INSTITUTIONAL EQUITY RESEARCH Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Please see penultimate page for additional important disclosures. PhillipCapital (India) Private Limited. (“PHILLIPCAP”) is a foreign broker-dealer unregistered in the USA. PHILLIPCAP research is prepared by research analysts who are not registered in the USA. PHILLIPCAP research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities Inc, an SEC registered and FINRA-member broker-dealer. Automobiles Opportunity in adversity INDIA | AUTOMOBILES | SECTOR UPDATE 9 April 2020 Covid-19 disruption to have far reaching consequences Industry was recovering from BS6 transition, weak economic growth and channel financing issues. Covid-19 is likely to derail that recovery and set the industry further back. We attempt to assess (and predict) its impact on the Indian Auto industry assuming a base case of partial lifting of lockdown in April and end of it by mid-May. We are lowering FY21/22 volumes and margin estimates leading to downward FY21 EPS revision of 20-80% across coverage. We anticipate a much greater impact in FY21 given the direct impact due to 1) lockdowns, 2) labour shortage/unavailability disrupting supply side. We also expect the demand to remain subdued at least for the first half of FY21. However, we could witness shift from shared to personal mobility. In our view, the sharp correction in stock prices offers attractive buying opportunities selectively. We remain bullish on Maruti, Escorts and upgrade Mahindra and Hero (all rated Buys). We downgrade Apollo Tyres due to concerns related to domestic CV. Volume growth in FY21 unlikely Auto volumes were ambling back to normalcy with a good festive season and retails were growing at a healthy rate in the first couple of weeks in March as well. However, spread of Covid-19 and ensuing lockdown led to volumes virtually drying up. Lockdown (in some form) is likely to continue for the whole of April, at least, in our view. Even after lockdown is lifted, production is unlikely to pick up hastily, primarily due to labour shortage, especially at small tier 2 vendors. We expect FY21 domestic CV, PV and 2W industry volumes to decline in high single digits (c.8%), while Tractor volumes are expected to fare better with a decline of 2%. Additionally, exports are also expected to remain weak due to the widespread nature of this pandemic, especially to the commodity (oil) driven economies. As a result we are lowering our volumes expectations for FY21 by 8-18%; FY22 to be materially better. Margins to be under even more pressure We expect margins for all covered companies to decline from already low levels of FY20 on account of negative operating leverage. Additionally, OEMs would need to offer greater discounts/promotions as well as support dealers given the low turnover anticipated. That said, lower commodity prices could absorb some of the negative impact. We expect FY21 EBITDA margins to be 20-300 bps lower vs our earlier estimates. Additionally, most OEMs would be supporting their full time and part time employees through this tough period, which, although, is much appreciated, will burden the margins. Not all’s doom and gloom Most of the Auto companies are debt free and cash rich, which should serve them well in these difficult times. We believe that this pandemic could turn the tide in favour of personal mobility over shared (even if temporarily) which could benefit entry level PVs and 2Ws. Additionally, given the essential nature of the rural economy (agri and others), we expect it to be at a lower risk and to pick up earlier than rest of the market. Hence, we prefer businesses with greater rural exposure like Mahindra, Escorts, Maruti, Hero and Bajaj. These companies are trading near their long term lows rendering the risk reward to be favourable. Volumes FY17 FY18 FY19 FY20E FY21E FY22E PV 3,046,663 3,287,396 3,392,913 2,802,546 2,578,342 2,836,177 Growth 9.2% 7.9% 3.2% -17.4% -8.0% 10.0% CV 711,643 852,520 1,006,845 737,011 678,050 806,879 Growth 4.2% 19.8% 18.1% -26.8% -8.0% 19.0% 2W 17,588,604 20,191,879 21,172,885 17,467,630 16,070,220 17,677,242 Growth 6.9% 14.8% 4.9% -17.5% -8.0% 10.0% Tractors 582,844 711,478 786,912 704,286 718,372 804,577 Growth 18.0% 22.1% 10.6% -10.5% 2.0% 12.0% Saksham Kaushal, Research Analyst (+ 91 22 6246 4126) Amar Kant Gaur, Research Analyst (+ 91 22 6246 4110) Rating Current Previous Maruti Buy Buy Escorts Buy Buy Mahindra Buy Neutral Hero Buy Neutral Bajaj Neutral Neutral Ashok Leyland Neutral Neutral Bharat Forge Neutral Neutral Apollo Tyres Neutral Buy CEAT Neutral Neutral Tata Motors Neutral Neutral Target Price Current Price Up / Down -side Maruti 6,015 5,350.0 12% Escorts 825 690.4 19% Mahindra 476 383.5 24% Hero 2,230 1,994.3 12% Bajaj 2,676 2,444.3 9% Ashok Leyland 48 45.7 5% Bharat Forge 259 245.1 5% Apollo Tyres 86 89.5 -4% CEAT 826 797.0 4% Tata Motors 77 74.5 3% Source: PhillipCapital India Research
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INSTITUTIONAL EQUITY RESEARCH
Page | 1 | PHILLIPCAPITAL INDIA RESEARCH Please see penultimate page for additional important disclosures. PhillipCapital (India) Private Limited. (“PHILLIPCAP”) is a foreign broker-dealer unregistered in the USA. PHILLIPCAP research is prepared by research analysts who are not registered in the USA. PHILLIPCAP research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities Inc, an SEC registered and FINRA-member broker-dealer.
Automobiles Opportunity in adversity
INDIA | AUTOMOBILES | SECTOR UPDATE
9 April 2020
Covid-19 disruption to have far reaching consequences Industry was recovering from BS6 transition, weak economic growth and channel financing issues. Covid-19 is likely to derail that recovery and set the industry further back. We attempt to assess (and predict) its impact on the Indian Auto industry assuming a base case of partial lifting of lockdown in April and end of it by mid-May. We are lowering FY21/22 volumes and margin estimates leading to downward FY21 EPS revision of 20-80% across coverage. We anticipate a much greater impact in FY21 given the direct impact due to 1) lockdowns, 2) labour shortage/unavailability disrupting supply side. We also expect the demand to remain subdued at least for the first half of FY21. However, we could witness shift from shared to personal mobility. In our view, the sharp correction in stock prices offers attractive buying opportunities selectively. We remain bullish on Maruti, Escorts and upgrade Mahindra and Hero (all rated Buys). We downgrade Apollo Tyres due to concerns related to domestic CV.
Volume growth in FY21 unlikely Auto volumes were ambling back to normalcy with a good festive season and retails were growing at a healthy rate in the first couple of weeks in March as well. However, spread of Covid-19 and ensuing lockdown led to volumes virtually drying up. Lockdown (in some form) is likely to continue for the whole of April, at least, in our view. Even after lockdown is lifted, production is unlikely to pick up hastily, primarily due to labour shortage, especially at small tier 2 vendors. We expect FY21 domestic CV, PV and 2W industry volumes to decline in high single digits (c.8%), while Tractor volumes are expected to fare better with a decline of 2%. Additionally, exports are also expected to remain weak due to the widespread nature of this pandemic, especially to the commodity (oil) driven economies. As a result we are lowering our volumes expectations for FY21 by 8-18%; FY22 to be materially better.
Margins to be under even more pressure We expect margins for all covered companies to decline from already low levels of FY20 on account of negative operating leverage. Additionally, OEMs would need to offer greater discounts/promotions as well as support dealers given the low turnover anticipated. That said, lower commodity prices could absorb some of the negative impact. We expect FY21 EBITDA margins to be 20-300 bps lower vs our earlier estimates. Additionally, most OEMs would be supporting their full time and part time employees through this tough period, which, although, is much appreciated, will burden the margins.
Not all’s doom and gloom Most of the Auto companies are debt free and cash rich, which should serve them well in these difficult times. We believe that this pandemic could turn the tide in favour of personal mobility over shared (even if temporarily) which could benefit entry level PVs and 2Ws. Additionally, given the essential nature of the rural economy (agri and others), we expect it to be at a lower risk and to pick up earlier than rest of the market. Hence, we prefer businesses with greater rural exposure like Mahindra, Escorts, Maruti, Hero and Bajaj. These companies are trading near their long term lows rendering the risk reward to be favourable.
Company-wise commentary: Maruti Suzuki Maruti Suzuki remains well positioned post the transition to BS6 with no diesel. Since, they began the transition much earlier than the industry, they had limited risk of being left with BS4 inventory. However, production, at least for the first quarter is expected to be materially lower and would pick up closer to the festive season. We expect Maruti to provide additional support to its dealers and also offer greater incentives to buyers in order to boost volumes as demand remains weak for most of FY21. However, we expect the latent demand to kick in towards the end of FY21 and into FY22. We are lowering our volume, margin and EPS estimates for FY21/22 by -18%/-16%, -270 bps/-160 bps and -35%/-28% respectively. Maintain Buy.
Escorts We expect covid-19 impact on tractor industry to be relatively lower, given the “essential” nature of rural (agri) economy. Shortage of labour should also aid farm mechanization trends which would ultimately benefit tractor industry. Additionally, any steps by the govt. to revive the economy post covid-19 will likely include focus on infrastructure development which directly benefits Escorts. Partnership with Kubota will open new markets for Escorts as well as aid development of farm implements, which would be incremental to earnings. We are lowering our volume, margin and EPS estimates for FY21/22 by -8%/-5%, -170 bps/-90 bps and -28%/-18% respectively. Maintain Buy
Mahindra Given its portfolio of SUVs and CVs, demand post BS6 transition remains a challenge for Mahindra’s auto division, which is exacerbated by covid-19. However, we expect Farm division to endure the impact of Covid-19 relatively better with impact on agri economy being relatively lower. Shortage of labour could also aid farm mechanization, which potentially benefits tractor industry. Recent stock price correction has left valuations very attractive at 6x FY22 EPS (adjusting for value of holdings in subsidiaries). Mahindra’s decision to refrain from putting fresh money in Ssangyong also bodes well for the investor sentiment. We are lowering our volume, margin and EPS estimates for FY21/22 by -15%/-13%, -210 bps/-100 bps and -41%/-25% respectively. Upgrade to Buy
Hero Motocorp Though Hero Motocorp has been able to clear most of its BS4 inventory ahead of deadline, its volumes are at most risk from BS6 given greater price increase. That said, in our view, Hero could benefit from being more rural facing (more than 90% of its volumes coming from mass market motorcycles), as we expect rural economy to be more resilient to covid-19. Additionally, we expect some sort of trend reversal in terms of shift towards share mobility (even if temporary) which would boost mass market motorcycle/scooter volumes. Hero’s valuations are also very inexpensive with it trading at 11x FY21 EPS, well below its historical average of 16x. We are lowering our volume, margin and EPS estimates for FY21/22 by -13%/-9%, -220 bps/-150 bps and -25%/-13% respectively. Upgrade to Buy
Bajaj Auto Bajaj Auto was able to outperform the industry in recent past as it was able to offset decline in domestic volumes with growth in exports. However, most of Bajaj’s significant export markets have oil dependent economy. Given the low oil prices, export volumes for Bajaj are likely to be significantly impacted. That said, Bajaj could do well domestically in entry level motorcycles (like Hero). However, Bajaj is currently trading at 16x FY21 EPS which is close to its historical average, leaving limited potential upside. We are lowering our volume, margin and EPS estimates for FY21/22 by -18%/-17%, -100 bps/10 bps and -22%/-17% respectively. Maintain Neutral.
Ashok Leyland Domestic CV industry is struggling with low demand owing to weak economic growth, BS6 transition. Covid-19 has worsened the situation. That said, Ashok Leyland has cleared its entire inventory (BS4), which was a challenge through most of last year. Scrappage policy is unlikely to be introduced in FY21 are slim, in our opinion. That said, it is currently trading at 1.5x FY21 P/B, well below its long term average (2.7x). We expect volume growth to be significantly higher in FY22 after more than 2 years of weak performance on a very low base. We are lowering our volume, margin and EPS estimates for FY21/22 by -17%/-13%, -310 bps/-150 bps and -76%/-35% respectively. Maintain Neutral.
Bharat Forge We expect Bharat Forge to face challenges to volumes and hence margins in the near term as all of its major end markets face slowdown including 1) US class 8, 2) US Oil and Gas (shale) and 3) Domestic CV. We don’t expect recovery in these end markets at least for a few quarters. There is also some potential Balance Sheet (receivables) risk given the challenging environment. That said, post the recent stock price correction it is trading at 16x FY22 EPS, below its long term average. We are lowering our revenue, margin and EPS estimates for FY21/22 by -9%/-6%, -240 bps/-130 bps and -40%/-19% respectively. Maintain Neutral
Apollo Tyres Apollo is expected to witness decline in volumes for FY21 given lower volumes across its end markets, especially CVs which is its largest market (more than 50%). Given the challenges in economy, even the aftermarket volumes are likely to decline with operators likely to opt to retread, rather than buy new tyres. Ramp up of its plants in AP and Hungary could also be impacted by covid-19. Though, favourable raw material (rubber) prices could offset some of the negative impact. Debt/Equity ratio of 0.6 also adds to the risk. However, it currently trades at 10x FY22 EPS, which is in line with its long term average, providing some valuation support. We are lowering our revenue, margin and EPS estimates for FY21/22 by -12%/-9%, -210 bps/-150 bps and -74%/-42% respectively. Downgrade to Neutral.
CEAT CEAT is relatively better positioned given its end markets are relatively diversified. However, volumes would remain weak in the near future as production at OEMs is likely to be significantly lower in FY21. Lower volumes are likely to more than offset the impact of favourable commodity prices. CEAT is currently trading at 13x FY22 EPS, which is close to its long term average. We are lowering our revenue, margin and EPS estimates for FY21/22 by -10%/-7%, -70 bps/-20 bps and -38%/-22% respectively. Maintain Neutral
Tata Motors Tata motors is facing issues on multiple fronts. Domestically, CV business is reeling from weak economy and BS6 transition, which is worsened by the covid-19 breakout. We expect this weakness to persist through the whole of FY21. Chances of
Page | 5 | PHILLIPCAPITAL INDIA RESEARCH
AUTOMOBILES SECTOR UPDATE
introduction of a scrappage policy are also pretty low in our opinion. JLR volumes are also expected to be subdued in China and other markets owing to covid-19. Given its scale, there is likely to be a significant operating deleverage impacting margins and profits. High HY (high yield) debt (JLR) and recent debt rating downgrades also remains a challenge. We are lowering FY21/22 volume and margin estimates for Tata Motors standalone by -24%/-17% and -350 bps/-210 bps and for JLR by -13%/-12% and -160 bps/-170 bps respectively. Maintain Neutral
Stock Price, Price Target and Rating History – Apollo Tyres
Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. We have different threshold for large market capitalisation stock and Mid/small market capitalisation stock. The categorisation of stock based on market capitalisation is as per the SEBI requirement.
Large cap stocks Rating Criteria Definition
BUY >= +10% Target price is equal to or more than 10% of current market price
NEUTRAL -10% > to < +10% Target price is less than +10% but more than -10%
SELL <= -10% Target price is less than or equal to -10%.
Mid cap and Small cap stocks Rating Criteria Definition
BUY >= +15% Target price is equal to or more than 15% of current market price
NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15%
SELL <= -15% Target price is less than or equal to -15%.
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