India’s car industry appears to be at an inflection point. Car sales tend to accelerate after the penetration rate passes 20-25 cars per 1,000 people – the point where India is now. We expect this rate to rise to 65 by 2025, translating into a sales CAGR of around 10% over FY15-25. Based on evidence from Japan, Korea and China, the risks to our forecasts are to the upside, providing economic growth and job creation don’t disappoint. This data-driven story is supported by powerful aspirational forces – more people are buying bigger, fancier cars. This bodes well for market leader Maruti, which has the best product range and distribution network. In the near term, both Maruti and Mahindra & Mahindra should benefit from strong rural demand and higher spending by civil servants.
Penetration and premiumisation = strong long-term growth
After six years of volatility, India’s car market looks to be on the verge of a period of sustainable, multi-year growth. Empirical data from Asian countries such as Japan, Korea, and China suggest that a penetration rate of 20-25 cars per 1,000 people is an inflection point that triggers acceleration in car sales.
We expect the rate of ownership in India to rise from 25 per 1,000 people to 65 by 2025, translating into a sales CAGR of around 10% over FY15-25. And judging by what happened in Japan, Korea, and China, the risks to our forecasts are to the upside. This long-term sustainable growth story is of course contingent on a commensurate rise in macro-economic indicators such as GDP, per-capita income, job creation and road construction, just as it was in the other Asian powerhouses.
Although the short-term picture is clouded by weak employment numbers in important white-collar industries such as IT, banking, e-commerce, and telecoms, sales of passenger vehicles have held up reasonably well. For example, market leader Maruti has continued to grow annual volumes by almost double digits. But this report is more than a statistical story based on rising penetration rates in other countries. The other important driver of growth in India is a very human one – premiumisation. Owning a car is a status symbol, but buying a new, larger, smarter vehicle is one step further down the aspirational road.
There are clear signs that the pace of premiumisation is accelerating. For example, the market share of sports utility vehicles (SUVs) has almost doubled in five years. In our view, the twin forces of penetration growth and premiumisation will help the industry move into a period of strong, sustained growth, a welcome relief after a steep fall in sales over FY11-14, and a slow if steady recovery since.
In this report we explain how to play these themes and also look at the shorter-term outlook for Maruti and Mahindra & Mahindra (M&M), the competition they face, the market positioning of their products, and the demand drivers. While we expect private sector demand to pick up over the next 2-3 quarters as macro conditions improve, it is the rural economy that is driving growth, helped by forecasts of a normal monsoon.
We slightly increase our earnings estimates for FY18 and FY19 to account for recent strong volume performance. As a result, we revise our target price to Rs 7,800 from Rs 6,700, which implies 11.7% upside from current levels. We continue to rate the stock a Buy because of the long-term structural growth story, driven by the company’s strong product portfolio and distribution reach. While Maruti is the main beneficiary of the long-term growth story, we see more value in M&M over the next 12 months due to higher exposure to the rural sector. The forecast for a normal monsoon and improved crop yields from the recent harvest should help demand.
Value growth stronger than volume growth
India’s passenger car market, the world’s fifth largest by sales, has grown at mid-to-high single-digits over the past three years. However, we believe industry “value growth” is much better than reported. While overall volumes grew about 7% in FY16, value increased around 10%. In FY17, industry volumes grew 9% y-o-y and value 12-13%.
This trend is being driven by buyers upgrading to sports utility vehicles (SUVs) from mid-size sedans and to premium hatchbacks from mid-size hatchbacks. We also believe first-time buyers are going for second-hand mid-size hatchbacks over entry-level small hatchbacks. The average price of second-hand cars is rising, which is helping people upgrade. We expect this process of “premiumisation” to continue.
Competitive landscape remains benign
Competition remains benign. Maruti (MSIL), which has nearly 50% of the passenger vehicle market, continues to outperform in terms of new launches, upgrades, and expanding its distribution reach. In our view, this had led fringe players like General Motors/Volkswagen to focus on exports in order to make their domestic operations economically viable (see the section titled Exports will be the focus for foreign OEMs).
Maruti’s strong market position is often attributed to its extensive distribution reach and low cost of ownership. No doubt this is true, but we believe Maruti’s biggest strength is its product portfolio, both in terms of choice and price. Most of its competitors have a limited number of successful models, which makes it difficult to retain customers or cross-sell products. Maruti, on the other hand, enjoys a virtuous cycle of new and old car sales. A higher number of successful models leads to better cross-selling and upgrades. This, in turn, leads to higher overall volumes, creating a network effect, higher resale value for Maruti cars and customer preference to buy new models.
Maruti’s second-hand business, True Value, continues to grow and is one of the company’s key strengths, with over 1,200 showrooms and outlets and more than 400,000 sales (exchanges) in 2016. The shift from an unorganised to an organised second-hand market should further help the growth of True Value. Maruti’s ability to spend on land acquisition should further help the True Value franchise and Maruti’s overall leadership position in India’s car industry.