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Pakistan Automobile: The resurgence of incumbents, (AKD Detailed Report, Nov 23, 2021)

Pakistan Automobile Assemblers

The resurgence of incumbents

We revisit our investment case on Auto Assemblers, assigning overweight stance to the sector where the recent wave of sell-offs has provided attractive entry points to take exposure in OEMs. Our investment proposition is premised on enticing long term growth in volume offtakes on the back of i) budgetary measures, ii) fading competition from imported CBUs, iii) mounting farmers’ income, and iv) major upgrades in existing product offerings. On the flipside, i) the commodity bull cycle, ii) revised regulations on auto financing arrangements, iii) monetary tightening and iv) threat from new entrants remain key downside risks for the sector in terms of volumes as well as margins. Our top pick for the sector is INDU (TP: PkR1,750/sh – 42% upside & 13% DY) which comes from i) first mover advantage in hybrid segment, ii) resilient demand outlook, and iii) superior margins, solid balance sheet, brand value and widespread dealership network. PSMC (TP: PkR280/sh – 25% upside) remains our second best pick. Our liking of the stock is based on i) robust sales outlook on the back of budgetary measures ii) fading competition in 1,000cc segment iii) stabilizing margins, and iv) launch of new Swift in the pipeline. We also initiate our coverage on HCAR with a Neutral Stance (TP: PkR240/sh— 12.5% upside) where considerable amounts of developments have already been factored in. Our rationale is based on major risks that engulf the company in form of gradual hike in interest rates which may adversely impact volumes of HCAR.

Enticing long term growth in volumes: Following V-shaped recovery of 60%YoY in FY21, the auto industry has been brushed up and set to reach its previous highs witnessed in FY17-18. We expect the current trajectory of growth to continue on the back of;  i) budgetary measures; ii) fading competition from imported CBUs; iii) mounting farmers’ income; and iv) major upgrades in existing product offerings. Following the budgetary measures (reduction in FED, GST and ACD on passenger cars), the volume offtakes, as reported by PAMA, surged 71% in 4MFY22. At the same time, SBP’s revised regulations have completely restricted the financing facility for imported CBUs which is expected to increase the market share of local OEMs. Going forward, we foresee the volumes of passenger cars to grow by 32%YoY in FY22 after incorporating the risks. Similarly, increasing purchasing power in rural areas is expected to keep the sales momentum buoyant, especially for INDU where ~50% of its sales comes from rural areas. Finally, major upgrades in existing product offerings and proposed increase in RD on imported CBU’s shall capture the lost market share to imported CBUs.

Incorporating the risks: Although the growth in volumes has surged past expectations in 4MFY22, we expect the growth to take a breather in FY23 due to persistent risks. The major risks that we incorporate are i) monetary tightening, ii) revised regulations for auto financing arrangements, iii) currency devaluation, iv) threat from new entrants, and v) commodity bull cycle. With global economies opening up, the demand for autos has surged, creating an imbalance between demand and supply of raw materials, hence, putting upward pressure on CRC/HRC prices, which have doubled since the start of pandemic. Similarly, the local has currency has depreciated by ~11%FYTD due to recent imbalances in external accounts, adversely effecting the production costs. As a trickle down effect, the SBP increased the policy rate by 150bps in the last MPS whereas another 75-100bps hike is expected in the upcoming MPS while the revised regulations for auto financing arrangements may contribute to the slowdown in FY23. Lastly, the threat from new entrants (KIA, Hyundai, MG, Proton and  Changan) remains a key downside risk.

Investment perspective: Despite the risks, the valuations remain enticing where we assign overweight stance to the sector with the recent wave of sell-offs providing attractive entry point to take exposure in OEMs. Our top pick for the sector is INDU (TP: PkR1,750/sh – 42% upside & 13% DY) which comes from i) first mover advantage in hybrid segment, ii) resilient demand outlook, and iii) superior margins, solid balance sheet, brand value and widespread dealership network. PSMC (TP: PkR280/sh – 25% upside - Buy) remains our second best pick. Our liking of the stock is based on i) robust sales outlook on the back of budgetary measures ii) fading competition in 1,000cc segment iii) stabilizing margins, and iv) launch of new swift in the pipeline. We also initiate our coverage on HCAR with Neutral Stance (TP: PkR240/sh— 12.5% upside & 4% DY) where considerable amounts of developments have already been factored in. Our rationale is based on major risks that engulf the company in form of gradual hike in interest rates which may adversely impact the volumes of HCAR since more than 40% of its sales are through auto financing arrangements.

AKD Research