The surge in volumes translated into a strong y-o-y growth in topline and a sharp increase in operating profit margins for auto companies in the September 2009 quarter. While the going has been good over the last quarter or so, issues such as a rollback of excise duty cuts, Euro IV emission norms, higher raw material costs and the upward pressure on interest rates could cause problems for the sector.
Costly inputs
Lower prices of raw materials such as steel was one of the key reasons for higher operating profit margins of auto companies. The other reasons being the cut in excise duties and higher volume growth. However, the firming up of steel prices from the lows seen in May could put the spanner in the works bringing operating profit margins under pressure. While steel prices are up by 20 per cent to about $552 per metric tonne, aluminium prices are up by 50 per cent to $2,035 per tonne from their respective lows in May 2009. Analysts, however, believe that unless raw material costs shoot up on the back of a recovery and increasing demand, the impact on the short term will be minimal with most of it reflecting in the March quarter. Says an analyst with IDFC-SSKI research, “While prices of aluminium, rubber, crude etc have substantially moved up in H1 FY10, steel has not gone up on expected lines. Overall, we expect operating margins to be impacted by about 100-150 bps by the end of the fiscal relative to the first half.”
No more breaks?
One of the key reasons cited by companies such as Maruti Suzuki and Tata Motors for the improved showing in the September 2009 quarter has been the stimulus package. The stimulus introduced in the December 2008 and March 2009 quarters included a four per cent cut in cenvat, special line of credit for truck and bus financing, accelarated depreciation and the upgradation of the urban transport system under JNNURM. Citi Investment Research believes that there is a 70 per cent chance of the government rolling back the duty cuts. IDFC-SSKI believes that given the risk of overshooting the budgeted fiscal deficit, the government is likely to partially roll-back the excise duty reduction for segments such as passenger cars. The biggest impact of any withdrawal of the stimulus measures for sector will be on the commercial vehicle segment, which has been struggling with problems of a drop in demand, lack of financing options for truckers and higher interest rates. While consumer sentiment is much better now than when the duty cuts were announced, analysts say that the impact will depend on the quantum of price increases that are effected by the companies in case of a rollback. On the exports front, the withdrawal of scrappage incentives in Europe from CY2010 would impact Maruti Suzuki the most as exports account for 14 per cent of its volumes.
Costly norms
The implementation of tighter emission norms from April 2010 for cars and trucks to Euro 3/4 standards could increase the cost of vehicles and lead to increase in prices. Commercial vehicle sales are expected to jump in the March 2010 quarter due to these provisions as dealers push more lower-priced vehicles before the change over takes place. Tata Motors, which expects the emission norm changes to induce pre-buying, will be the biggest beneficiary of the change as it commands a 63.5 per cent market share in the medium and heavy commercial vehicle (M&HCV) segment.
Pressure on rates
Interest rates have been benign so far and more banks are now lending to the sector than was the case a year ago. However, considering that inflation is moving up and the RBI has turned hawkish on its monetary policy stance expect rates to harden, with the impact most severe on CVs and least on cars and two wheelers in that order. Says Sachin Mathur, head of research, Crisil Research, “While there may be an upward pressure on interest rates especially in the March quarter, CV segment will be affected more than passenger vehicles.” Analysts believe that the cash component could replace a part of the credit in the latter’s case. While truck owners and fleet operators who buy the vehicles entirely on credit will find it more difficult to repay their loan instalments, the situation in the case of cars (about 70 per cent of passenger vehicles are on credit) is less severe. Expect companies such as Hero Honda and Maruti Suzuki, which get a larger share of their revenues from the rural markets –40 per cent and 15 per cent respectively, to be impacted less than other auto players.
While these factors could slow down growth, the likelihood of a strong recovery in the second half of FY10 and a low base has led most analysts to bet on a y-o-y volume growth of about 15 per cent for FY10 and about 10-12 per cent growth for FY11. Saturated urban markets and an existing high base could mean single digit growth rates for two-wheeler makers in FY11. Commercial vehicles could record a growth rate of 10 per cent in FY10 largely on account of light commercial vehicles which could see a 25 per cent jump in volumes in FY10. Moreover, CV growth rates in the December 2009 quarter are likely to be higher because of the low base last year. Expect M&HCVs to register marginal to flattish growth in the current fiscal. Expect a 12-15 per cent growth for passenger vehicles in FY10 and FY11. The only factor that could help companies sustain momentum is obviously, a stronger than expected economic recovery which would rub positively on consumer sentiment.
We look at the prospects for India’s largest listed auto entities.
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Tata Motors
The key issues over the next few months to look out for in Tata Motors would be the impact of rising raw material prices, sales in the March quarter due to pre-buying and performance of overseas subsidiary, JLR. The company believes that higher volumes are likely to mitigate the increase in raw material costs thus neutralise the impact on operating profit margins which jumped 579 bps to 13.36 per cent in the September 2009 quarter. Price increases could be another tool which the company could employ as it had done over the last year increasing prices on its M&HCV portfolio by about 7-8 per cent. Analysts believe that it will be tough for the company to hold on to these margins as most of the cost reduction measures have been taken and raw material costs are likely to move up.
While the expected pre-buying could boost volumes in the short term, economic recovery in sectors such as construction, mining will decide the growth of its M&HCV volumes in FY11. Thus far, strong IIP numbers for four consecutive months (June-September) indicate that demand could improve going ahead. JLR volumes could see some improvement as US auto sales have moved up sequentially and European auto sales were up on a y-o-y basis for October. Though the story is looking much better for Tata Motors due to the volume recovery, payment of the bridge loan and new product launches going ahead, the positives are already priced in. The stock after gaining nearly 15 per cent over the last one month is trading at an expensive 25 times its FY11 earnings.
Maruti Suzuki
With a 100 per cent capacity utilisation at its Gurgaon facility and its Manesar facility under expansion, India’s largest passenger vehicle maker is sitting on demand backlog or waiting period of 4-12 weeks on some of its top selling models such as Swift, Dzire and Ritz. Analysts say that neither the auto makers nor component suppliers expected the surge in festival sales, which were further worsened by the labour agitation.
While domestic sales driven by the strong showing in the rural sector and sales to government employees have been robust, the company could face hurdles on the export front as European governments wind down the scrappage scheme next year. The company is looking at alternative markets to fill the expected dip in demand and this will not be easy. The company has sold about 80,000 units in the fiscal year to date and has a sales target for exports of 130,000 for the fiscal.
Going ahead, the company is planning to increase its share of sales to the bigger cities and private sector employees. The management indicated that key concern areas for the company would be interest rates, liquidity, inflation and fuel pricing. With demand robust for its model and the Manesar plant likely to scale up gradually to 3 lakh units over the next year and a half, the company could achieve above industry growth rates for FY10 and FY11. At current levels, the stock is trading at 17 times FY11 estimated earnings. Considering that the earnings growth is projected at 18 per cent y-o-y for FY11, the scope for a major upside is limited. Buy at dips.
| MARGIN CONCERNS | ||||||||||
| in Rs crore | Maruti Suzuki | M&M | Tata Motors | Hero Honda | Bajaj Auto | |||||
| FY10E | FY11E | FY10E | FY11E | FY10E | FY11E | FY10E | FY11E | FY10E | FY11E | |
| Net sales | 27,287 | 31,668 | 29,001 | 32,416 | 67,721 | 78,437 | 15,516 | 17,996 | 10,575 | 11,936 |
| OPM (%) | 10 | 9.8 | 11.5 | 13.8 | 3.1 | 5.4 | 17.7 | 16.6 | 21 | 19.8 |
| Net profit | 2,236 | 2,629 | 1,968 | 2,213 | -3,108 | 1,255 | 2,105 | 2,284 | 1,381 | 1,577 |
| P/E (x) | 19.6 | 16.6 | 14.7 | 12.8 | ----- | 24.9 | 15.4 | 13.5 | 16.2 | 13.8 |
| Return on assets (%) | 14.2 | 13.9 | 8.3 | 8.5 | 0.7 | 2.4 | 29.2 | 26.7 | 23.7 | 21.6 |
| Cashflow per share (Rs) | 110 | 125 | 98.8 | 110 | 49.6 | 98.1 | 115 | 129 | 85.5 | 96.4 |
| Consolidated financials, Source: Bloomberg and analyst estimates | ||||||||||
Mahindra & Mahindra
India’s largest utility vehicle (UV) company saw its October sales surge 26 per cent y-o-y to 25,670 units on the back of a 32 per cent jump in sales of its UV range comprising Xylo, Bolero and Scorpio.
Farm equipment business, which contributes 40 per cent to revenues, also saw sales move up by a fifth to about 18,000 units. While tractor sales have been strong due to increase in rural credit disbursements and higher minimum support prices, going ahead expect growth rates to moderate post the festival season and the weak monsoon.
To capture a higher share of the fast growing LCV market, the company recently launched its sub 1-tonne vehicle Gio and is likely to make its entry into the motorcycle market next year. Volume growth, cost control and lower raw material prices which helped the company boost consolidated OPMs to 18 per cent in the September quarter will be hard to match as volume growth is likely to slow down and raw material prices are firming up.
The stock has jumped 17 per cent over the last one month and at the current price of Rs 1,040 is trading at 13 times its FY11 earnings of Rs 79. Analysts peg the sum of parts valuation at Rs 1,025 indicating that the stock has already run up ahead of fair valuations.
Bajaj Auto
Bajaj has continued its good September quarter