We resume coverage on PSMC with a Sell stance based on a December 2021 TP of PKR143/sh. We expect a slow recovery of lost sales (post-Mehran discontinuation) amid rising competition and a weak financial standing – which leads to a protracted recovery out of losses.
A number of new entrants will inundate the Economy segment in the near term (Kia has already entered), leading to a very competitive landscape for PSMC. This will diminish its pricing power and keep profit margins low – exacerbating its susceptibility to turnover tax.
PSMC is trading at depressed valuations (P/B 0.6x) vs. peers and its own historical average (0.8x). We think it requires greater visibility of profits and a big catalyst for sales (such as Taxi scheme) for it to emerge out of low utilization levels and command higher valuations.
Recommend Sell on slow sales recovery and persistent losses
We have a Sell stance on Pak Suzuki Motor Co. Ltd (PSMC), based on a December 2021 TP of PKR143/sh (DCF based). Our thesis is based on slow recovery of lost sales over CY20-21f, which will keep margins low and likely maintain losses in the next two years. PSMC’s sales declined by 23% yoy in CY19 and further 63% yoy in 1QCY20. The expected increase in competition in the Economy segment is a major threat to PSMC (refer Page 2), which had previously been the sole assembler of economy cars in Pakistan (after Indus Motors discontinued Cuore in 2016). The discontinuation of Suzuki Mehran is a big blow to both sales and margins (consistent annual sales of c.40,000 units), and the set of recent new models is not strong enough to overcome the loss of Mehran, in our view. We think PSMC needs a big catalyst for sales such as Taxi scheme to boost sales, but such an event seems improbable in the near term.
Weak financial performance and slow new model launches
PSMC has resorted to significant short-term borrowing for working capital since Alto’s launch in CY19 (c.PKR32bn), as advances from sales and cash have dried up. It now has a debt-to-asset ratio of 56% (compared to an average of 17% in the previous five years). This is mainly due to the substantial decline in car bookings and concurrent inventory pile-up. Because of a slower-than-expected recovery in auto sales – first due to Covid-19 lockdown conditions and later new competition – we expect PSMC to maintain high leverage on its books. In light of the new competition, PSMC may have to introduce new models or revamp existing ones more frequently than it has in the past – adding burden on cash-flows and undermining its ability to address competition, in our view.
Susceptibility to turnover tax to remain high in the next 2 years
Besides high leverage, a number of factors will continue to make PSMC prone to turnover tax. We expect it to operate at an average capacity utilization of 55% during CY20-22f (5yr average of 83%), while Opex (as a percentage of sales) has risen significantly in recent years (partly due to the new model launches). We think PSMC also finds itself in a conundrum, where price increases (in response to any cost pressures) will protect margins but also hurt sales, which in turn will make turnover tax more probable. Note that there is a high possibility of a reduction in the rate from 1.5% presently in the next Budget, but we think volume growth will remain more crucial for lifting profitability sustainably.