Time to recalibrate?Maruti top buy, Bajaj top sell idea: While we remain positive on the long-term fundamentals of the Indian auto market, we believe there are significant headwinds to growth and profitability in the near-term. We expect sales growth to slow further in FY13e (estimates) due to a rise in ownership cost, weak sentiment and slower income growth. As stock valuations are not reflecting the near-term challenges; risk-return seems unfavourable. We recommend Outperform on MSIL (Maruti Suzuki) and Tata Motors and a contrarian Underperform on Bajaj Auto and Hero Motocorp.
Long-term fundamentals strong? prefer PV over 2Ws: Rising income, improving affordability and low penetration provides large growth opportunity for the automobile companies in India. We expect passenger vehicle (cars and UV) sales to double in next four years as we expect growth higher than 16% CAGR (compound annual growth rate) achieved in the last ten years. Further, the margin profile for PVs (passenger vehicles) is likely to be stable as strong finance presence (70% vs 10% in China) limits the scope of sharp price cuts (like China). We expect 2W (two-wheeler) sales growth to be slower (10% CAGR) over FY12-16e as 2W penetration in urban India has reached high levels similar to other mature markets and incremental growth will be expensive.
The year ahead?where is the growth?: After two years of 26% growth, auto volume growth slowed to 12% in FY12. We expect a further dip in growth to 10% in FY13e due to slower rural income growth, weak consumer sentiment and high ownership cost. Our analysis indicates that rural consumption will remain subdued in the near-term. We think 5-10% hike in fuel prices is inevitable, which will further delay the pick-up in growth.
Competitive intensity to rise in 2Ws? how will Bajaj react?: In the medium-term, we expect competitive intensity to rise most in 2Ws as Honda (third largest player) plans to up production capacity by 60% in the next 12 months and expand sales reach to non-urban markets. Honda will aggressively price its new bike, Dream Yuga, which they claim, offers best fuel-efficiency and power in the segment. Bajaj is vulnerable to competition due to what we believe is a weaker sub-brand in the executive segment (Discover) vs Hero?s (Splendor/ Passion). Further, Hero has a wider distribution reach, while Honda?s reach is similar to Bajaj?s.
Premium valuation not factoring in cyclical slowdown: The auto sector has had what we view as a dream run over the last three years (FY10-12). Auto sales growth has been very strong during this period and stock prices have been buoyant. The BSE Auto Index outperformed the benchmark Nifty by 79%, 12% and 19% in FY10, FY11 and FY12. We expect demand growth to slow in FY13e due to the rising cost of ownership and slower economic growth. As stock valuations are not reflecting this weak demand outlook, risk-reward appears unfavourable. Stock selection will be key for outperformance in the auto space from hereon in. We prefer MSIL & Tata Motors and reaffirm our contrarian Underperform on Bajaj Auto.
Switch from Bajaj to MSIL
MSIL: For Maruti Suzuki, FY12 has been a tough year with slowing car sales, production loss due to IR (industrial relation) issues and adverse movement in currency (JPY & INR). Currently, MSIL is in the midst of its strongest 12-month period in terms of new product launches. After the successful launch of the Swift and Dzire, the company has recently launched a new MPV, Ertiga. This will be followed by a new 800cc car in Oct 2012. We believe margin improvement due to favourable product mix is not being factored in by the Street; our FY13e earnings estimate for MSIL is 16% higher than the consensus. MSIL is our top-pick in the Indian auto space and our revised target price of R1,665 provides 18% potential upside.
Tata Motors: We like Tata Motors for its Jaguar Land Rover (JLR) business, which contributes about 85% of profits. We are confident that strong growth at JLR will continue in FY13e on the back of the success of Evoque and strong demand from markets like China and the US. We believe a potential slowdown in domestic CV (commercial vehicle) sales will have only a small impact. The current stock price implies an EV/Ebitda of 4.9x (times) for JLR, which is inline with its peers. We remain at Outperform with a revised TP of R370 that provides 16% upside.
Mahindra & Mahindra: We like M&M for its leadership position in key segments and greater emphasis on R&D and new product development. However, we believe there are near-term challenges for the company as tractor sales are likely to remain weak in H21FY13e, thus operating margins will come under pressure. Its auto business is trading at 13x PER (price-to-earning ratio) based on FY13e, a 10% discount to its peers. We remain at Outperform with a revised TP (target price) of R760 that offers 8% potential upside.
Ashok Leyland: We expect M&HCV (medium & heavy commercial vehicles) sales to remain subdued in FY13e as we are not expecting any significant improvement in industrial growth. A diesel price hike is inevitable, which will put pressure on truckers? profitability. We are forecasting sales volume growth of 5% for ALL in FY13. The stock is trading at 8x FY13e EV(enterprise value)/Ebitda. Maintain Neutral with a revised TP of R32/share.
2Ws: We expect a slowdown in 2-wheeler sales growth this year due to higher fuel prices, slower rural income growth and weak consumer sentiment. Ws have grown at a CAGR of 21% over the last three years versus a 10-year average of 10%.