Equity Analysis /
Pakistan

Indus Motors: Downgrade to Neutral on greater-than-expected volume decline

    Ahmed Raza
    Ahmed Raza

    Investment Analyst

    Intermarket Securities
    1 October 2019

    We reduce our Jun’20 TP for INDU to PKR1,080/sh (vs PKR1,270/sh previously) and downgrade our stance from Buy to Neutral. The expected decline in sales during FY20 will likely be much larger than we had anticipated earlier due to FED on cars, higher input duties and most importantly, the documentation drive in the economy.

    Our long-term thesis on INDU remains intact for its premium positioning in Pakistan’s automobile space. We also see a strong rebound in sales from FY21, due to declining inflation and interest rates, where historic data also corroborate it. Moreover, new OEMs do not seem to be eyeing the sedan market, in our view.

    INDU currently trades at FY21 P/E of 8.0x, higher than compared to the KSE-100 index. We think the prolonged slowdown over FY20 and depressed earnings can lead to better entry points. We have a similar view on its peer, HCAR (TP: PK135/sh).  

    Volumetric decline to be sharper in FY20 than previously expected

    We reduce our Jun’20 TP for Indus Motors (INDU) to PKR1,080/sh (vs PKR1,270/sh previously) and downgrade our stance from Buy to Neutral. Volume decline in FY20 will likely be much sharper than our earlier estimate, a view shared by INDU’s management after dismal sales in 2MFY20 (4,586 units, down 54%yoy). We now see sales at 32k units for INDU during FY20, compared to 53k units assumed earlier. In addition to higher prices from Jul’19 and increased policy rates (up 575bps in last 12mths to 13.25%), INDU also attributed the documentation drive in the economy to dismal sales. To recall, the government has imposed CNIC requirement for purchases above PKR50K, while the FBR is actively pursuing non-filers of income tax. Recent tax filers stand at only 2.6mn out of a population of more than 200mn (although up by 69%yoy). This has resulted in lower purchases from customers outside the formal economy.

    Government taxes contributed the most in the last price hike

    Jul’19 price hikes of c.15% (latest price revision by INDU) were also the highest compared to earlier price increases due to (i) FED imposed on cars in the FY20 budget and (ii) 5% additional custom duties on imports. As per management, 42% of Corolla’s retail price includes government taxes, compared to 37% in FY19. Another drag on earnings will come from lower other income, in our view. Customer advances, which averaged 2-3mths of sales during FY19, allowed a positive working capital cycle for INDU and it earned interest income on it. This is not the case anymore due to demand slowdown. We are less concerned with gross margins as we expect PKR to remain stable around 160 against US$.

    Competition is gearing up but INDU to likely to retain its premium position

    Among new OEMs, Kia has already started operations by launching Sportage (2,000cc SUV) and Picanto (1,000cc hatchback). Moreover, Hyundai is also expected to be in the market by 2HFY20. However, new players are yet to announce any plans for the sedan market. This is due to strong brand value of both INDU (Corolla) and HCAR (Civic and City), in our view. Therefore, new players might stay within the SUV or economy category in the interim. News reports also suggest that INDU might replace Corolla Xli/Gli with Toyota Vios or Yaris but management has not yet confirmed it. Company has the same response on the next generation of Corolla, as the current model has almost completed its lifecycle.

    Volume rebound should be strong as history suggests

    Our projected numbers indicate a 43% yoy decline for local car sales in FY20, close to what happened in FY09 (down 48%yoy) but sales grew by 41%yoy in the following year. Aside from historic data, we think lower inflation and interest rates may contribute to volume recovery. Lower car penetration, rising urbanization and improved security situation are other factors that point out to a long-term market potential. INDU’s plan to increases its capacity by another 10k via debottlenecking is still intact, underscoring their longer-term demand horizon, in our view.

    Risks: (i) Significant PKR depreciation against USD and JPY, (ii) entry of new players In sedan category, and, (iii) Below expected sales due to FED on cars.