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1) What are the major cost items for this business?
In general, the three largest cost items for auto manufacturers in India are raw
materials (70-80% of revenue), sales/marketing (2-3% of revenue), and employee
costs (2-6% of revenue). The raw-material component comprises two parts:
commodity costs (equivalent to about 15-20% of revenue) and the value-added
input from parts suppliers (about 55-60% of revenue).
2) What has been the trend in the price of these items? Has the price change been
accelerating or decelerating?
Prices of steel components and tyres are on the rise for all companies across all
segments (cars/two-wheelers/commercial vehicles). For most companies, employee
cost and sales/marketing expenses are rising in line with revenue, but are
accelerating slightly faster in some cases.
3) All else being equal, what is the EPS sensitivity to a 10% change in each of the
major cost items?
4) In prior periods of accelerating inflation, how have sector valuations changed?
The valuation of the India Auto Sector moved higher from 2005-07, during a
period of accelerating inflation. The average one-year forward PER increased from
9-12x in 1H05 to 13-18x in 2H07, due to: 1) the growth momentum in domestic
demand, reflected in volume growth of 17% for Maruti Suzuki and 16% for
Mahindra & Mahindra for 2H07, and 2) the rally in India’s capital markets during
2H07 (the SENSEX traded at 18-20x in 2H07 compared with 12-14x in 1H05)
5) What has been the trend in selling prices? To what extent can higher costs be
passed on?
Selling prices have been trending upward over the past 3-4 quarters, due partly to
new emission norms (moving to Euro IV) and partly to rising input costs.
Commercial-vehicle players have raised vehicle prices the most (by about 6-7%),
followed by passenger-car and two-wheeler makers. However, price hikes in the
future may not be as swift, and manufacturers could see pressure on margins,
unless steel prices start to soften (we expect this in 2H11). Having said this, we
would like to point out that players in this sector would have come under even
greater pressure if the government had raised the excise duty to 12% from 10% in
the Union Budget 2011 (announced on 28 February 2011), as the market had been
expecting.
6) If cost increases can be passed on, is there a lag? If yes, how long does that lag
tend to be?
The lag when passing on price increases to customers can vary from one month to
one quarter. However, the lag and degree of price increase also depend on demand
and the competitive environment.
7) Does cost inflation cause supply disruptions along the production chain as
producers adapt their processes or cut output in the face of weaker margins?
Cost inflation alone doesn’t lead to serious supply disruptions along the production
chain. OEMs like Maruti Suzuki do ensure stable prices for key vendors by
reasonably compensating them for cost increases. We haven’t seen manufacturers
in India cut production due to weaker margins. Production plans usually depend on
the demand environment and inventory situation.
8) What is the outlook for share prices in the sector, bearing in mind cost
pressures and the potential for PER or PBR compression?
Commodity- and oil-price inflation could have a bearing on share-price
performances in the near future, and result in share prices being range-bound with a
slight negative bias. However, from a medium-to-long-term perspective, we
believe share prices in the sector have substantial upside potential, on the back of
what we see as their robust revenue- and earnings-growth potential. We expect the
1Q FY12 (April-June 2011) quarter to be a little challenging on the cost front for
all companies, but believe it should start to ease after that. In the case of Maruti
Suzuki, we believe the Yen’s movement against the Rupee would be critical for its
gross-profit margin in the future.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
1) What are the major cost items for this business?
In general, the three largest cost items for auto manufacturers in India are raw
materials (70-80% of revenue), sales/marketing (2-3% of revenue), and employee
costs (2-6% of revenue). The raw-material component comprises two parts:
commodity costs (equivalent to about 15-20% of revenue) and the value-added
input from parts suppliers (about 55-60% of revenue).
2) What has been the trend in the price of these items? Has the price change been
accelerating or decelerating?
Prices of steel components and tyres are on the rise for all companies across all
segments (cars/two-wheelers/commercial vehicles). For most companies, employee
cost and sales/marketing expenses are rising in line with revenue, but are
accelerating slightly faster in some cases.
3) All else being equal, what is the EPS sensitivity to a 10% change in each of the
major cost items?
4) In prior periods of accelerating inflation, how have sector valuations changed?
The valuation of the India Auto Sector moved higher from 2005-07, during a
period of accelerating inflation. The average one-year forward PER increased from
9-12x in 1H05 to 13-18x in 2H07, due to: 1) the growth momentum in domestic
demand, reflected in volume growth of 17% for Maruti Suzuki and 16% for
Mahindra & Mahindra for 2H07, and 2) the rally in India’s capital markets during
2H07 (the SENSEX traded at 18-20x in 2H07 compared with 12-14x in 1H05)
5) What has been the trend in selling prices? To what extent can higher costs be
passed on?
Selling prices have been trending upward over the past 3-4 quarters, due partly to
new emission norms (moving to Euro IV) and partly to rising input costs.
Commercial-vehicle players have raised vehicle prices the most (by about 6-7%),
followed by passenger-car and two-wheeler makers. However, price hikes in the
future may not be as swift, and manufacturers could see pressure on margins,
unless steel prices start to soften (we expect this in 2H11). Having said this, we
would like to point out that players in this sector would have come under even
greater pressure if the government had raised the excise duty to 12% from 10% in
the Union Budget 2011 (announced on 28 February 2011), as the market had been
expecting.
6) If cost increases can be passed on, is there a lag? If yes, how long does that lag
tend to be?
The lag when passing on price increases to customers can vary from one month to
one quarter. However, the lag and degree of price increase also depend on demand
and the competitive environment.
7) Does cost inflation cause supply disruptions along the production chain as
producers adapt their processes or cut output in the face of weaker margins?
Cost inflation alone doesn’t lead to serious supply disruptions along the production
chain. OEMs like Maruti Suzuki do ensure stable prices for key vendors by
reasonably compensating them for cost increases. We haven’t seen manufacturers
in India cut production due to weaker margins. Production plans usually depend on
the demand environment and inventory situation.
8) What is the outlook for share prices in the sector, bearing in mind cost
pressures and the potential for PER or PBR compression?
Commodity- and oil-price inflation could have a bearing on share-price
performances in the near future, and result in share prices being range-bound with a
slight negative bias. However, from a medium-to-long-term perspective, we
believe share prices in the sector have substantial upside potential, on the back of
what we see as their robust revenue- and earnings-growth potential. We expect the
1Q FY12 (April-June 2011) quarter to be a little challenging on the cost front for
all companies, but believe it should start to ease after that. In the case of Maruti
Suzuki, we believe the Yen’s movement against the Rupee would be critical for its
gross-profit margin in the future.
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