27 December 2011

Automobile (S.Arun) Overweight ::BofA Merrill Lynch

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Automobile (S.Arun)
Overweight
Key drivers of sector outlook
􀂄 Following sluggish volume in the current fiscal due to higher fuel costs and high
inflation/interest rates, we expect auto volumes to bounce back in CY12/FY13 on
pent-up demand and reversal of the interest-rate/inflation cycle. Despite the current
slowdown, structural uptrend in the industry is intact – driven by an improving
demographic profile, rising disposable income and new launches.
􀂄 We expect PV/cars as well as LCV segments to register the strongest growth rates
(est. 20%) while two-wheeler sales will likely increase 10% given the relative
penetration. Trucks could maintain a high single-digit growth rate, as reversal of
the interest/inflation-rate cycle compensates for slower IIP growth. Tractors are
expected to maintain double-digit demand growth as wage inflation will remain the
key driver of farm mechanization.
􀂄 We expect margins to improve slightly on a YoY basis due to: (1) stable
commodity prices, (2) better volumes and operating leverage on resolution of
production issues and pent-up demand, and (3) lower discounts. As a result, we
expect sector profitability and growth to be in double digits.
􀂄 On valuations, while two wheelers are trading above mid-cycle valuations (though
not stretched), four wheelers’ multiples are below the mid-cycle and have troughed
for some. We, therefore, expect upside from current levels and expect the sector to
perform inline with the market in FY13.
Top Buy: Maruti Suzuki
􀂄 Our non-consensus call is based on expectations of 45% consol. EPS CAGR
over the next two years, driven by: (1) 25% sales CAGR, and (2) margin
improvement of 250bp.
􀂄 We expect Maruti’s domestic sales volume to grow 20% annually and regain
market share, on the back of: (1) resolution of labor issues, (2) new products,
and upgrades to existing products, (3) expansion of diesel and CNG offerings,
and (4) entry into utility vehicles.
􀂄 We believe margins this year will improve, and estimate 250bp expansion during
the forecast period due to: (1) increased localization, (2) price hikes and lower
discounts, (3) better sales mix due to increased contribution from exports and (4)
operating leverage on ramp-up of production, especially of profitable models
such as Swift, Dzire.
􀂄 We expect premium multiples to be maintained, being a proxy as the only listed
pure-play in the fastest growing segment of passenger vehicles. Price objective
of Rs1,350 is based on early cycle recovery P/E of 15.4x FY13E. The stock
currently trades at 11.9x FY13E earnings.

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