Dec 24, 2003|
Auto in 2003: A perspective
If one were to consider the lead indicators of recovery in economic activity and consumer demand, the importance of automobile sales cannot be understated. Thus, unlike select sectors that feel the impact of a recovery with a lag effect, the auto sector generally witnesses significant growth in rwhevenues and profitability in the initial phase. So, when profits grow at a faster rate, stock markets also tend to reward it in a big way. This is how one could sum up the performance of the auto sector in one paragraph in the last one year. However, consider the outperformers within the sector and what are the prospects of the auto sector going forward.
It is not that the auto sales started to look up only in FY03. It all started in September 2001, the momentum gained ground in FY03 and the pace of growth has only accelerated for the large part of FY04. This is highlighted from the table below that shows the YoY growth in volumes sold across segments for the first eight months of FY04 with a perspective on FY03. As is apparent, barring light commercial vehicles (LCVs) and the two-wheeler segment, the YoY growth in units sold has outpaced what one saw in FY03. The tractor segment, which saw a YoY sales decline for the third consecutive year in FY03, has also seen a lower decline in volumes sold for the period between April to November 2003. Clearly, the utility vehicle (UVs) commercial vehicle (CVs) have outperformed the two-wheeler segment in terms of volumes sold with the tractor segment underperforming in a big way.
In a nutshell...
Source: M&M website and our estimates, *YoY growth
|HCVs & Buses
**Comparative data for April to October
Ideally, shouldn't the stock market mirror this? Indeed, it does, as is evident from the graph below that highlights the gains, if one had invested Rs 100 in these stocks a year ago. Mahindra & Mahindra (M&M), which has presence in UVs and tractors, has outperformed (231% gain YoY) followed closely by commercial vehicle manufacturers like Telco (166% gain) and Ashok Leyland (160% gain). Though volumes grew at a faster pace, in light of a competitive environment, two-wheeler majors have not been able to reap the full benefit and therefore have underperformed on a relative basis.
Having looked at the auto sector performance in FY03 and 9mFY04, what does future hold for the sector? Will revenue growth continue at a brisk pace and do current valuations reflect the medium-term growth prospects? Historically, there has been a co-relation between growth per capita income and automobile sales. Just to put things in perspective, while GNP per capita (gross national product) grew at a CAGR of 11% between FY71-FY01, passenger car production increased by 9%. The co-relation seems to be stronger, even if one considers the twenty and ten year trend.
While economic prospects are promising for the long-term, it is pertinent to emphasise two key factors that we believe would continue to provide strength to automobile demand. Firstly, the government spending on infrastructure is likely to improve road connectivity and enable manufacturers to target the under-penetrated semi-rural and rural market. This is well supported by cheaper financing cost, better availability of finance in light of expansion of branches and products by the banking sector as a whole.
Just to quantify our belief, we expect the auto sector to grow in line with the GDP in the long-term of 3 to 5 years. Coming to individual segments, we expect UV demand to grow at a CAGR of 10% over the next 5 years with CV volumes estimated to grow by 7%-8% for a similar time horizon. Though the tractor segment is likely to see a sharp spurt in volumes in FY05, but it will grow at a much slower pace of 5% over the next 5 years. We also expect motorcycle and passenger car sales to grow at a CAGR of 12% and 8% respectively over the same period.
But the key factor one has to ascertain is how much of this growth is already reflected in current valuations. Of course, auto majors are looking at exports to grow volumes significantly in the future. While we have exercised conservatism on our export projections, the table below highlights valuation based on P/E on a relative basis. While we expect the tractor sector to post a sharp rise in volumes in FY05, much of it seems to be factored in when it comes to Punjab Tractors. In the case of two-wheeler and car segments, it has to be remembered that it is a very competitive environment in the domestic market and margin expansion beyond FY04 will be limited. Given this backdrop, barring a few opportunities, investors have to exercise caution if the investment horizon is less than 2 years.
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