Moving into fast lane backed by rural catalysts
The Indian automobile industry is in a sweet spot on the back of a cyclical recovery across segments. Rural India is turning out to be the growth frontier for the automobile industry, as near-normal monsoon for 2 years and receding effect of demonetization have bolstered consumer confidence. Rural incomes would receive a further boost over the next several months from Govt interventions in the run-up to the 2019 general election and state elections in 8-9 agri-centric states. We believe that the stage is set for strong growth in automobile demand in H2FY18 and FY19 mainly due to: 1) increase in Govt capital spending and focus on rural economy, 2) near normal monsoon and higher disposable income in view of 7th Pay Commission awards, 3) new launches, 4) benign interest rates and 5) a low base. Two Wheelers (2W), Tractors and Passenger Vehicles (PV) segments are likely to witness strong double-digit volume growth over FY17-19E, while Medium & Heavy Commercial Vehicles (MHCV) volume growth would see a turn around.
We have added 2 names to our research coverage with BUY recommendations – Escorts and Atul Auto. Escorts would be a major beneficiary of upcycle in Tractors/Construction equipment, and margins are expected to expand markedly due to rising scale as well as cost-reduction initiatives. Atul Auto is a pure Three Wheeler play, which is likely to witness strong volume growth and margin expansion on the back of high-margin new products. Hero MotoCorp, Escorts, Mahindra & Mahindra and Maruti Suzuki are our top picks, as they continue to have strong brand equity, extensive distribution network as well as strong rural franchise, and would be major beneficiaries of demand revival in the next 2 years. Also, we believe that Tata Motors would be an outperformer, led by potential levers such as strong sales/margin performance at JLR and lower losses in the standalone business.
Domestic 2Ws to grow at 11% each in FY18E/FY19E: Post the disruption due to demonetization in H2FY17, we expect a strong recovery over the next 2 years, led by: 1) higher rural income with near-normal monsoons, 2) higher disposable incomes in view of 7 th Pay Commission salary hikes kicking in, 3) falling cost of ownership, 4) uneven distribution in penetration, and 5) lack of a organized public transport system. Our top pick is Hero MotoCorp, followed by Eicher Motors.
Domestic Tractors to grow at 12%/8% in FY18E/FY19E: Monsoon has a major influence on demand for tractors and, this year, rains have been near-normal with deficient showers in only a few regions. While some regions also saw floods, a largely normal monsoon for the second straight year and growing MSPs (minimum support prices) have boosted the prospects for higher disposable incomes in rural areas. Rural income would further receive a boost in the run-up to the 2019 general election and state elections in 8-9 agri-dependent states from possible Govt interventions such as aggressive procurement of foodgrains, farm loan waivers, curbs on input prices (fertilizers, seeds etc) and subsidy on farm equipment. Key beneficiaries will be Escorts and M&M.
Domestic PVs to grow at 10%/12% in FY18E/FY19E: New launches have been the main growth driver over the last 2 years and we believe they would continue to propel growth going ahead. Also, strong rural demand and higher disposable income in view of the 7th Pay Commission awards kicking in would aid growth. We expect Maruti Suzuki and Tata Motors to clock robust growth, led by positive response to their recent new launches and network expansion. Meanwhile, fortunes of M&M depends on the performance of its upcoming new models.
Domestic M&HCVs to grow at 0.3%/9% in FY18E/FY19E: Q1FY18 witnessed a double-digit fall due to pre-buying before the introduction of new emission norms. Volumes are likely to recover from Q2FY18 onwards, led by replacement demand, higher sales of construction tippers, restrictions on overloading and gradual improvement in industrial production. We like Ashok Leyland, which would continue to gain market share, led by growing acceptance of EGR (exhaust gas recirculation) trucks vs SCR (selective catalytic reduction) trucks of competitors.
Top picks: FY18/FY19 would be good years for beneficiaries of rural demand such as Hero MotoCorp, Escorts, M&M and Maruti Suzuki. Tata Motors would be our dark horse, as currency worries subside and volume growth momentum persists.
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