Hopes of rate cuts, demand revival prop Maruti Suzuki, M&M

Upsides for the stocks though would be capped, given rising competition & fair valuations

Led by Mahindra and Mahindra  (M&M) and Maruti Suzuki India, automobile stocks have rallied over   three months. The stocks have gone up on hopes of a rate cut, as well as demand recovery in the second half of 2013-14. In addition, the M&M stock rallied on hopes of a turnaround in its Korean subsidiary, Ssangyong, in the current financial year. Though both companies have made market share gains in April, and are leaders in their respective categories, given the run-up in share prices, there is little scope for appreciation from these levels.

Analysts peg the sum-of-parts valuation for M&M at Rs 925 (Ssangyong share Rs 33) and given the current price of Rs 987, there is little scope for upside. Maruti is slightly better on this count, given traction in demand for petrol vehicles, stabilisation of discounts and favourable foreign exchange movement on the back of a weaker Japanese yen. Its price targets (Rs 1,900-Rs 2,000) offer gains in the region of 12-17 per cent.

Rate cut, demand revival hope       
Volume growth and demand continue to elude most players with the only bright spots coming from rural-centric sales (tractors for M&M, Hero MotoCorp’s two-wheelers in rural sales). ICICI Direct’s Nishant Vass and Venil Shah say in a muted market, some greenshoots in terms of good products (Maruti’s Ertiga, Renault’s Duster) with right pricing have been successful and with Amaze doing well, the customer sentiment is ‘slowly but surely turning’. Further, the easing in the wholesale and retail inflation numbers provides support for rate cut actions and a decline in interest rates. With 70 per cent of cars financed on borrowed money, a cut in interest rates could help improve demand, feel analysts.

“Sales of four-wheelers are highly sensitive to interest rates, and hence, we could see demand rebounding as RBI (Reserve Bank of India) reduces rates. Furthermore, we expect strength in consumption demand in 2H (second half of) FY14, which should also help the sector,” say Barclays India analysts Bhuvnesh Singh and Kunal Agarwal. They estimate passenger vehicle sales to grow eight per cent in FY14 and 15 per cent in FY15.

M&M: Intensifying competition
The company saw its passenger vehicles sales stay flat on a year-on-year basis and dip 20 per cent in April compared to March. One of the reasons for the same was the three per cent increase in excise duty on sports utility vehicles (SUVs). Most of its vehicles with the exception of the Quanto and the Verito fall in the SUV category and are thus more expensive after the duty hike. This could be a dampener. While the company is banking on a rate cut to improve sentiments among buyers, it is imperative that M&M launches new variants which meet the criteria for lower excise bracket. While it has lined up the launch of the Verito Vibe in the first week of June, competitive pressures are also rising.

Rivals are also looking to be a part of the utility vehicle segment, which has high growth potential. After the success of Renault’s Duster, M&M now has to contend with General Motors’ Enjoy multi-purpose vehicle, which was launched last week, as well as Ford’s Ecosport SUV (launch due in June). Six more new launches by competitors are in the pipeline over the next two years and M&M may not be able to counter these as its own mid-size SUV (W105) is only slated to hit the market in mid-2015. Navin Matta of Daiwa Capital believes greater competition and a lack of new model launches will result in further marketshare losses for M&M in the utility vehicle segment.

Positively, while utility vehicle sales have been sedate in April, festival demand has helped push up volume growth for tractor sales, which were up 38 per cent year-on-year. Citi analysts, however, say there could be a build-up of inventory on expectations of a strong monsoon and the situation will be clear over the next couple of weeks.

Maruti: Core portfolio yet to fire
While Maruti’s Dzire and Ertiga continue to do well, growth in volumes for the company is linked to momentum for its bread and butter A2 segment (Alto, Swift, Wagon-R, Zen, A-Star and Ritz), which constitutes 60 per cent of its domestic volumes. Sales of these vehicles have been languishing due to the lack of diesel options, which, given the price differential, has been the biggest hurdle for India’s largest small car player.

While there is competition in the sedan space from the likes of Honda Amaze, so far there has not been much of an impact on Swift Dzire. The compact sedan sells as much as its smaller Alto model with a monthly run rate of 20,000 units. With its labour problem nearly sorted out, the company has been able to claw back its share in the passenger car market. Further, ICICI Direct analysts say Maruti will be able to regain its 40 per cent share (43 per cent in April, sub-40 per cent in FY13) with addition of new diesel capacity and outperformance of its petrol portfolio as diesel-petrol fuel price rationalisation happens.