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Automobiles: The going gets tough - Views on News from Equitymaster
 
 
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  • Jan 9, 2001

    Automobiles: The going gets tough

    Automobile stocks have consistently underperformed over the past year due to poor market conditions. Almost all sectors of the automobile industry i.e. commercial vehicles, passenger cars, scooters, mopeds and tractors have seen a slowdown in sales. The only exception has been motorcycles, which saw robust demand from the rural sector and change in consumer two wheeler preferences.

    The factors that adversely affected demand were implementation of the uniform sales tax, drought conditions, hike in oil prices, a slowdown in industrial and agricultural production. For the period April-October 2000 volumes in medium and heavy commercial vehicles (M & HCV's) fell by 20%, passenger cars by 2%, scooters by 20%, and tractors by 9% YoY.

    On the costs side too, auto companies faced tremendous pressure. Due to increasing competition companies have been aggressive on new product launches in the past year. Margins on these new products are thinner as compared to their earlier established brands. New products also add to the marketing and advertising burden. The costs associated with euro compliance also added to the operating expenditure. As demand side conditions were not favourable most manufacturers were unable to pass on the increase in compliance costs to consumers and had no option but to absorb them. This contributed to the drop in operating margins for the auto sector in the 1HFY01.

    Operating margins (%) 1HFY00 1HFY01
    Telco 7.1 5.9
    Ashok Leyland 7.4 7.0
    Bajaj Auto 14.9 8.0
    Hero Honda 13.4 12.9
    TVS Suzuki 11.1 8.8
    Mahindra & Mahindra 10.6 5.2
    Punjab Tractors 17.4 17.5

    Commercial vehicles

    In the M & HCV sector, Telco and Ashok Leyland faced tough times during the year. Their CV sales from April to October 2000 fell by 25% YoY and 11% YoY respectively. Ashok Leyland, however was better off due to its strong presence in the growing bus segment. It was also helped by the stricter emission norms in the capital city of New Delhi, which saw the state transport undertaking placing orders to replace older vehicles.

    To save its market leadership position, Telco has decided to come out with new models in the 2 - 40 tonnes range. The move is aimed at reviving the market and face future competition. Competition in this segment is expected to go up with the entry of Volvo during the year.

    Volumes in the utility vehicles (UVs) segment grew by 8% YoY during the first seven months of the current year. However the only players to register gains were Telco's Sumo and Toyota's Qualis. Qualis has eaten into the market share of most other players. Mahindra & Mahindra (M & M) reported a decline of 18.4% in volumes, Bajaj Tempo volumes declined by 19% and Maruti Udyog a decline of 55.2% YoY. M & M 's market share fell from 58% in FY2000 to 46% in the current financial year.

    The light commercial vehicle (LCV) segment showed a positive trend in the current year and grew by 11% in the first seven months of FY01. Ashok Leyland, Eicher Motors and Swaraj Mazda registered strong growth rates of 91%, 41% and 25% during this period. Telco's volumes went up by 11% and it continues to enjoy the highest market share in this category of 62%. Most of the players saw better volume growths in the export markets as compared to the domestic market.

    Passenger cars

    The passenger car segment faced mixed trends in the year gone by. While the medium and large size cars saw an improvement in volumes, the small passenger car segment registered a decline in volumes. The main reasons for this decline is the implementation of uniform sales tax, which made cars more expensive in certain important markets like Delhi. The introduction of new models saw a shift in consumer preference towards larger sized cars.

    Price hikes in the car segment cannot be ruled out in financial year 2001 as companies are likely to incur significant costs to make their products compliant with emission norms. Besides, the depreciation in the rupee too has added to the higher import bill of many of the multi-national car companies. As a result many companies have already announced price hikes in the passenger car segment to counter the increase in costs, effective January 2001. They are left with little choice, as the market is not showing any signs of improvement.

    Two and three wheelers

    In the three-wheeler market, Bajaj Auto continues to enjoy the highest market share (81% in FY2000). Though the three-wheeler market has been stagnant in the last couple of years due to licensing problems from various state governments, it is likely to revive as pollution norms across the country become stricter. To take advantage of this Bajaj Auto launched its 4 stroke, CNG model in May 2000 in New Delhi. For the period April-November 2000 the company sold 110,706 vehicles, a decline of 2%.

    The two-wheeler segment has been the most vibrant in the automobile sector in the past five years growing at a CAGR of 19%. The reasons for this are many: rise in income levels, impact of urbanisation, easy availability of finance and of course the most important fact, that two wheelers are preferred entry level vehicles. This being due to their low price and reasonable maintenance costs.

    Due to the fact that India has experienced normal monsoons for over a decade and rural incomes have risen there has been a significant shift in the composition of this segment. Scooters accounted for 44% and motorcycles 33% of the two wheeler market in FY97, this has changed tremendously. In the current year, scooters account for 26%, as compared to motorcycles which account for 55% of the two wheeler market. The market has grown in favour of motorcycles over scooters as 60% of motorcycle demand comes from rural areas. The urban economy has not grown as fast, hence low demand for scooters. Besides changes in consumer preference too is driving up the demand for motorcycles.

    In the coming year however, prospects of the motorcycle segment are under a cloud. Agriculture production declined by 2% in FY2000, and is expected to clock in a growth of only around 0.9% in FY01E. This would result in a slowdown in rural market demand due to the lag effect of agricultural income. Hence, it is quite likely that motorcycle demand will slowdown in FY2002.

    Tractors

    The past year did not start on a very good note for the tractor industry due to drought conditions in the states of Gujarat and Rajasthan. Monsoons in 2000 resulted in deficit rainfall in certain states and flooding in some others. As a result tractor volumes in 1HFY01 fell by 11.9% YoY. Though the scenario on high inventory levels has started to ease in recent months, the tractor industry is expected to close the year with a negative growth rate.

    Tractor major, M & M has however done well and garnered a market share of 35% in the current year (28% in FY2000). It has achieved this through a strategy known as 'advancing'. In this, the manufacturer gives the tractor on a trial basis with no immediate down payment. The amount is to be collected at a later date. Most other players have lost market share. However, this strategy of advancing might increase the bad debts of M & M.

    Valuations

    In terms of share price performance almost all the major stocks took a beating in the past year. Telco, the market leader in commercial vehicles underperformed the market due to slowdown of Indica sales as well as downtrend in medium and heavy commercial vehicles. Besides, the costs associated with the Indica project, higher usage of Cummins engines and costs associated with emission norms have resulted in Telco reporting a huge loss in 1HFY01. The company's share price which fell to a low of Rs 69, has now however made a come back. This is mainly due to the likelihood of its tie up with an international car company for its Indica division, its hard cost cutting measures to improve margins and re-introduction of its lower priced 697 engines in the CV market.

    In two wheelers, Bajaj Auto continues to seen a downward trend due to the fact that the scooters segment is degrowing and margins are under pressure as its sales mix shifts towards motorcycles. Though the company will soon be launching a no frill version of their traditional scooters in the hope to revive the dying market, in the near term any improvement seems unlikely. Also concerns regarding the company's huge other income component has kept investors wary of the stock and many opted to get out during the company's recent buy back.

    Hero Honda, continues to surge ahead on the back of higher market share and buoyancy in the motorcycle market. The concerns regarding Honda's 100% subsidiary did drive down the share price of the company. However as the company continues to be aggressive on product launches backed by support from Honda, has negated the fears. It is currently trading at 10.8x FY02 earnings, this is at a premium to its peers Bajaj Auto and TVS Suzuki. Though the trend in motorcycles is buoyant currently, investors need to be cautious on the likelihood that this segment is likely to face a slowdown.

    Tractor majors, M & M and Punjab Tractors too are down on the back of low demand for tractors. M & M also faces pressure on margins due to aggressive product launches and low demand for its UV's. Punjab Tractors is best positioned incase of a recovery due to its high margins, conservative financing policies and wide product range.

    Outlook

    The overall outlook for the automobile sector does not seem very bright in the coming year. The slowdown in the economy is a major concern for the industry. Specifically we do not see any vast improvement in commercial vehicles, passenger cars, two wheelers and tractors in the next few months. Though the demand scenario is unlikely to get worse, however it is unlikely to get better.

    On the margins front we expect the pressure to continue with new product launches and higher costs related to emission. Unless companies take huge steps towards cost cutting they are unlikely to see any improvement in margins.

    In terms of competition the auto sector is concerned about WTO regulations post April 2001. However, it is likely that the new auto policy would result in raising import tariffs across the board so as to favour the domestic industry. The auto policy is also expected to encourage manufacture of vehicles in the country and discourage the imports of assembled parts.

    In the passenger car segment there is likely to be a decline in excise duty from 40% to 32%. However this is unlikely to boost volumes as some car companies have already hiked prices effective January 2001.

    The Indian passenger car market could see a bout of consolidation in the next few years. With global consolidation becoming a normal phenomenon we feel that India too will face the same. In an industry that is saddled with overcapacity and steep competition, the key to survival has to be consolidation. Economies of scale in manufacturing, marketing, and distribution are the answer for better performance in future.

     

     

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