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What does the 2W sector tell us about our industry?

(1) The combined market cap. of the 2W automobile stocks reflects general optimism about the potential size of the 2W market based on near-term volumes while (2) individual market caps of stocks show selective bias among investors about the prospects of companies. Both reveal deeper issues in the investment industry.

Combined market cap. of the 2W sector does not make any sense

The combined market cap. of US$75 bn of the listed Indian 2W companies seems quite incredulous in the context of the potential size (profits and volumes) of the sector. Simple math (see Exhibit 1) shows that Indian companies will have to sell (1) around 0.55 bn vehicles on an undiscounted basis, (2) 4.5 bn vehicles on a discounted basis in perpetuity and (3) almost 2 bn vehicles (65 mn vehicles per year) on a discounted basis over 30 years to justify the current market cap. of the companies (listed and unlisted).

Preposterous implied industry size indicates too much short-term focus

We attribute the large disconnect between (1) the implied market size of the Indian 2W sector based on current market cap. of the sector and (2) the likely market size of the sector based on fundamental factors of the number of households and penetration (see Exhibit 2) over the next 10-20 years to the growing focus of the industry on monthly volume data at the cost of long-term market size. We can only remind investors that the market cap. of stocks is based on cash flows in perpetuity and not on a few months or years.

Individual market caps. of 2W stocks make no sense either

The individual market caps of the listed 2W companies are incomprehensible in the context of their likely volumes and profits in the next several years and decades. Our reverse DCF valuation exercises (see Exhibits 3-6) show that BJAUT, EIM, HMCL and TVSL will sell 13 mn, 3.8 mn, 10 mn and 16 mn vehicles in FY2036E and 25 mn, 7.5 mn, 14 mn and 30 mn vehicles in FY2041E. These implied numbers are incompatible with the likely size of the market, even adjusting for exports accounting for a decent portion of volumes. We can assume generous assumptions of future profitability, but current profitability and returns are already quite high and will fall sharply from current levels in the future.

Unfathomable individual market cap. of 2W stocks implies selective bias

We attribute the generous market caps of all the 2W stocks to (1) selective bias among investors, with different sets of investors taking different views on their ‘chosen’ companies with respect to their market shares and profitability, (2) oversight of implied long-term market volumes and (3) generous assumptions about industry profitability even in the long term. The market is extrapolating the current neat demarcation of segments of the 2W industry (see Exhibit 7) sustaining in perpetuity, which will support the current high profitability (see Exhibit 8) of the industry in perpetuity or result in even higher profitability in the future. We have serious reservations about such self-serving assumptions.

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