commodity
costs on other parts of its portfolio namely—3Ws and exports. Hero Honda over
time has shown better ability to manage its raw material expense.
No comments:
Post a Comment