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Pakistan Automobiles: Earnings revised for Auto Assemblers; Under-Weight maintained

• We are revising our earnings forecasts of Pakistan Automobile universe for FY20-22F, incorporating (1) recent volumes trend, (2) revision in margin assumptions and (3) lower interest rates.
• Our earnings forecasts are revised up for (1) Indus Motors (INDU) owing to better-than-expected 9MFY20 earnings and response received for the newly launched Yaris and (2) Millat Tractors (MTL) given higher-than-expected sales during COVID-19 lockdown.
• Whereas, we revise down our estimates for Pak Suzuki (PSMC) and Honda Car (HCAR) given deteriorating outlook on sales in the near-term.
• We are revising down our FY20E and FY21F universe unit sales assumptions by 15% and 12%, respectively.
• In the midst of COVID-19 lockdowns, for the first time in Pakistan’s history, no car sales (as reported by PAMA) were recorded in Apr-2020. May-2020 was not much different either, with only 4,473 units sold during the month vs. average monthly sales of 11,534 units during 8MFY20.
• To recall, Pakistan car sales were already under immense pressure due to higher car prices and high interest rates as car sales for 8MFY20 (pre-COVID-19) were down by 44% YoY.
• We maintain our Under-Weight stance on the sector with a Sell stance on PSMC. Our preferred plays in the sector our INDU and MTL.
• We are revising up our earnings forecasts for INDU for FY20E-FY22F by 11%-33%.
• Our earnings revision is based on (1) higher-than-expected earnings recorded during 9MFY20 and (2) response received for the newly launched Yaris.
• In 3QFY20, INDU reported a gross margin of 12%, which was up by 2ppts QoQ. INDU has reported a gross margin of above 10% in 9MFY20.
• As per our channel checks with dealers, consumers response to recently launched Yaris has been very encouraging and currently there are 3,500-4,000 number of cars booked across various dealerships.
• However, there are some concerns on delivery of Yaris as upon its launch in mid-March, the production was discontinued due to COVID-19 lockdown. The delivery date given to customers at various dealerships is Sept-2020.
• We expect pressure on margins in the last quarter of FY20 due to low sales volume resulting in high Fixed costs/unit.
• Historically, INDU always had a strong balance sheet compared to its peers and as of the latest balance sheet numbers, the company has a total net cash & cash equivalents of Rs24bn (Rs305/share), 31% of the market cap.
• We maintain our BUY stance on INDU with key risks to our thesis include (1) less than expected sales of Yaris, (2) higher than expected impact of COVID-19 and (3) more than expected PKR devaluation.
• We are revising up our earnings forecast for MTL for FY20 by 38% The revision in earnings is mainly on back of more than anticipated sales in 4QFY20. Due to the lockdown imposed in the country, we anticipated a higher decline in sales.
• Government allowed agricultural activities during lockdown along with exemption status to tractor manufacturers, which helped the MTL in recording sales during this period.
• However, uncertainty over government’s announced subsidy of Rs2.5bn on locally manufactured tractors resulted in customers delaying their buying decisions.
• As per our channel checks, major industry players like MTL and AGTL have ruled out any subsidy after it was not made part of the FY21 budget documents.
• The key risk to tractor sales going forward will be the damage to crop yield due to locust attack, which can negatively impact the sales volume going forward.
• We maintain our BUY stance on the stock with key risks to our thesis include (1) negative impact on farmer income due to locust attack and (2) decline in sales volume owing to COVID-19.
• We are revising down our earnings forecast for PSMC for 2020E-2022F, where we expect the company to report a loss of Rs28.9/share in 2020E.
• We are revising down our estimates, primarily on the back of downward revision in our margin assumptions and impact of recent low sales because of COVID-19. 
• HCAR and INDU have increased their car prices by 3-5% in this quarter, however PSMC has still not increased its car prices in spite of PKR devaluation by 8% against the USD during this quarter.  
• PSMC largely caters the market of (800-1000cc) small car segment and has lower pricing power to pass on the impact of incremental cost to its consumers.
• PSMC has the highest debt on its balance sheet amongst the automobile industry (Rs32bn) as its D/A ratio is 41% as compared to 7% of HCAR and 0% of INDU, which will keep its finance cost at higher level despite recent interest rate cut.
• Furthermore, the new entrants like Prince, Kia & United have launched models in the same segment 0-1000cc in which PSMC primarily operates.
• To highlight the impact of new entrants, the market share of PSMC in 1Q2020 has declined to 44% as compared to 56% in 1Q2019.
• We maintain our SELL stance on the stock with key risks to our thesis include (1) higher than expected pick up in volumes and (2) better-than-expected margins.
• We are revising down our earnings forecast for HCAR for MY21F-MY23F by 6-45%.
• Our earnings revision is based on subdued gross margin of 6.2% and 7.8% in MY21 and MY22, respectively coupled with lower volumes recorded in the first 2 months of MY21, which are only 326 units as compared to 5,788 units in 2MMY20.
• We believe margins will remain largely under pressure despite hike in car prices by 2-3% across all variants in May-2020. From the start of this quarter to date PKR has depreciated by 8% against the USD, which will keep margin at restrained level.
• Non Production days of almost 2 months in MY21 will also increase the Fixed costs per unit for the company, which will further contract the margin.
• HCAR observed 64 Non Production days in 3QMY20, which led to depletion of 4ppts in its gross margin YoY. 
• We believe recovery in volumes for HCAR will not be easy as it primarily caters market of 1300cc to 1800cc segment and its main competitor INDU has recently launched the new model i.e. Yaris, which we believe will keep the sales of city under check.

We maintain our ‘HOLD’ stance on HCAR with key risk to our thesis (1) more than expected decline in volumes and (2) more than expected PKR devaluation.