Equity Analysis /

Pakistan Autos: Another year of volume decline, but we see value in INDU

    Intermarket Securities
    22 July 2019
    • We estimate that local OEMs will see a 12% yoy decline in FY 20 to 211k units. Decline will emanate from a tough macroeconomic environment and a sharp increase in retail prices (up 15% on average since Jun’19). We see more sales related issues for HCAR (higher interest rates and ageing models) but less for PSMC (launch of Alto and de facto ban on used imported cars).
    • For April-June’19 results, we expect PSMC quarterly losses to continue due to the application of increased turnover taxes (from 1.25% to 1.50%). This tax will also impact HCAR now, as lower volumes and FX losses will squeeze pre-tax profits; we expect a 65% yoy drop in NPAT in the quarter. INDU’s 32% yoy profit drop will come from lower other income and margin compression.
    • We have a Marketweight stance on the sector; INDU is our only Buy (TP: 1,270; 19% upside) within the space. We believe its brand value and pricing points will stand out in a challenging year. We are Neutral on HCAR (higher interest rates and ageing models) and recommend Sell on PSMC (turnover taxes). 

    FY 20 will be challenging for auto sales

    Incorporating revised FX/interest rates and FY 20 budgetary measures, we expect a sharper volume decline in FY 20f (down 12% yoy) vs FY 19 (down 7% yoy). As the PKR devalued by 12% against the US$ during Q4 FY 19, OEMs increased prices by 15% on average since Jun’19, the sharpest increase since PKR depreciation began in Dec’17. Price increases also included the cascading FED charge irrespective of engine size, against an earlier 10% FED applied on cars with engine size above 1,700cc. FED is now 2.5%/5.0%/7.5% on cars <1,000cc/1,000-2,000cc/>2,000cc. Another negative measure from the FY 20 budget is the increase in minimum tax (on turnover basis) to 1.50% from 1.25%. This will hurt the economy player (PSMC) more, in our view. However, we expect decent volume growth from FY 21f due to (i) higher GDP growth (IMF expects GDP growth to accelerate from FY 21f), (ii) low base effect as total car sales (including imports) will be similar to FY 15 levels, according to our estimates and, (iii) model launches from new OEMs.

    Marketweight on the sector, Buy on INDU

    Incorporating the developments mentioned above, our target prices are down by 7%-30%. INDU is our only Buy with a Jun’20 TP of PKR1,270/sh given its (i) strong brand value that should contain competition and (ii)  likely introduction of next generation Corolla. On PSMC, we have a Sell with a Dec’19 TP of PKR160/sh. We believe that a tougher minimum taxation regime disproportionately increases the tax burden for an OEM in the Economy segment. Our Mar’20 TP of PKR135/sh for HCAR implies a Neutral stance, where the current round of monetary tightening will impact HCAR the most due to its high share in financing backed vehicles. We are also concerned about the uncertainty on new model launches. However, the company seems to be trading at a significant discount to its replacement value; Kia Lucky invested PKR19.5bn for a new plant of similar capacity, but HCAR’s current market cap is only PKR17.4bn.

    Turnover tax will add to OEM worries 

    For Q4 FY 19 results, we expect a massive 66%/46% yoy/qoq drop in profits owing to (i) 17% yoy volume decline for the three OEMs, (ii) 6% average PKR depreciation during Q4 and (iii) application of higher turnover tax. PSMC is expected to post its third consecutive quarterly loss courtesy a thinner margin profile, a leveraged balance sheet and the application of the turnover tax. HCAR witnessed the most volume decline of 33% yoy during Apr-Jun’19 due to 10% the FED on Civic; we expect a 66% yoy drop in NPAT, also from FX losses and turnover tax. INDU will fare better relatively, as it outperformed the industry in terms of sales. However, we think margins will remain on a downward trajectory and other income will be lower too. Other income for INDU had been stable until recently, due to its order book of up to two months, but cars are now available without any lag due to weakening demand.

    Risks: (i) PKR depreciation against yen and US$, (ii) adverse regulatory measures and, (iii) entry of new competitors.