Equity Analysis /

Pakistan Autos: Difficult year ahead; prospects likely to improve beyond FY23

  • We reduce our IMS Auto Universe EPS estimates and Target Prices, mainly on account of supply chain constraints.

  • We trim our 2023-26f margins for the OEMs by an average 1ppt, and volumetric estimates by 5ppt on average.

  • We have a Buy rating only on INDU, with a revised TP of PKR1,280/sh. We remain Neutral on HCAR and PSMC

Intermarket Securities
19 October 2022

We reduce our earnings forecast and Target Prices by an average of 7% and 9%, respectively, on account of persistent supply chain constraints and an uncertain near-term macroeconomic environment.     

Elevated car prices in a high interest rate environment have led to weak sales during FY23td, PKR volatility may continue to dampen industry margins in 1HFY23, before respite comes moving into FY24f. We trim our 2023-26f margins for the OEMs by an average 1ppt, and sales volume estimates by 5ppt on average. 

We have a Buy rating only on INDU, with a revised TP of PKR1,280/sh, due to its strong balance sheet and ongoing investment in the HEV segment. We continue to remain Neutral on both HCAR and PSMC.

We continue to prefer INDU

We trim our earnings estimates for the IMS Auto Universe, in light of i) recent sharp PKR/USD volatility (depreciated c.6.5% FY23td), ii) dampened near-term demand outlook amid administrative measures and elevated interest rates (although seem to have peaked), and iii) sharp price hikes amidst an uncertain near term macroeconomic outlook. Despite the earnings downgrade, we maintain our Buy rating on INDU (TP of PKR1,280/sh), where our liking stems from balance sheet strength, lower contribution of auto-financing as compared to peers, and unique growth prospects from expansion into the HEV segment (likely to commence in 2023). We also maintain our Neutral rating on both HCAR (TP of PKR200/sh) and PSMC (TP of PKR199/sh). A positive trigger for HCAR is the launch of a new model (HR-V; included in our estimates), however, HCAR faces the greatest threat from PKR slippage owing to low localization levels. For PSMC, the recently launched Swift and potential new models in the long run are likely to boost margins to a healthier level, in our view. 

Trim estimates; room for positive surprises is there

Over the 2023-2026f period, we cut our volumetric estimates by a further 5% on average. Multiple price hikes since FY22 and potentially lower rural sales contribution in the aftermath of recent floods, are likely to weaken sales growth in FY23f, in our view. Key upside risks to our investment thesis arise from i) PKR appreciation against the USD, ii) receding commodity prices from highs, iii) surge in demand due to sooner-than-expected smoothening of supply chain woes, iv) sooner-than-expected monetary easing and v) earlier new product launches. These factors have the potential to shift our liking for the industry, where share prices are already down c.25% since our last estimate revision. On the flipside, increase in competition from new entrants may keep margin growth and new model sales in check. 

Negatives seem to have been priced in

In light of the ongoing import restrictions, weak corporate profitability in the Jun’22 quarter and significantly low sales between the Jul-Sep’22 period, the sector underperformed the KSE100 by c.23% since May’22. That said, production constraints are expected to start easing off from Jan’23, we flag that sector fundamentals are arguably near bottom. Another key positive for the sector could be an earlier-than-expected reversal in the interest rate cycle. Although, we currently prefer INDU as our top pick, peaking of interest rates may spur upwards price movement in HCAR and PSMC as well.

Going by precedence, HCAR’s share price usually outpaces its peers in an interest rate downcycle. PSMC and INDU generally trail HCAR in the same environment, but still corroborate our case that the peaking of interest rates and potential reversal, may spur growth in the share prices of the Auto OEMs. Also, we observe that in times of ballooning CAD, auto sales tend to decline, likely owing to the resulting fiscal and monetary tightening. Between FY20-22, the sharp demand in auto sales is attributed to i) pent up demand following the Covid-19 lockdowns and ii) sharp economic growth (which also led to a massive CAD reading). The significant CAD in FY22, is also a reason for the ongoing CKD imports curtailment measures. As the macroeconomic environment and CKD imports improve, auto sales should regain lost momentum, in our view.