Acche din for auto industry

The picture in the rear view mirror may not be all that pleasant for the automobile industry in India. The windshield, nonetheless, is showing industry is gearing for brighter days ahead after lacklustre performance in the last couple of years. Although, total domestic sales of automobile had increased by three per cent on yearly basis in 2014, overall growth figure masks the disappointing sales recorded underneath by various segments.

Two wheelers, which constitute 80 per cent of total sales by a number of units, recorded yearly growth of 7 per cent that helped to pull the entire growth number for the industry. The other three broader segments, i.e. passenger, commercial vehicles and three wheelers, all saw a decline in the number of units sold in 2014 compared to what they sold last year. The reasons for such lacklustre performance is mostly attributed to weakening economic growth apart from higher interest rate, increased excise duty, rise in fuel prices and muted infrastructure activity.

The fortune of auto industry is closely tied with economic activity and is reflected in the performance of the economy and industry. The auto industry had seen a strong annual growth of 21.3 per cent over a period of 20-12 when economy grew at average rate of eight per cent. Nonetheless, in next two years GDP growth rate fell below five per cent and growth slumped to average three per cent. The BSE Auto index tracking the share performance of major auto companies saw two per cent drop in its value for the year ending March 2014.

The good news is that economy seems to be turning corner now and growing at 5.7 per cent for the first quarter of 2015, highest in previous nine quarters.  The acche din for economy seems to be coming, what does this holds for the auto industry and their stocks. The BSE Auto Index has already appreciated by more than 40 per cent year till date on the anticipation of smooth ride for the auto industry going ahead. Autos, the early cycle outperformer,  have already run ahead of their financial performance. Is this a euphoria created by the overall better sentiment in the economy or something materially is changing on the surface. Our story will try to find out what is happening at ground and which are the right pockets of investments?

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Commercial Vehicles:

The commercial vehicle (CV) segment was impacted most in the entire auto segment due to the slowdown in the economy. After clocking a sales growth of 39 per cent in 2010, when the economy was operating at full throttle, the growth in this segment seemed to hit a road block after weakness in economic activity.  It has continuously seen a fall in the growth rates since 2010 and for last two financial years that is for FY13 and FY14, the growth rate dropped to negative two and twenty per cent respectively.

The latest figure, nonetheless, is showing this segment is coming out of down cycle after two years of demand contraction. For the month of September sales of CV has, though, remained flattish on yearly basis it has increased on monthly basis. The reason for muted performance on yearly basis was the dull show by light commercial vehicle (LCV) one of the important constituent of CV segment. The other major segment medium and heavy commercial vehicle (MHCV) did well in the same period. Sales of LCV for the month of September 2014 fell by 9.2 per cent to 39715 units compared to 43148 units in the same month last year.

The fall is less compared to the double digit fall that this segment witnessed in the month of August. MHCV, however, has seen a strong rebound in sales in the month of September and grew strongly by 21.6 per cent on yearly basis and recorded total sales of 18706 units. This was led by better performance in the Truck segment that witnessed the highest pace of growth (up 27.9 per cent), while the MHCV Bus segment continued to report a decline (down 1.7 per cent on YoY basis) in September 2014. What is encouraging to note is that on sequential basis sales of CV has increased by 15 per cent and both segment that is LCV and MHCV has witnessed increase in Volume.

If we analyse the data company wise, it is Tata Motors that has led to the fall in the volume of LCV. Tata Motors, which is market leader in LCV segment of sub one tonne segment, saw its sales volume dropping by 23 per cent on yearly basis for the month of September 2014. In contrast, the MHCV segment of the company grew by 18 per cent in the same time and this is the second consecutive month of growth for the MHCV segment. Rest all other major players in the CV segment saw both their segments (LCV and MHCV) growing on yearly basis. The best performance was put by Ashok Leyland among CV segment that grew by 27.1 per cent on yearly basis for the month of September.

The reason for such performance was improvement in freight rates across key routes, expectations of pick-up in investments in infrastructure as well as manufacturing space along with renewal of mining activities in some parts of the country suggest that the down cycle in MHCVs has bottomed out. According to a report by Indian Foundation of Transport Research & Training (IFTRT), truck rentals or freight rates have improved by 4-5 per cent in the month of September 2014 on account of movement of agro-products and higher dispatches by SME manufacturing units into trading centres to increase inventory for the ongoing peak festival season.

The same report also highlights about the optimism in the truck freight market in which fleet owners have started exploring and planning fleet replacement so that when in the near future the stalled infrastructure projects resume activity, these fleet owners will be able to capture business. This clearly signals that demand for commercial vehicle will be sustained and will be more in medium and heavy truck segments.

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Passenger Vehicle

The sales of passenger vehicle (PV), which include passenger cars, utility vehicles (UVs) and vans, has seen a remarkable recovery in the first six month of FY15 after witnessing a drop of seven per cent in the previous year. Infact sales growth of PV has been on decline since FY12.

However, the tide seems to be turning for PV segment in last six months. The PV segment grew by nine per cent on yearly basis during the month of September 2014. This is the fourth consecutive month of double digit growth for this segment, which has helped the segment to grow at 11.5 per cent for the first half of FY15. The increase in sales was both sequential as well as on yearly basis. The key driver of this segment growth in H1FY15 was volume contribution of new models launched over the last one year. It is estimated that new brands contributed to one-third of incremental volumes of the PV industry as a whole in H1FY15. Some of the new PV brands introduced over the last 12 months including Maruti Suzuki Celerio, Hyundai Grand i10, Hyundai Xcent and Honda Mobilio were amongst the primary contributors to incremental volumes in the last six months. What also helped companies to post better number is heavy discounts being offered by them on a large number of PV models. Among the passenger car, it is the compact sub-segment that includes vehicle like Xcent and Amage has witnessed best growth in the six month ending September 2014 while mini and mid size segment has witnessed fall in the growth due to changing customer preferences.

The major listed player expect for the Tata Motors saw increase in the passenger car sales in the month of September 2014 and leading the pack is the market leader Maruti Suzuki, which saw its domestic PV sales increasing by almost ten per cent on yearly basis followed by M&M that saw its sales volume increasing by 5.2 per cent. The laggard in this segment is Tata Motors that saw its PV sales volume declining by 7.1 per cent for the month of September on yearly basis.

Going ahead we feel that the momentum may continue and the latest sales volume during the month of October fully support this. Although, companies are yet to announce their October sales volume, dealer checks suggests that most car companies has seen around 20 per cent increase in sales in the month of October 2014. In addition to the pickup in economy what is supporting this sales increase is drop in fuel prices and stable interest rates all this leading to increase consumer confidence.

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Two Wheeler

The Indian two wheeler industry, largest in the world in terms of volumes, is the only pocket that has been able to show a continuous increase in its volume in last five years ending March 2014. The two wheeler segment has grown at a CAGR of 15 per cent for the five year ending FY14 and unlike other segments that have shown a negative growth during last year, sales of two-wheeler segment in India has increased by seven per cent.

In the first half of 2015, the two-wheeler industry’s growth was even stronger with sales volumes expanding by a healthy 19 per cent on yearly basis, the fastest pace of growth in last four years.  While strong demand for scooters that contributed a little more than quarter of total domestic two-wheeler sales of the industry has been the primary driving force behind overall two wheeler industry expansion in the last few years, the motorcycle segment’s contribution to this segment growth gained momentum in the same period by virtue of greater replacement demand and new model launches by various original equipment manufacturers (OEMs).In terms of sales by company, Hero MotoCorp continues to remain the leader with a share of more than two-fifth at the end of 2014-15. For the first six month of FY15, company sold 14.5 per cent more unit than what it sold in the same period last year. In H1FY15 company sold more than 34 lakh units. In terms of growth, TVS Motor has exhibited best growth among the listed players. The cumulative sales unit for first half of this financial year stood at 1239133 units, an increase of 28 per cent from last year same time. The other leading Indian two-wheeler OEM namely, Bajaj Auto has experienced a tepid growth in their two wheeler segment (including exports) in the first half of FY15. The company posted volume growth of mere 3.8 per cent on yearly basis for H1FY15.

Going forward this segment will continue to grow at around ten per cent. This will be supported in short term by replacement demand, however, in longer term, there are various structural positives attached with domestic two-wheeler industry like that will drive the future growth of the industry. Some of them are favourable demographic profile, moderate penetration levels growing urbanization and large opportunity available to grow presence in overseas markets, mainly Africa and Latin America.

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Outlook and valuation:

The worst seems to be behind for the auto industry and all the headwinds that hindered the demand for the sector are fading away. Interest rate, one of the most important factors in determining the demand for the autos has remained stable for some time now. Moreover, the recent trends in the inflation measured by both wholesale price index (WPI) and consumer price index (CPI) are coming down fast, which will give the central bank the leeway to cut interest rate. If we analyse the yield movement of bonds, it indicates we may see cut in key policy rates earlier than expected. This will definitely help to boost demand for the auto industry.

The moderation in interest rate will also accelerate the infrastructure activity that has high co-relation with the CV sales. What will also fuel the demand for the autos is the fall in the crude oil prices, which are already trading at two year low and is likely to remain at the subdued level for some time now. Moreover, one should not forget that demand in the sector has remained subdued in last few years that has already led to the pent up demand.

All this augurs well for the auto industry going forward. Therefore, outperformance of auto company’s share prices in last one year is not without any reason and hence has been one of the best performing sectors. Regardless, as we explained earlier auto stocks are early cycle outperformer and almost all auto stocks performed well.

The rise is so much so that many of them are trading at valuation that is premium to their historical valuations. For example shares of Maruti Suzuki and Eicher Motors are currently trading at price to earnings (PE) ratio of more than 22 and 33 times of their forward earnings compared to average historical PE of 14.5x and 17x respectively.

Infact all the major listed players except for Tata Motors are trading at their above average historical valuation. Ideally this should call for caution on part of investors towards the auto stocks.  Nevertheless, we believe that valuation multiples to remain at this level or might go up even from this level as we expect demand environment to improve from here on and that will drive earning upgrades for auto companies that in turn provides comfort to the rich valuations. Therefore we remain positive in the sector and these are the stocks we believe will outperform the sector and market going forward.

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Economy linked to growth of auto industry @ 8.5%

India’s largest carmaker Maruti Suzuki India (MSI) states that a 4-5% economic growth is not good enough for the auto industry to grow at an ideal rate. Secondly, this sector needs a lower inflation. In addition to this, structural and legal hassles in doing business are other challenges that are needed to be addressed. A rate cut will be a shot in the arm for the industry. So folks do enjoy the bumpy ride.

In the existing year Maruti Suzuki has managed to stay ahead of competition in small and premium small car segments performing well. Up ahead how do you expect the growth of small car segments to be and would that result in achieving a robust market share in future also?

I think the small car segment will continue to be the most important automobile sector in the country. We won’t become  China-like market, where big cars rule the roost. In India surely small cars will continue remain  the dominant sector in future. For Maruti Suzuki also it is a very important segment, but it is very difficult to comment on market share as different times and circumstances come into play and I don’t want to comment on future prediction about market share.

Of late we have seen some spurt in automobile sales. In future do you foresee this growth to be sustainable?

First of all there is no substantial growth in sales till now and, if you ask me, then certainly I expect much higher growth in coming years. As the economy grows, auto industry too will grow. If we compare today’s growth with past years then we have to keep in mind that today our base is quite large, so to achieve a growth of say 10% is quite difficult. On the other hand our industry is very much linked to the growth of economy. Now if our economy is expected to grow at 6.5% next year then I would imagine that the car industry would probably grow by 8% to 8.5% and, compared to the growth we had in last 2-3 years, a growth like that would be good for the industry. I surely believe that the car industry has bottomed out as some growth has come and the industry is not nearing its end now nor in future also.

How do you expect the premium Sedan C segment to grow in the coming fiscal year after the launch of new CIAZ model by the company? Are you planning to launch more models in this segment?

You have to first understand that CIAZ is not a new segment at all for Maruti Suzuki and it has been launched in the same segment of SX4 and erstwhile Baleno. So we are already present there and now the company has given a premium feel to this segment with the launch of new CIAZ.  We are obviously bullish on this segment but as far as launching new models are concerned, we usually don’t comment on that strategy of the company.

Rate of interests is still a concern for the automobile sector but with decline in CPI and WPI do you foresee a rate cut in the near future and its impact on the auto sector?

Certainly high rate of interest is one of the main concern for the automobile sector as it is for any other industry. Currently some indicators of the economy like inflation do point out that the rate of interest would come down, but nobody can say when it would happen. If inflation continues to decline and remains down and if RBI is confident that inflation won’t flare up again then surely there would be a rate cut. If it happens then it would be a big respite for all industries, including the automobile sector, as it reduces the cost of car ownership. We have to keep in mind that due to rate cut, affordability of a car increases but it is not the only factor that it will improve the sales of cars dramatically. Surely it will be a big positive. We have to keep in mind that rate of interest is dependent upon supply and demand, the monetary policy of the country. If there is a rate cut then it would be the right shot for the industry as a whole.

What are the two main concerns that currently affect the growth of automobile sector?

I think the first concern of the industry as a whole is the low economic growth. It affects all sectors including the automobile sector. Growth of economy has to be higher for any industry to grow at a brisk pace. In fact it is big a concern that the current economic growth is much lower than what it should be. A 4-5% economic growth is not good enough for the auto industry to grow at an ideal rate. Secondly automobile sector needs a lower inflation. In addition to this structural and legal hassles in doing business are other challenges that are needed to be addressed. The new government under Prime Minister Narendra Modi is trying to do just that. Actually that’s all part of the package to make doing business easier. If doing business becomes easy then it will lead to reduction in the cost of doing business in the country, which ultimately leads to more affordable products to the consumers. We have to understand that manufacturing is all about competitiveness and what Mr. Modi is trying to make industry more competitive.

Compact SUV segment is growing fast, do you think this segment is sustainable and what is your strategy for the same?

We are also planning to enter into the segment of compact SUV and it will enter the market in 2016. I am hopeful this segment will continue to grow in next 5 years. In fact, if you ask me, then big expensive Sedans and SUVs market will also grow in coming times along with small car segment but in proportion to overall market they will still remain low.

What kind of capex will Maruti undertake in coming 2-3 years and what is capacity building plan?

Our annual capex usually remains around Rs 4000-5000 crore per year and it will continue on the same line. As far as capacity building is concerned there is no more space for expansion in our Gurgaon and Manesar plants in Haryana. The next phase of capacity building is expected in our Gujarat plant. As all cars plants come up in a phased manner, the first phase of 2.50 lakhs cars capacity in Gujarat plant will come up by the middle of 2017. Also going by the amount of land we own in Gujarat, the total potential capacity of that plant could go up to 1.5 million cars, which obviously takes years to come. Production mix of our future capacity will be dependent on market condition and whatever products the market require, we will produce there.

How do you take the fierce competition in the sector, is it a threat to your leadership?

Competition is always good for any industry, consumers and everybody else. So there should be competition in all industries. If some companies are not able to face up the competition, market will ensure that they wind up shop, but as long as competition is there it will ensure that everybody in the market will work hard and remain smart.