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Auto: Is excise reduction beneficial? - Views on News from Equitymaster
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Auto: Is excise reduction beneficial?
Sep 9, 2005

Recently, there have been indications by the government of a reduction in excise duty on manufacturing of compact cars (Segment A and B cars). This has positively impacted the price of some auto stocks like Maruti and Tata Motors. In this article, we shall try to understand whether such a reduction in excise is actually beneficial to the auto company and if yes, then to what extent. A highly taxed sector
The Indian automobile industry is amongst the highly taxed ones. To put this in perspective, all passenger cars currently attract excise at 24%, sales tax at 12% (on excise as well as freight, thus creating a cascading effect), road tax in the range of 4% to 11% (rising with car costs) and octroi. Further, with the customs duty on components thrown in, the taxes together account for over half of what a customer pays for a car. Another interesting fact to note is the correlation of a reduction in excise duty with the growth in volumes. (see chart below)

As the proposal of reducing the excise duty is only for compact cars, the companies that are likely to benefit the most are Maruti and Tata Motors. It should be noted that compact cars account for around 75% of the volumes of the passenger car industry. Assuming that the cost of producing a car is Rs 2 lakh and it retails at Rs 3 lakh, an 8% reduction in excise will straightway enable a Rs 16,000 cut in its price (or 5% of the selling price).

What can be the potential effect of the reduction?

For the purpose of this article, we have restricted ourselves to the volume numbers of Maruti, as it is the leader in the passenger car segment with 54% market share and a significant presence (70% of the companyís total volume sales in FY05) in the compact car segment. Further, we have extrapolated FY05 and FY06 volume numbers to assess the impact of the above changes. Another assumption that we have considered is that the company will pass on 80% of the benefits to the consumers. Similarly, on front of price elasticity, we have relied on the study of National Council of Applied and Economic Research (NCAER). As per its report, the price elasticity is 1.8 times, indicating a change in demand by 1.8 units for a change in price by 1 unit. Thus for a 4% reduction in price of the vehicle, the additional demand should increase by around 7.2%. Putting all this into numbers the final picture will appear as follows.

  FY05 FY06
Incremental units 29,066 46,347
Incremental sales (Rs m) 9,214 15,431
NPM 7.8% 7.8%
Incremental earnings (Rs m) 719 1,204
No of shares (m) 289 289
Incremental EPS 2.5 4.2
EPS (FY05) 29.5 29.5
% increase in EPS 8.4% 14.1%

Post the announcement of the probable price reduction, Marutiís stock has already gained by 7%. This is when the indices have registered a 3% increase. However, one should also remember that the finance minister has just given an indication of a reduction of excise without specifying any time frame. Apart from this, he has not even specified the expected reduction in the excise rates i.e., whether it will be 4% or 6% or 8% (which we believe will be the upper band of reduction and on which our calculations are based on). Hence the current run up in the stock price based purely on the above-mentioned announcement does not seem to be justifiable.

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Feb 22, 2018 03:37 PM