Automobiles - MHCVs: Riding the growth train; sector update:: Edelweiss PDF link

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Demand for medium and heavy commercial trucks could surprise positively, driven by structural changes like rising trading activities, continuous gain of market share from railways and improving profitability of truck operators. Lead indicators suggest that demand decline has bottomed out while our channel checks confirm the improvement in truck demand. Our forecasting model suggests that truck sales will grow 11% and 17% in FY13 and FY14, respectively. Key beneficiaries will be companies with right products and wide distribution networks. We upgrade recommendation on Ashok Leyland and Tata Motors to ‘BUY’. We initiate coverage on Eicher Motor with‘BUY’.

Truck demand on structural upswing

Structurally, demand for trucks has been on an upswing with the growth rate over the past 10 years surpassing that of cars and two wheelers. Essential growth drivers have been:  (1) increased trading activity, implying less volatility in truck demand and longer cycles; (2) continuous market share gain from Indian Railways, (we believe for every 1% decline in rail freight growth, truck demand jumps 4%); (3) improving profitability of transport operators due to shift to higher tonnage vehicles; and (4) rising long-term contracts in organised freight movement that boosts freight visibility and condition of younger fleet triggers a replacement chain.

Lead indicators allude to strong upturn in demand in H2FY13

Our study of five lead indicators (i.e., manufacturing inflation, IIP, interest rates, GCF and liquidity) indicates that truck demand is at its bottom. Our economist believes that interest rates and inflation have peaked and are likely to reverse in H1FY13; hence, we expect a strong recovery in H2FY13. Our channel check suggests improvement in demand scenario for trucks in haulage segment (80% of truck market) over FY12. Our demand forecasting model hints at a truck demand growth of 11% and 17% in FY13 and FY14, respectively.

Profitability to improve with operating leverage, debt deleverage

We expect an EBITDA margin and ROE to expand by 1%-2% and 4%-7% respectively across the sector over the next two years, driven by operating leverage and debt deleveraging.

Upgrade Ashok Leyland, Tata Motors; initiating Eicher Motors with ‘BUY’

Companies with right products and wide distribution networks will be the key beneficiaries of the imminent upswing in the cycle. Also, increasing demand for higher tonnage vehicles will help leading companies expand their EBITDA margins and RoE profile (mainly due to high operating leverage and debt deleverage). We have revised earnings estimates upwards for Ashok Leyland and Tata Motors on higher sales volume and margins. Our FY13E/14E EPS for Ashok Leyland, Eicher Motors (CY12E/CY13E) and Tata Motors are 15%/37%, 8%/21% and 4%/3% ahead of the Bloomberg consensus. We have upgraded Ashok Leyland and Tata Motors to 'BUY' from 'HOLD' with target prices of INR39 and INR334 respectively. We also initiate coverage on Eicher Motors with a ‘BUY’ rating and a target price of INR2,807.

Automobiles - MHCV: Riding the growth train; sector update

Regards,