Will US be the next China for JLR?—Part II

By: | Published: March 7, 2016 12:08 AM

While a slowdown in the US is certain, the deceleration will be controlled in extent and not a hard landing

In the past few weeks, we met with multiple investors in Hong Kong and Europe. To our surprise, investors are more worried about the US market than our perceived risk to JLR. We highlighted in our report that a US slowdown is nearly certain, but should be moderate. However, part of the investor community expects/sees a sub-prime level crisis in the auto market.

Why we believe a US slowdown is certain: The US has seen the longest upcycle for its auto industry in the past 50 years; therefore, we question the growth sustainability in 2016/17. US current SAAR is ~17.5m, which is the same as the pre-subprime crisis level. Auto consumer credit is nearly at an all-time high (~$1 trillion). The auto loan book now accounts for 9-10% of total consumer loans in the US (see chart) and investors fear aggressive funding in recent years could be facing a sub-prime equivalent crisis in the auto market.

Why we still think it may not be a hard landing: We assume the extent of deceleration will be controlled and not a hard landing. Auto loans may be at all-time high but delinquencies rates are still low. Further, while the share of sub-prime auto buyers has been increasing within the auto loan book, it is still lower than the pre-subprime years. In fact, the rate of change in auto delinquencies is not much different than other asset classes like mortgages. Also, the ASP and average household health have improved over the years. The ratio of housing loans has come down, implying people have chosen to buy cars over houses post the global financial crisis (GFC), which does not necessarily mean there is a bubble in the auto car finance market. Meanwhile, as oil prices remain weak, consumer confidence and employment rate are holding up as well.

How bad can it get for JLR: Our conservative Ebitda margin forecast of 14-15% in FY17/18e already factors in some pricing decline. Further, we believe the current valuation of 7x 12 month forward PE doesn’t provide any credit for the strong new product traction by JLR. JLR is yet to launch a significant number of models – XE, gasoline ingenium engine Evoque, Discovery Sport and F-PACE in the next 3-6 months in the US. However, in the scenario of a sharp fall in the US market, even our conservative forecasts would be at risk. A sharp slowdown in the US would lead to severe pricing pressure globally considering the ambitious capacity build-up in the US and other countries and we could see further 200-300bp downside to our Ebitda margin forecasts in FY17/18e. We make no changes to our estimates. Remain Buy with a TP of R460.

Why fear of a US slowdown?

2015 was the sixth year of strong auto industry growth in the US and is the longest up cycle in the past 50 years; thereby, we question the growth sustainability in 2016/17e. US current SAAR is ~17.5m, which is the same as the pre-subprime crisis level. Auto consumer credit is nearly at an all-time high (~1 trillion) and capacity expansion plans are ambitious.

Quality of auto loan book is the key concern

Auto consumer credit is nearly at an all-time high (~1 trillion) and is now ~9% of the total consumer loans in the US. Investors fear aggressive funding in recent years could be facing a sub-prime equivalent crisis in the auto market.

We believe growth moderation is certain, but it may not be as bad as a sub-prime crisis

Clearly, all indicators suggest the market is at the peak and we should be ready for moderation. However, we are assuming the extent of deceleration to be controlled and not a hard landing. Auto loans may be at an all-time high but delinquencies rates are still low. While the share of sub-prime auto buyers has been increasing within the auto loan book, it’s still lower than the pre-subprime years. One may argue such indicators may turn adverse quite swiftly, but based on the current rate, we believe the risks seem manageable. Meanwhile, as oil prices remain weak, consumer confidence and employment rate are holding up as well.

How bad can it get for JLR?

Base case scenario (HSBC published estimates): US volumes are up 25% in 2015 for JLR and are now contributing nearly 20% of total volumes. Undoubtedly, the US has clouded the outlook for JLR; however, our conservative Ebitda margin forecast of 14-15% in FY17/18e already factors in some pricing decline. Further, we believe the current valuation of 7x 12-month forward PE doesn’t provide any credit for the strong new product traction by JLR. JLR is yet to launch a significant number of models—XE, gasoline ingenium engine Evoque, Disco Sport and F-PACE in the next 3-6 months in the US. Last but not the least, we

believe the Street is quite braced for a potential fall in the US

growth rates, which wasn’t the case for China.

Worst case scenario of a collapse in the US auto market: Admittedly, in the scenario of a sharp fall in the US market, even our conservative forecasts will be at risk. A sharp slowdown in the US would lead to severe pricing pressure globally, considering the ambitious capacity build-up in the US and other countries and we could see further 200-300bp downside to our Ebitda margin forecasts of 14-14.5% in FY17/18e.

HSBC

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition