After two years of strong growth, the India auto sector is in a cyclical slowdown. While we remain positive on the sector?s long-term growth prospects, we believe the near-term environment remains challenging.
Two-wheelers: We forecast a 14% volume CAGR for the two-wheeler segment over FY11-16 (18%/16% YoY growth in FY12/ FY13), based on rising incomes, supportive social and demographic trends, and rising fuel costs.
Cars: We believe the sharp increase in petrol prices over the past year has had a significant impact on the affordability of a new car buyer. In addition, the widening gap between the price of petrol and the price of diesel has made the diesel variant car relatively attractive.
Vans and utility vehicles (UVs): We expect slower demand growth in vans as these are largely dominated by Maruti?s petrol-fuelled models. Demand for UVs (ex vans) is also likely to slow although could fare better than cars.
MHCVs: We remain negative on MHCVs. We believe demand is likely to slow significantly given rising interest rates and weak industrial growth. In addition, we think MHCV demand in Q2 FY12 will likely fall YoY, given the high comparison base because of the sharp spike in sales due to the regulatory changes in emission levels.
LCVs: LCV demand should remain robust, driven by continued strong growth in the mini-truck segment. New launches Ace Zip and Magic Iris have lower prices and are likely to gain market share from goods and passenger three-wheelers in markets where they are allowed to be driven without permits. We therefore expect LCVs to grow 15% YoY in FY12.
Tractors: Sales of tractors in the domestic segment grew 32%/20% in FY10/FY11. We expect this momentum to persist as the industry continues to benefit from increased investment in rural infrastructure and strong agricultural growth.
We believe the outlook for the auto sector remains challenging in the near term, as we expect raw material costs to rise further in Q1 FY12 and domestic volume growth to slow. However, the recent trend of declining steel prices has raised prospects of potential margin improvement from Q2 FY12 onwards.
Maruti Suzuki India
We believe sharp increases in petrol prices have further hit slowing demand. We believe Maruti Suzuki is likely to be affected in H1 FY12 due inadequate capacity for diesel models. However, we expect a strong recovery in H2 FY12 as the second unit of the Manesar factory comes online. Maruti?s cheap valuation, relative to its history, suggests most of the negatives are reflected in its share price. Maruti remains our preferred stock in the sector.
Hero Honda
We maintain our ?buy? rating on Hero Honda, as we expect it to be a strong beneficiary of rural demand. Based on our outlook for solid growth in this segment, we believe the competitive environment will be benign and pricing power will be strong in the near term. We therefore forecast a 19% earnings CAGR for FY11-13 for Hero Honda, driven by 17%/14% volume growth in FY12/FY13.
Mahindra & Mahindra
We remain positive on Mahindra & Mahindra , given its leading tractor and UV franchise. We expect demand and pricing power to remain strong, and UV demand to surprise on the upside with the forthcoming launch of the below 4m Xylo, which will open up a new segment for the company. We remain positive on the Ssangyong acquisition as the company?s export volumes continue to rise. We maintain ?buy? rating but reduce our price target from R880 to R840 to reflect our lower earnings estimates for the standalone operations.
At the consolidated level, subsidiaries? earnings have risen, resulting in our higher EPS estimates. However, our valuation is not impacted materially as we value the subsidiaries at the current market price, adjusted for a 20% holding company discount.
We remain positive on Bajaj Auto given our view on two-wheeler demand for FY12/13. Bajaj has also been able to maintain strong export volumes. However, withdrawal of DEPB incentives is a negative. We therefore reduce our earnings estimates for FY12 and FY13. We maintain our ?buy? rating but reduce our price target from R1,750 to R1,600 to reflect our lower earnings estimates.
TVS Motor
We remain positive on TVS Motor based on our expectation for strong volume growth in the scooter and moped segments to result in margin expansion. Potential laun-ches in the motorcycle segment could improve volume growth in FY13. We estimate 18%/16% overall volume growth in FY12/FY13.
At our price target, the stock?s implied valuation would be 13x FY13E PE. We believe its valuation is attractive at 5.3x FY13E EV/Ebitda ? around a 40% discount to its peers. We maintain our ?buy? rating but lower our price target from R80 to R70 to reflect our lower earnings estimates.
Ashok Leyland has been losing market share to Tata Motors and Eicher in the MHCV segment. We remain negative on MHCV demand growth for Leyland and expect 0% YoY growth in FY12 versus 5% YoY growth for the industry. We believe the near-term growth for MHCVs remains challenging given the sluggish near-term Index of Industrial Production and the high base in terms of MHCV demand for Q2 FY12 due to purchases ahead of the change in emission norms in Q2 FY11. We believe margins will remain under pressure due to slowing sales.
Tata Motors
We downgraded Tata Motors from ?buy? to an anti-consensus ?sell? rating on 13 June on concerns about a deteriorating growth outlook for Jaguar Land Rover (JLR) and a negative view on the domestic MHCV segment cycle. JLR?s retail sales in the EU were down 20% YoY in April. We believe increasing incentives for Jaguar in US and lower sales volumes in the domestic market will keep margins under pressure.
UBS Investment Research