Competitive intensity unlikely to increase; raw material to decide sector outperformance
Year 2013 outlook: will sector outperformance persist for sixth year? Outperformance will likely be driven by a positive surprise on margins.
Marutimaintaining Buy (target price R1,600); Tata Motors maintaining Hold (target price R250); M&M maintaining Hold (target price R890, 5% increase); Bajajmaintaining Buy (target price R2,120, 6% increase); Heromaintaining Sell (target price R1,650); Ashok Leyland maintaining Hold (target price R23.5); and Heromaintaining Sell (target price R1,650). We are generally in line or marginally below consensus on EPS (earnings per share) estimates across our coverage.
Margin upside is the key driver to stock outperformance: The BSE Auto Index has outperformed the Sensex for five straight years (CY08-11 & YTDyear-to-date); therefore, the bar is high in 2013, particularly for Tata Motors and Mahindra, which have outperformed across nearly all-time horizons. While the business outlook is positive for demand and margins, we believe the likely volume growth is factored in the current stock prices. Valuations are generally above mid-cycle levels; hence, outperformance will likely be driven by a positive surprise on margins. We see such a possibility at Maruti and Bajaj.
Our top pick is Maruti, followed by Bajaj, Tata Motors, Mahindra, Ashok Leyland and Hero in order of preference.
Margins: will they repeat the goldilocks scenario of CY09? In CY09, auto companies benefitted from a fortuitous combination of rising demand and falling raw materialas a result, the BSE Auto Index outperformed the Sensex by 100% that year. Raw material prices have been relatively stable this year and the outlook remains benign for 2013. We have forecast modest improvement in margins (50-100bps) for most of the companies under our coverage. In the past, a fall in raw material prices has expanded margins despite elevated levels of competition.
We expect a cyclical upturn in volume growth: We expect 4W (four-wheeler) growth to accelerate to 16% (7% in FY13e) due to better availability of diesel cars from Maruti and the normalisation of demand for entry-level gasoline cars. For 2W (two-wheelers), we expect a modest upturn to 9.6% (4% in FY13e), driven by falling interest rates and better availability of scooters from Honda after its capacity enhancement. MHCVs and tractors could witness a cyclical upturn, particularly in H2FY14e. Our FY13e/14e forecasts are: heavy CVs, -14%/10%; light CVs, 18%/15%; tractors, 0%/8%. We expect competitive activity to remain at similar levels to the current year except for UVs (utility vehicles), which