EUR 9.12 For Business Accounts Only

The Drive, (AKD Auto Monthly Report, June 22' 2023)

Pakistan Auto Sector Monthly Report

 

The Drive

 

As we approach the end of the fiscal year, the auto sector has been underperforming for valid reasons, with a decline of 18.1% in the CYTD, underperforming the KSE100 index by 18.7%. We maintain an underweight stance for the auto sector. Reasons being 1) supply chain issues arising from the LC restrictions, 2) exchange rate fluctuations, and 3) Price hikes affecting the demand outlook. Overall, we advise our investors to consider these risks before taking any position in the sector.

 

11MFY23 numbers highlight: The current challenges faced by the auto sector are rightly highlighted by the significant decline in sales numbers. Total industry sales have plummeted by 51%YoY in the 11MFY23, resulting in a cumulative sale of total of 153k units compared to 308k units sold during SPLY. The passenger car segment has witnessed the highest negative growth, with a decline of 56%YoY, followed by tractors with a decrease of 46%YoY.

 

Federal budget was no help either: The imposition of a 10% super tax is expected to further dent the profitability of the sector. However, the reduction of the minimum tax regime will benefit PSMC in the current year as the company is projected to report a loss of PkR12.9bn in 1QCY23. This reduction in said turnover tax will result in tax savings of approximately PkR239mn (PkR2.9/sh) for the company. On the other hand, the removal of the fixed tax regime on Asian manufactured vehicles above 1,300cc is expected to have an albeit negligible but positive impact on the local auto demand. Additionally, there has been a reduction in customs duty on certain CKD parts for Heavy Commercial Vehicles (HCV) aswell, lowering it from 10% to 5%. This change is considered positive for HCV assemblers such as GAL and GHNI.

 

AIDEP 2021-26: Due to the ongoing challenges in the auto sector, it seems highly unlikely that the set targets of the current auto policy (AIDEP 2021-26) will be achieved. The goal of achieving an annual production of 500k units appears increasingly difficult to reach given present circumstances, as achieving the 400k annual unit sales mark by 2026 is a question mark aswell. Similarly, the target of exporting 10% of the total import value for the assemblers also remains improbable.

 

Sector in a crossfire: The devaluation of the exchange rate has exacerbated the already supply-side issues for the auto sector. Rupee has depreciated by 40% against the USD in FYTD, prompting local assemblers to increase vehicle prices by ~35% since July’22. These price increases have naturally created challenges, primarily on the demand side, will become even more apparent once supply issues get resolved. On the flip side, rampant price increase have provided some respite to the margins and bottom line of assemblers. During the Mar’23 quarter, the AKD auto universe achieved an avg. gross margin of 9.3% vs. avg. of 4.9% in SPLY.

 

LC issues prevails: LC restrictions have drastically hampered the production capabilities of local OEMs, first beginning back in May’22. As a result, companies are frequently encountering plant shutdowns and have largely transitioned to operating in a single shift. More recently, PSMC suspended production  both its four-wheeler and motorcycle plants, with the shutdown lasting from 22nd Jun’23 to 8th Jul’23. Similarly, INDU's plant has also observed cumulative shutdown of 26 days during the calendar year. Likewise, HCAR’s plant was also shut down on 09 Mar’23 and  resumed operations recently on 15 May’23 (67days closure) in present calendar year. Consequently, the company only managed to produce 25 units in May’23, and with zero production in the month before.

 

Demand outlook: We expect the current fiscal year to end with negative industry growth of ~52%YoY. However, we anticipate a positive growth trend in the next fiscal year, primarily due to an overall low base. Furthermore, we contemplate import restrictions to gradually ease off starting 2HFY24. However, we expect demand recovery in FY24 to witness a pushback on the back of lower consumer income growth and overall higher prices, for this reason, a v-shaped volumetric recovery may still not be expected even after the easing of LC restrictions.

 

Investment Perspective: Given the current circumstances, it is anticipated that the prevailing restrictions on LCs will persist until there is an improvement in the country's FX reserve situation. The automotive sector heavily relies on importing CKD kits for assembly (~50% of value), making it highly vulnerable to the risks associated with the ongoing LC restrictions. Taking these factors into account, we maintain an underweight stance for the auto sector. Reasons being 1) supply chain issues arising from the LC restrictions, 2) exchange rate fluctuations, and 3) Price hikes affecting the demand outlook. Overall, we advise our investors to considering these risks will be taking any position in the sector.

 

 

AKD Research