The industry is in a boom phase. Rising stock prices, hence, are accompanied by falling valuations
One of the best indicators of consumer demand is the state of the automobile industry. Rising auto sales are usually indicative of a healthy economy, which is why there's a grain of truth in the old saw, "What's good for General Motors is good for America". (The opposite is also true unfortunately.)
A vehicle is a big-ticket item. Any vehicle is also the end-product of several value-chains, which means the auto-market has multiple externalities. In most cases, vehicle sales are financed, and again, higher sales indicate interest rates are at acceptable levels.
The Indian auto industry has made a spectacular recovery in the past nine months. According to numbers released by SIAM (Society of Indian Automobile Manufacturers), after near-stagnation in 2007 and 2008, calendar 2009 has seen domestic auto sales up 17 per cent to 1.13 crore units (all categories combined) compared to 96 lakh units in calendar 2008. The December 2009 sales of 10 lakh units were an amazing 70 per cent higher than December 2008 sales of 6 lakh units, suggesting that the recovery is gaining momentum.
December was not a flash in the pan. It was the ninth straight month when sales grew year-on-year and November also saw 60 per cent growth in unit sales. The growth has been spread more or less evenly since passenger cars, two wheelers, three wheelers and commercial vehicles have all seen double-digit growth.
Part of this is due to a base effect with stagnation through most of 2007 and 2008. Apart from the overall recession that affected consumer confidence through 2008, the effect of higher interest rates and rising fuel costs was definitely felt.
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The stimulus packages early in 2009 did their bit to help. Moderating interest rates and tax cuts also played a part in reviving demand. Automakers have all displayed slick marketing skills and great courage with a series of new launches made under daunting circumstances.
The recovery in the Commercial Vehicle (CV) segment would suggest that a jump in GDP growth rates since goods traffic is usually an excellent proxy for GDP growth. Truck and bus sales have more than doubled year-on-year in December 2009, though they were still below 2007 peaks.
Margins have also risen for most automakers. The cost of raw materials and components has fallen in the past year, when metal prices softened. The brightening industry prospects are reflected in the fact that most auto stocks have comfortably outpaced the Nifty in the past 6-9 months.
The boom phase of the last auto-cycle lasted five years, and the following bust phase lasted around two years. Between 2002-03, and the peak in 2006-07, the market expanded by over 70 per cent. The current cycle has moved into expansion mode just about 9 months ago and if it is at all comparable to the last cycle, the industry should have several years of growth ahead.
Several factors underpinned the last boom. Apart from rising per capita income, retail credit became a lot easier to access during that period as banks and non-banking finance companies (NBFCs) started to focus on individual customers. At the same time, the first massive road building plans were put into execution by state and central government agencies, creating roads that could handle rising traffic volumes.
The per capita income growth story remains strong and should in fact, strengthen further over the next two or three years. Retail financing has become more freely available and more sophisticated, especially in the vehicle segment. The UPA is apparently committed to reviving energising the road-building programmes after relative stagnation in the past couple of years.
There are possible hindrances to growth, of course. Last year delivered a nasty shock to a new generation of consumers, who suddenly realised that even white-collar MNC jobs were not safe in a global recession. Interest rates are not low at the moment and could rise soon. The ambitious road-building projects are mostly still on the drawing board.
Most auto stocks and auto ancillary stocks are quite highly valued since anticipated growth has been factored into prices. Nevertheless, growth prospects appear to be very strong and could well beat expectations in the coming fiscal. Auto industry financials are characterised by one classic cyclical pattern. Rising stock prices are accompanied by falling PE ratios since profits outpace valuations during the boom phase. There is every chance of this happening in 2009-10 and 2010-11.