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UBS Investment Research
India Auto Sector
R eiterate preference for rural plays
Two-wheelers (2Ws), tractors and LCVs best placed in terms of growth
We believe FY12 will remain a challenging year because of a high comparison
base and the sharp deterioration in the macroeconomic environment due to high
inflation and interest rates. We reiterate our preference for rural plays. We expect
government support and rising rural incomes to result in robust 2W, tractor and
light commercial vehicle (LCV) sales growth. Our negative outlook for medium
and heavy commercial vehicles (MHCV) is based on slowing industrial growth.
We remain positive on 2W growth: 18%/16% growth in FY12E/FY13E
As highlighted in our Q-Series®: India Auto Sector—Will 2W growth beat the
trend? report (21 April 2011), we expect 2W demand to remain strong, driven by:
1) rising incomes; 2) increasing rural demand; and 3) positive demographics and
social trends. We believe demand for 2Ws will also increase because high inflation
and rising petrol prices will widen the affordability gap between 2Ws and cars.
Near-term margin outlook muted due to rising commodity prices
Higher contract prices for steel and other raw materials will likely put further
pressure on automobile companies’ operating margins. Although recent weakness
in steel prices has raised prospects for margin improvement from Q2 FY11, we
remain cautious. However, we believe pricing power for 2Ws and tractors will
remain strong.
Preferred stocks: Hero Honda, M&M and Maruti
We maintain our view that Hero Honda and Mahindra & Mahindra (M&M) will be
key beneficiaries of rural growth. We believe most of the negatives are reflected in
Maruti Suzuki India valuations. We expect the competitive environment in the
passenger vehicle market to stabilise in FY13.
Summary and investment case
After two years of strong growth, the India auto sector is in a cyclical slowdown.
This is further exacerbated by a sharp deterioration in macroeconomic factors
such as:
(1) rising interest rates
(2) high inflation
(3) sharply increasing petrol prices; and
(4) slowing industrial growth and demand.
While we remain positive on the sector’s long-term growth prospects, we
believe the near-term environment remains challenging.
2Ws: We forecast a 14% volume CAGR for the 2W segment over FY11-16
(18%/16% YoY growth in FY12/FY13), based on rising incomes, supportive
social and demographic trends, and rising fuel costs (there is almost a 2x gap in
income levels required to afford a 2W compared with the cheapest entry level
car) that make private vehicles (PVs) relatively unattractive. We estimate an
increase in GDP at purchasing power parity (PPP) per capita from US$3,000-
4,500 over FY10-16 would help increase 2W penetration to 157 per thousand.
Cars: We believe the sharp increase in petrol prices over the past year has had a
significant impact on the affordability of a new car buyer. In addition, the
widening gap between the price of petrol and the price of diesel has made the
diesel variant car relatively attractive. We believe the A2 (compact car) segment
sales will be most affected by rising petrol prices, given 63% of sales in this
segment are of models that are not diesel variants. For the A3 (mid-sized car)
and above segments, where a large proportion of demand is for diesel variants,
we believe demand will be largely unaffected.
Vans and utility vehicles (UVs): We expect slower demand growth in vans as
these are largely dominated by Maruti’s petrol-fuelled models. Demand for UVs
(ex vans) is also likely to slow although could fare better than cars.
MHCVs: We remain negative on MHCVs. We believe demand is likely to slow
significantly given rising interest rates and weak industrial growth. In addition,
we think MHCV demand in Q2 FY12 will likely fall YoY, given the high
comparison base because of the sharp spike in sales due to the regulatory
changes in emission levels. 1
LCVs: LCV demand should remain robust, driven by continued strong growth
in the mini-truck segment. New launches, Ace Zip and Magic Iris, have lower
prices and are likely to gain market share from goods and passenger three-
wheelers in markets where they are allowed to be driven without permits
(known as non-permit markets). We therefore expect LCVs to grow 15% YoY
in FY12.
Tractors: Sales of tractors in the domestic segment grew 32%/20% in
FY10/FY11. We expect this momentum to persist as the industry continues to
benefit from increased investment in rural infrastructure and strong agricultural
growth. Most manufacturers expect 12-15% growth in FY12.
Table 1: UBS outlook: India auto volume growth by segment
(YoY) FY12E FY13E
2Ws 18% 16%
Cars 9% 17%
UVs 11% 16%
MHCVs 5% 12%
LCVs 15% 22%
Source: UBS estimates
Margin pressure to remain in the near term
We believe the outlook for the sector remains challenging in the near term, as
we expect raw material costs to increase further in Q1 FY12 and domestic
volume growth to slow. However, the recent trend of declining steel prices has
raised prospects of potential margin improvement from Q2 FY12 onwards.
However, due to volatile commodity prices, we cannot assume margin
improvement in the second half. Limited operating leverage will make it
difficult to absorb further increases in raw material costs, in our view.
Nonetheless, we believe 2Ws and tractors are better placed to offset commodity
price pressure. Given the strong growth outlook and benign competitive
environment for 2Ws, we believe their prices will remain strong.
After two years of strong growth, capacity utilisation remains high in the tractor
segment with most manufacturers planning to add capacity. We therefore expect
the strong pricing environment for tractors to continue for the next couple of
years.
Buys
Maruti Suzuki India
We believe sharp increases in petrol prices have further impacted slowing
demand. We believe Maruti Suzuki India (Maruti) is likely to be affected in H1
FY12 due inadequate capacity for diesel models. However we expect a strong
recovery in H2 FY12 as the second unit of the Manesar factory comes online.
Also, we expect the company’s launch of two to three new launches (New Swift,
New Dzire [4m sedan] and the R3 concept-based UV) in H2 FY12 to drive
growth in FY13.
Maruti’s cheap valuation, relative to its history, suggests most of the negatives
are reflected in its share price. We expect the competitive environment to
stabilise in FY13. Maruti remains our preferred stock in the sector.
Hero Honda
We maintain our Buy rating on Hero Honda, as we expect it to be a strong
beneficiary of rural demand for 2Ws. Based on our outlook for solid growth in
this segment, we believe the competitive environment will be benign and pricing
power will be strong in the near term. We expect Hero Honda to gain market
share in scooters because of increasing demand for scooters in small cities and
towns. We therefore forecast a 19% earnings CAGR for FY11-13 for Hero
Honda, driven by 17%/14% volume growth in FY12/FY13.
Mahindra & Mahindra
We remain positive on Mahindra & Mahindra (M&M), given its leading tractor
and UV franchise. We expect demand and pricing power to remain strong in this
segment, and UV demand to surprise on the upside with the forthcoming launch
of the below 4m Xylo, which will open up a new segment for the company. We
remain positive on the Ssangyong acquisition as the company’s export volumes
continue to rise. Based on our pro-forma numbers, we expect significant
earnings accretion from Ssangyong in FY13 and beyond.
We maintain Buy rating but reduce our price target from Rs880.00 to Rs840.00
to reflect our lower earnings estimates for the standalone operations due to
higher raw material and staff costs. At consolidated level, subsidiaries’ earnings
have risen, resulting in our higher EPS estimates. However, our valuation is not
impacted materially as we value the subsidiaries at the current market price,
adjusted for a 20% holding company discount.
Bajaj Auto
We remain positive on Bajaj Auto (Bajaj) given our view on 2W demand for
FY12/13. Bajaj has also been able to maintain strong export volumes. However,
withdrawal of Duty Entitlement Pass Book (DEPB) incentives is a negative. We
therefore reduce our earnings estimates for FY12 and FY13. We maintain our
Buy rating but reduce our price target from Rs1,750 to Rs1,600 to reflect our
lower earnings estimates due to the removal of DEPB benefits from FY13
onwards and near-term pressure on margins from a potential increase in
discounts and mix deterioration due to launch of relatively cheap motorcycles
such as Boxer. Management remains focused on maintaining high margins and
continues to raise prices to offset commodity price pressure.
TVS Motor
We remain positive on TVS Motor (TVS) based on our expectation for strong
volume growth in the scooter and moped segments to result in margin expansion.
Potential launches in the motorcycle segment could help improve volume
growth in FY13. We estimate 18%/16% overall volume growth in FY12/FY13.
At our price target, the stock’s implied valuation would be 13x FY13E PE. We
believe its valuation is attractive at 5.3x FY13E EV/EBITDA—around a 40%
discount to its peers. DEPB withdrawal and slow ramp-up of the Indonesia
operations remain a concern. We maintain our Buy rating but lower our price
target from Rs80.00 to Rs70.00 to reflect our lower earnings estimates due to
removal of DEPB benefits from FY13 onwards and continued pressure on
margins due to slower ramp-up of operations in Indonesia.
Sells
Ashok Leyland
Ashok Leyland (Leyland) has been losing market share to Tata Motors and
Eicher in the MHCV segment. We remain negative on MHCV demand growth
for Leyland and expect 0% YoY growth in FY12 compared with 5% YoY
growth for the industry. We believe the near-term growth for MHCVs remains
challenging given the sluggish near-term Index of Industrial Production (IIP)
and the high base in terms of MHCV demand for Q2 FY12 due to purchases
ahead of the change in emission norms in Q2 FY11. We believe margins will
remain under pressure due to slowing sales.
Tata Motors
We downgraded Tata Motors (TAMO) from Buy to an anti-consensus Sell
rating on 13 June 2011 on concerns about a deteriorating growth outlook for
Jaguar Land Rover (JLR) and a negative view on the domestic MHCV segment
cycle. JLR’s retail sales in the EU were down 20% YoY in April 2011. We
believe increasing incentives for Jaguar in US and lower sales volumes in the
domestic market will keep margins under pressure.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Auto Sector
R eiterate preference for rural plays
Two-wheelers (2Ws), tractors and LCVs best placed in terms of growth
We believe FY12 will remain a challenging year because of a high comparison
base and the sharp deterioration in the macroeconomic environment due to high
inflation and interest rates. We reiterate our preference for rural plays. We expect
government support and rising rural incomes to result in robust 2W, tractor and
light commercial vehicle (LCV) sales growth. Our negative outlook for medium
and heavy commercial vehicles (MHCV) is based on slowing industrial growth.
We remain positive on 2W growth: 18%/16% growth in FY12E/FY13E
As highlighted in our Q-Series®: India Auto Sector—Will 2W growth beat the
trend? report (21 April 2011), we expect 2W demand to remain strong, driven by:
1) rising incomes; 2) increasing rural demand; and 3) positive demographics and
social trends. We believe demand for 2Ws will also increase because high inflation
and rising petrol prices will widen the affordability gap between 2Ws and cars.
Near-term margin outlook muted due to rising commodity prices
Higher contract prices for steel and other raw materials will likely put further
pressure on automobile companies’ operating margins. Although recent weakness
in steel prices has raised prospects for margin improvement from Q2 FY11, we
remain cautious. However, we believe pricing power for 2Ws and tractors will
remain strong.
Preferred stocks: Hero Honda, M&M and Maruti
We maintain our view that Hero Honda and Mahindra & Mahindra (M&M) will be
key beneficiaries of rural growth. We believe most of the negatives are reflected in
Maruti Suzuki India valuations. We expect the competitive environment in the
passenger vehicle market to stabilise in FY13.
Summary and investment case
After two years of strong growth, the India auto sector is in a cyclical slowdown.
This is further exacerbated by a sharp deterioration in macroeconomic factors
such as:
(1) rising interest rates
(2) high inflation
(3) sharply increasing petrol prices; and
(4) slowing industrial growth and demand.
While we remain positive on the sector’s long-term growth prospects, we
believe the near-term environment remains challenging.
2Ws: We forecast a 14% volume CAGR for the 2W segment over FY11-16
(18%/16% YoY growth in FY12/FY13), based on rising incomes, supportive
social and demographic trends, and rising fuel costs (there is almost a 2x gap in
income levels required to afford a 2W compared with the cheapest entry level
car) that make private vehicles (PVs) relatively unattractive. We estimate an
increase in GDP at purchasing power parity (PPP) per capita from US$3,000-
4,500 over FY10-16 would help increase 2W penetration to 157 per thousand.
Cars: We believe the sharp increase in petrol prices over the past year has had a
significant impact on the affordability of a new car buyer. In addition, the
widening gap between the price of petrol and the price of diesel has made the
diesel variant car relatively attractive. We believe the A2 (compact car) segment
sales will be most affected by rising petrol prices, given 63% of sales in this
segment are of models that are not diesel variants. For the A3 (mid-sized car)
and above segments, where a large proportion of demand is for diesel variants,
we believe demand will be largely unaffected.
Vans and utility vehicles (UVs): We expect slower demand growth in vans as
these are largely dominated by Maruti’s petrol-fuelled models. Demand for UVs
(ex vans) is also likely to slow although could fare better than cars.
MHCVs: We remain negative on MHCVs. We believe demand is likely to slow
significantly given rising interest rates and weak industrial growth. In addition,
we think MHCV demand in Q2 FY12 will likely fall YoY, given the high
comparison base because of the sharp spike in sales due to the regulatory
changes in emission levels. 1
LCVs: LCV demand should remain robust, driven by continued strong growth
in the mini-truck segment. New launches, Ace Zip and Magic Iris, have lower
prices and are likely to gain market share from goods and passenger three-
wheelers in markets where they are allowed to be driven without permits
(known as non-permit markets). We therefore expect LCVs to grow 15% YoY
in FY12.
Tractors: Sales of tractors in the domestic segment grew 32%/20% in
FY10/FY11. We expect this momentum to persist as the industry continues to
benefit from increased investment in rural infrastructure and strong agricultural
growth. Most manufacturers expect 12-15% growth in FY12.
Table 1: UBS outlook: India auto volume growth by segment
(YoY) FY12E FY13E
2Ws 18% 16%
Cars 9% 17%
UVs 11% 16%
MHCVs 5% 12%
LCVs 15% 22%
Source: UBS estimates
Margin pressure to remain in the near term
We believe the outlook for the sector remains challenging in the near term, as
we expect raw material costs to increase further in Q1 FY12 and domestic
volume growth to slow. However, the recent trend of declining steel prices has
raised prospects of potential margin improvement from Q2 FY12 onwards.
However, due to volatile commodity prices, we cannot assume margin
improvement in the second half. Limited operating leverage will make it
difficult to absorb further increases in raw material costs, in our view.
Nonetheless, we believe 2Ws and tractors are better placed to offset commodity
price pressure. Given the strong growth outlook and benign competitive
environment for 2Ws, we believe their prices will remain strong.
After two years of strong growth, capacity utilisation remains high in the tractor
segment with most manufacturers planning to add capacity. We therefore expect
the strong pricing environment for tractors to continue for the next couple of
years.
Buys
Maruti Suzuki India
We believe sharp increases in petrol prices have further impacted slowing
demand. We believe Maruti Suzuki India (Maruti) is likely to be affected in H1
FY12 due inadequate capacity for diesel models. However we expect a strong
recovery in H2 FY12 as the second unit of the Manesar factory comes online.
Also, we expect the company’s launch of two to three new launches (New Swift,
New Dzire [4m sedan] and the R3 concept-based UV) in H2 FY12 to drive
growth in FY13.
Maruti’s cheap valuation, relative to its history, suggests most of the negatives
are reflected in its share price. We expect the competitive environment to
stabilise in FY13. Maruti remains our preferred stock in the sector.
Hero Honda
We maintain our Buy rating on Hero Honda, as we expect it to be a strong
beneficiary of rural demand for 2Ws. Based on our outlook for solid growth in
this segment, we believe the competitive environment will be benign and pricing
power will be strong in the near term. We expect Hero Honda to gain market
share in scooters because of increasing demand for scooters in small cities and
towns. We therefore forecast a 19% earnings CAGR for FY11-13 for Hero
Honda, driven by 17%/14% volume growth in FY12/FY13.
Mahindra & Mahindra
We remain positive on Mahindra & Mahindra (M&M), given its leading tractor
and UV franchise. We expect demand and pricing power to remain strong in this
segment, and UV demand to surprise on the upside with the forthcoming launch
of the below 4m Xylo, which will open up a new segment for the company. We
remain positive on the Ssangyong acquisition as the company’s export volumes
continue to rise. Based on our pro-forma numbers, we expect significant
earnings accretion from Ssangyong in FY13 and beyond.
We maintain Buy rating but reduce our price target from Rs880.00 to Rs840.00
to reflect our lower earnings estimates for the standalone operations due to
higher raw material and staff costs. At consolidated level, subsidiaries’ earnings
have risen, resulting in our higher EPS estimates. However, our valuation is not
impacted materially as we value the subsidiaries at the current market price,
adjusted for a 20% holding company discount.
Bajaj Auto
We remain positive on Bajaj Auto (Bajaj) given our view on 2W demand for
FY12/13. Bajaj has also been able to maintain strong export volumes. However,
withdrawal of Duty Entitlement Pass Book (DEPB) incentives is a negative. We
therefore reduce our earnings estimates for FY12 and FY13. We maintain our
Buy rating but reduce our price target from Rs1,750 to Rs1,600 to reflect our
lower earnings estimates due to the removal of DEPB benefits from FY13
onwards and near-term pressure on margins from a potential increase in
discounts and mix deterioration due to launch of relatively cheap motorcycles
such as Boxer. Management remains focused on maintaining high margins and
continues to raise prices to offset commodity price pressure.
TVS Motor
We remain positive on TVS Motor (TVS) based on our expectation for strong
volume growth in the scooter and moped segments to result in margin expansion.
Potential launches in the motorcycle segment could help improve volume
growth in FY13. We estimate 18%/16% overall volume growth in FY12/FY13.
At our price target, the stock’s implied valuation would be 13x FY13E PE. We
believe its valuation is attractive at 5.3x FY13E EV/EBITDA—around a 40%
discount to its peers. DEPB withdrawal and slow ramp-up of the Indonesia
operations remain a concern. We maintain our Buy rating but lower our price
target from Rs80.00 to Rs70.00 to reflect our lower earnings estimates due to
removal of DEPB benefits from FY13 onwards and continued pressure on
margins due to slower ramp-up of operations in Indonesia.
Sells
Ashok Leyland
Ashok Leyland (Leyland) has been losing market share to Tata Motors and
Eicher in the MHCV segment. We remain negative on MHCV demand growth
for Leyland and expect 0% YoY growth in FY12 compared with 5% YoY
growth for the industry. We believe the near-term growth for MHCVs remains
challenging given the sluggish near-term Index of Industrial Production (IIP)
and the high base in terms of MHCV demand for Q2 FY12 due to purchases
ahead of the change in emission norms in Q2 FY11. We believe margins will
remain under pressure due to slowing sales.
Tata Motors
We downgraded Tata Motors (TAMO) from Buy to an anti-consensus Sell
rating on 13 June 2011 on concerns about a deteriorating growth outlook for
Jaguar Land Rover (JLR) and a negative view on the domestic MHCV segment
cycle. JLR’s retail sales in the EU were down 20% YoY in April 2011. We
believe increasing incentives for Jaguar in US and lower sales volumes in the
domestic market will keep margins under pressure.
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