Auto: Red flags become more prominent says Emkay

Emkay Global Financial Services has come out with its report on auto space. The research firm expects all the companies to raise prices to more than offset the impact of excise duty hike.

• Budget 2012-13 has raised red flags which can postpone the cyclical recovery in demand/profitability for 4-wheelers Believe 2-wheelers is a safer segment despite concerns w.r.t. to ATOT
• Passenger cars – risk arises due to demand polarity towards diesel, imminent fuel price hike (as per roadmap on subsidies), limited int. rate cut may fail to spur demand vs expectation
• CVs - ~400 bps excise hike, fragile demand recovery and subdued freight rates will lead to higher demand for used vehicles in near term. Sharp rebound in GCF will be the key
• Upgrade HMCL to ACCUMULATE, Downgrade BJAUT to ACCUMULATE and TVS to HOLD. Retain HOLD on MM, AL, EIM, REDUCE on MSIL and ACCUMULATE on TTMT

Passenger cars – Not a repeat of 2002-03/2008-09: As can be seen from the graph below, during 2002-03/2008-09sustainable demand   recovery has been accompanied by sharp decline in interest rates (in a short span) and excise duty reduction. However, currently, not only excise duty has been increased but there are increasing risks that interest rate cut may not be adequate to spur demand. Excise duty and service tax increase along with a much larger gamut of services under service tax, will create a pressure on the wallet of the consumer.

Fuel price – a double whammy: We believe that there exists a double whammy as sharp increase in fuel price will feed inflation (and hence interest rates) or demand polarity towards diesel vehicles will continue. This will affect the demand for petrol vehicles. Current losses of OMC on petrol at Rs ~4/ltr is the highest post deregulation. Also, price differential between petrol/diesel is at its peak in the last 8 years. Hence, any hike in petrol prices will impact demand for petrol vehicles. Also, pressure would continue on large part of the demand given the limited supply of diesel engines.

Excise duty to increase by 4%: to create pressure on near term demand: In Union budget 2012-13, flat rate of Rs 10,000 in case of sales in ‘chassis form’ has been replaced by an ad valorem rate of ~3% . We understand that only ~10% of M&HCVs are sold as fully built units. Thus for vehicles sold in chassis form, effective increase in excise rate would be from ~10% +Rs 10,000 currently to ~15%. A sharp increase in prices can result in higher demand for older vehicles and put pressure on new vehicle demand as the demand recovery has been fragile and in select pockets. While ICV (7.5 – 12ton) and tipper segments have continued to do well, demand has remained subdued for Multi Axle vehicles (>16 ton) and haulage segments

Emission norms implementation in October 2010 is a case in point: Demand during H2FY11 was affected post the implementation of emission norms which resulted in ~4% increase in prices. This led to pre buying in 2QFY11 followed by a subdued Q3.

Bottoming Gross capital formation – a silver lining: Historically, growth in M&HCV goods has largely tracked gross capital formation (GCF) with a lag in some periods (highlighted below). Bottoming of GCF is the silver lining. From here on benefits of favorable base effect should kick in for GCF. We retain our 8% volume growth estimate for M&HCVs goods in FY13 to 324,000 units.

Demand recovery precedes passenger cars: Our analysis of demand for cars and two wheelers for past 18 years indicates that initial signs of demand uptick are first visible in two wheelers followed by cars. Moreover, two wheeler demand has been relatively stable with only one instance of strong decline in FY08. This we attribute to one time system issue related with – aggressive discounting and financing (dealer and consumer). Current scenario has improved considerably for two wheelers with dependency on financing at its lowest amongst other segments.

Outlook and our view: As of now, we largely maintain our FY13 volumes estimates across companies. We expect all the companies to raise prices to more than offset the impact of excise duty hike. We see higher risk to our 1HFY13 earnings. We upgrade earnings of Hero Motocorp, Maruti Suzuki and Tata Motors for FY13 due to company specific factors. Upgrade in case of Hero Motocorp is due to excise duty benefits from tax free Hardiwar plant. Upgrade in MSIL is to factor in current favorable cross currency rates.