Cars to the rescue

In a new, more exhaustive version of Sector Watch, R Sree Ram examines analysts’ reports to find out why the automobile sector is no longer cruising ahead.

     Print Edition: March 20, 2008

After the phenomenal build-up to and the subsequent launch of the Tata Nano, there’s been an increased interest in cars. Sadly, that might not translate into increased profits for the industry. Worse, it appears as if the entire automobile industry is entering a cyclical downtrend. According to the Society of Indian Automobile Manufacturers, growth in domestic sales in April-January 2008 slipped by 4.82% compared to the same period a year ago. Sluggish sales were largely because of tighter liquidity conditions and hardening interest rates.

“It is important to keep in mind the inherent cyclicality of demand. Specifically, after three or four years of growth, the automobile market tends to slow down for a year or two and recover subsequently”
Priyamvada Balaji, Director, Fitch Ratings
“For four-wheelers, strong double-digit growth is possible due to changing demographics”
Ramnath S, Director, IDFC-SSKI Securities

Macro issues such as a higher base effect and cyclical trends could prolong the slowdown. Analysts expect this trend to continue for two to three quarters. “It is important to keep in mind the inherent cyclicality of demand. Specifically, after three or four years of good growth, the market tends to slow down for a year or two and recover subsequently. This has been an ongoing feature of the market,” says Priyamvada Balaji, director, Fitch Ratings.

Analysts also seem worried about steps like free insurance and different discounts offered by companies to spur lacklustre sales. Not only do such measures squeeze already sluggish margins, they could put pressure on profitability. Although exports are still robust for two-wheelers and commercial vehicles, their margins are lower than domestic sales.

Fortunately, the sluggishness in sales might not be uniform across all segments. While the two-wheeler industry was clearly affected by hardening interest rates, analysts expect the passenger car and light commercial vehicle segments to clock robust growth numbers. “For four-wheelers, strong double-digit growth is possible due to changing demographics.

A number of firsttime buyers are directly moving to cars rather than first buying twowheelers and moving to cars,” says Ramnath S, director, IDFC-SSKI Securities. This could also affect the sales growth of two-wheelers. The sales of commercial vehicles might fluctuate for the next one year. With the emergence of the hub-and-spoke network system in the logistics sector, analysts expect increased sales of light commercial vehicles and trucks, as these vehicles ferry goods from hubs.

GDP growth and IIP numbers
Rise in industrial growth and mining activities
Change in emission norms
Change in demographics
Disposable incomes and affordability levels
Growing proportion of young population
However, as commercial vehicle manufacturers could take time to adapt, analysts suggest that investors steer clear of these companies for the time being. In the case of two-wheeler companies, market watchers suggest that the best strategy is to sell when the stock reaches its target price. It’s interesting to note that apart from Maruti Suzuki, none of the positive recommendations are based on the performance of the core business.

For instance, Bajaj Auto is in favour due to the decent performance of its subsidiary companies, as the main company has posted negative sales growth. “From a core business perspective, Hero Honda looks better than Bajaj Auto. However, Bajaj is attractive given its huge investment book and underlying demerger possibility,” says Aniket Mhatre, research analyst, Prabhudas Lilladher.

Despite Hero Honda’s good results, the overall gloomy outlook for the industry is forcing broking houses to take a cautious view. Enam Securities downgraded the stock to underperformer (see table Stocks To Watch Out For). If not for the robust performance of their subsidiaries, Tata Motors and Mahindra & Mahindra would also have been affected by the slowdown.

The positive calls for these diversified companies are due to the difference between the current market price and the sum of the parts valuation (see page 30 for details on sum of the parts valuation). Although Tata Motors’ subsidiaries have posted a year-on-year growth of 88% in profit after tax, the slowdown in commercial vehicle sales and the negative outlook for the global auto industry is forcing analysts to take a range-bound view.

Maruti Suzuki seems the one company that analysts fancy. “The company reported a top line and net profit growth of 27% and 24% respectively in the third quarter of 2008. Despite the market slowdown and rise in raw material cost, the company has controlled the fall in margins”, says a report from Reliance Money. The firm has set a target price ofRs 1,030 in 12 months for Maruti.

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