Sector fundamentals likely to improve: We believe automobile volume growth will improve over the next three years (FY14-17) as the two biggest factors that drive automobile demand, per capita income and cost of ownership, are likely to be favourable for volume growth. We expect passenger vehicles to report sharper volume growth than two-wheelers due to pent-up demand and lower penetrations. We maintain our positive call on the sector and like Bajaj Auto, Mahindra & Mahindra Ltd, Maruti Suzuki India and Tata Motors. We have raised our target price for Maruti Suzuki to Rs 2,025 (from Rs 1,900 earlier).
Key trends that are likely to play out over the next few years in the sector
* Our analysis of the past 10 yearsí trend in automobile demand indicates that volume growth recovers sharply when there is strong rise in real income. Demand rises at a strong pace when real income grows sharply even if cost of ownership also rises at a fast clip. Real income growth is the biggest driver of automobile demand in India, in our view.
* Automobile demand was quite strong during FY07-10 (double-digit growth) when growth in real income per capita averaged around 7% while cost of ownership was flattish. However, over the past two years (FY12-14), demand has slumped as cost of ownership has increased sharply while growth in real income per capita has declined to an average of 4%. We expect real income per capita to slowly improve to 5-6% levels while cost of ownership to remain subdued, which should aid in 10-12% CAGR (compound annual growth rate) in automobile demand over the next three years (FY14-17).
* A divergent trend was seen to the above highlighted thesis in case of the utility vehicle segment growth. The utility vehicle sector (including SUV, multipurpose vehicle and vans) has grown at a faster pace over the past 10 years than passenger cars (17% CAGR versus 13% CAGR) despite a sharper increase in cost of ownership. We believe the key reason for such a trend was the strong growth in the mini-SUV (sports utility vehicle) segment, which attracted lower excise duty rates.
* We expect mini-SUV demand to outstrip passenger car demand as the mini-SUV segment takes off. We believe FY16 could be a strong year for the UV sector as manufacturers will launch four new SUVs and two MPVs (multipurpose