Auto Sector ; Margin Expansion V/s Demand Contraction

Auto Sector

 

Margin Expansion V/s Demand Contraction

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The current decline in metal prices in a bleak volume scenario is viewed as a positive for the automobile sector. We analyzed historical data to understand the importance of decline in metal prices on EBIDTA margins and stock performance vis-à-vis Sensex. We conclude that

n Volumes are the most important factor for EBIDTA margin expansion and stock outperformance.

n In absence of volumes, the impact of decline in metal prices is diluted. Decline in metal prices may cushion the margins but not facilitate stock outperformance.

n Despite the decline in metal prices, actual earnings have failed to beat initial expectations. This is evident from the fact that stock outperformance has been accompanied by increase in 1 year forward valuations, based on actual earnings. The subsequent underperformance of the stock vindicates our stand.

n It is difficult to accurately determine the benefits from decline in metal prices on raw material cost and EBIDTA margins. We expect surprises, both positive and negative, in FY10.

We have a cautious outlook on demand, despite a series of positive steps taken by the government. We believe that the steps taken by the government takes care of only the liquidity aspect of demand. The more important aspect of spending power (capital and confidence) is still uncertain. Unless there is a revival in spending power, we do not expect liquidity to have a significant impact on demand. We are hopeful of demand revival due to a series of steps taken by the government and the RBI on the liquidity front (and expect FY10 to end on positive note). However, it is difficult to determine the timing and the pace of revival. Also, we do not rule out sacrifice of the benefits of decline in metal prices for bringing in volumes. Infact, we do not rule out downward revision to estimates, as at present, there is no clear indication of timing of revival in the spending power.

Given the above facts, we prefer the two wheeler segment, as we have higher confidence on the demand scenario due to strong rural economy, 50% share of demand from rural and semi urban areas and lower dependence on finance.

Reco	Company	CMP (Rs)*	TP (Rs)
SELL	ALL	15	16
REDUCE	BAL	426	435
BUY	HH	801	946
HOLD	M&M	311	370
REDUCE	MSIL	584	575
HOLD	TML	163	200
SELL	TVS	19	19

* CMP as on 9th Jan-2009