In view of the government’s demonetisation drive, auto companies are being affected and the best way to make most out of the auto stocks is to stick with firms with a competitive advantage, says Deepak Jain, Auto Analyst at IDFC Securities.
He said shortage of currency notes is hitting two-wheeler companies more than the four-wheeler firms. He advised investors to bet on companies that have good growth prospects in the long-term. Maruti Suzuki and Eicher Motors make good bets, he said. Below is the verbatim transcript of Deepak Jain's interview to Sumaira Abidi & Nigel D'Souza on CNBC-TV18.
Nigel: We are likely to see a hit on both two-wheelers and four-wheelers. What is your take on it?
A: Demonetisation is impacting the sectors across the industry and it's clear that we are going to see that happen.
There are two impacts. The first impact which comes in when the money shortage, as we are seeing currency shortage which is going on as of now, so it impacts two-wheelers more than four-wheelers because for two-wheelers 40-50 percent is cash, the financing level is 30-35 percent. So it is clearly going to impact that the first and the hardest probably in the near term. However, cars, about 75-80 percent financing, so it is uses more of a banking channel than the others. So the direct impact is on two-wheelers.
There are all sorts of things that they can do. One of them is zero down payments that they are talking about. I am not sure whether it is going to be implemented or not but they will probably take steps to try and combat this, if it is going to last beyond the near term. I am sure they will have to look at it. I don't think they won't cut prices because pricing cut will not help in such a scenario to that extent if there is a currency shortage, it won't help combat that too much. So I do not think there is going to be too much of price cut immediately. If it lingers on, it's highly competitive and if the volumes do not pickup then that comes at a much later stage. Therefore, I do not think you are seeing that in the next one or two months on that front. Financing schemes, as I mentioned, could come in - that is the part of the impact.
There are two or three other impacts to highlight. The second impact will come in in terms of cars and commercial vehicles (CVs) specifically, the used car prices. So what we gather used cars or used vehicle prices have fallen quite a bit in the past couple of weeks and that will have an impact on the replacement cycle and the replacement cycle will probably tend to get elongated. So prices of used cars as of now have probably fallen about 50 percent odd or 40-50 percent. I do not know whether they will recover or not but that's the immediate impact that we are seeing and so the replacement cycle gets impacted in the secondary round of it.
The third round is if the gross domestic product (GDP), I am talking about both the unaccounted and accounted GDP taken together, if that is going to take some sort of a hit then the overall demand slows down and the CV cycle gets -- the freight rates have already fallen 25-30 percent as of now. They could recover to some certain extent but if there is continued pressure, the CV cycle gets impacted. So it's going to be an impact on all three of them. The first impact comes on two-wheelers immediately.
Sumaira: There are also some source based information, things that we have picked up from talks with dealers perhaps people in the companies as well, is that there could be some plant shutdowns that the companies might now look at perhaps even maintenance shutdown is what they might call it. How would you look at, would it be severely stock negative?
A: Maintenance shutdown, if they get earlier then it makes sense because we know that the next one-two months, at least at the minimum is going to get impacted. So I would look at it, for instance Maruti goes for a shutdown in December, if they bring it forward, it actually makes sense for them.
Sumaira: What are you top picks in this space?
A: Given that there are near term concerns and we do not know how things could pan out, whether there could be 5 percent or 10 percent more downside. I would want to stick with companies which have competitive advantage and which are in operating segments, which have the potential to grow over the long-term even though there could be a resetting of some sorts in FY18 given this demonetisation but those which have a longer term value; I think those are the companies that I would look at. So the two companies which clearly fit in that scenario is Maruti Suzuki and other is Eicher Motors.
However, I am not saying there couldn't be 5-10 percent downside from these levels; it is possible if things do not improve in next one-two months, but longer term, if you pick either of these segments. If you look at Maruti for instance, car market over the longer term has to grow at a reasonable fast trade. The competitive intensity in that space has come off a bit also in the near term a couple of their products have waiting periods, the Baleno, Brezza, they have got waiting periods. It should be less impacted even by a near term slowdown.
Similarly, if you look at Eicher Motors, the same thing applies. They are in a niche with very little competition. They have got three month waiting period which should ease things out for them, in fact Eicher is the only company I have spoken to and it says that as of now they have seen no major change in the off take as of now. It could change in the future but as of now they have not seen any major impact on the off take at least at this stage. So these are the two stocks I would look at.
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