Dec 27, 2005|
Auto: A long-term play!
Last year, we had said that auto stocks are no more a 'value buy'. Stock prices and valuations will be influenced by performance, which is increasingly becoming competitive. In this context, the risk profile is on the higher side. At the end of 2005, the actual performance of the automobile industry reflects our statements. If one had invested Rs 100 in the entire basket of auto stocks (represented by the auto index) at the end of 2004, one would have marginally outperformed the BSE-Sensex (see adjacent chart).
On the volumes front, financial year 2006 (till November) had been a mixed bag for the sector. While two-wheelers and tractors continued to witness robust volumes growth, the performance of commercial vehicle (CV) and passenger car manufacturers were unimpressive. Even within segments, there was divergence. In the CV segment, medium and heavy commercial vehicles (M&HCVs) registered a marginal 1% YoY growth. This has been more than adequately compensated by a stupendous demand growth in the light commercial vehicles (LCVs), which grew by 21% YoY. Similarly, while passenger car volumes grew by just 5% YoY, utility vehicles maintained a robust growth of 10% YoY. In the two-wheeler space, while motorcycles grew by 19% YoY, the demand for scooters declined by 5% YoY.
|What we said at the start of 2005?|
Volume growth across segments, barring tractors, is likely to slowdown in FY06 and beyond, on the back of higher interest rates and significantly higher fuel prices.
Two-wheelers will continue to remain competitive and scope for margin improvement will be restricted.
Given the fact that the Indian passenger car manufacturers' operating margins are significantly higher than some of the best auto manufacturers in the world, the decline seems inevitable.
As can be seen from the above chart, the performance of the automobile sector, except for the two-wheeler segment, has been in line with our expectations. However, in the CV segment, the key driver has been LCVs, as against M&HCVs. The impressive growth in LCVs is largely due to creation of a new 'sub-one tonne' category, with the launch of 'Tata ACE' (this segment was non-existent till now). The lack of demand for M&HCVs can be attributed to the rise in fuel prices and 'government's indecisiveness' on the implementation of emission norms in Northern parts of the country. This affected the volume growth of Tata Motors, as it has a significant presence in this region. Also, the fact that certain parts of the country witnessed natural calamities did not help either.
|What is the actual scenario?|
The two-wheelers continued to witness strong growth, led by motorcycles. This was primarily due to a series of new launches that resulted in upgradation within segments. Apart from this, benign interest rates and higher disposable income also aided demand.
In line with our expectations, tractor sales continued to grow at a healthy pace. The advent of good monsoons (both in quantity and in spread), last year as well as in this year, has had a positive impact on food grain output in both the years. Easy availability of loans also played an important role. The performance of the tractor segment has to be viewed in this background.
On the operating margins front, most of the companies under our coverage reported an improvement, contrary to our initial expectations. This has been partly due to better product mix and partly due to price hikes announced by the automobile manufacturers. It should be noted that companies have announced a price hike in the range of 1% to 2.5% during the current fiscal.
M&M continued to be the outperformer for the second consecutive year. A deeper analysis into the performance of the company reveals that the optimism is justified. During 2005, in the tractor segment, the company has managed to outperform the industry growth of 14% YoY (upto November 2005). This has enabled M&M to increase its market share from 27% in FY05 to 32% in FY06 (upto November 2005). Similarly, on the UVs front, though M&M has lagged the industry growth in totality, the product mix has been improving (as company is selling more of 'Scorpio' and 'Bolero', where the margins are relatively higher). Apart from this, the company has been able to make inroads in the different international markets.
The stock of Punjab Tractors has been the laggard for a long time now and 2005 was not different. It should be noted that the company has been losing its market share since FY01. In FY01, the company had a market share of 18%, which has been gradually declined to 11% in FY06 (upto November 2005). Having said that, one should commend the efforts of the company to improve operating margins in the current year, especially when its peers were facing raw material cost pressures. On a relative basis, the performance of the company at the topline level is far from impressive. At the end of the day, the auto sector is about higher volumes, as the scope for margin improvement beyond a threshold level is limited. Punjab Tractors has to regain market share to outperform going forward.
We expect the growth rate to slowdown to single digits in FY07 (barring two-wheelers). Not only will high base effect restrict the YoY growth, higher fuel prices and expected increase in interest rate could also act as a dampener.
|The laggard: Punjab Tractors|
Secondly, competition is likely to intensify further, especially in passenger vehicles and CVs. Apart from existing players like Telco, Maruti, Hyundai, Ashok Leyland and M&M that have aggressively capital expenditure plans, new players like Renault and MAN also have growth plans. This could alter the demand-supply situation and thereby, impact the pricing power. However, falling steel prices could provide some cushion to margins, as steel account for around 55% of operating costs.
As far as valuations are concerned, from a 2-year perspective, most of the positives have already been factored in. Having regards the cyclical nature of the industry, the risk to reward ratio is skewed in favour of the former. However, from a long-term perspective, an investor should invest in such companies that have or will have a significant global presence. Similarly, diversified product portfolio can also play a compensating role, thereby providing some insulation against the downside risk (underperformance by any one segment). It should be noted that the automobile sector is said to be a barometer of the economy. If the economy is expected to maintain its growth rates, the automobile industry should be a key beneficiary. Where we differ is on valuations, even as we remain positive on the long-term growth prospects.
To read our thoughts on year 2005 and our view for 2006, click here - Reflections 2005.
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