HDFC Bank Investment Advisory Group

December 18, 2014

Indian Automobile Industry - Recovery in Commercial Vehicle

Sector Update
India is seventh-largest vehicle producer in the world with an average annual production of 17.5
Million vehicles, of which ~13% are exported. The overall vehicle sales in India grew at a CAGR of
9.87% during FY05-FY14 while commercial vehicle (contributing 3.4% of total sales in volumes
terms) grew at CAGR of 10.7% over the same period. However, the demand for Commercial
Vehicle (CV) is closely linked to economic growth rate and with Indian economy struggled to post
GDP growth rate above 5% for seven (excluding 5.2% YoY in Q2FY14) out of eight quarters till
FY14, the CV segment saw a decline of 2% YoY in FY13 and 20% YoY in FY14.
CV registering ~20%YoY decline for two consecutive years started show early signs of improvement

Source: Bloomberg

Recovery in MHCV whereas LCV struggles due to lag effect

The overall CV demand in India remained depressed throughout FY13 and FY14. During FY13,
the overall CV sales dipped by ~2% due to weak performance by Medium and Heavy Commercial
Vehicles (M&HCV) segment which was partially offset by Light Commercial Vehicle (LCV).
However, in FY14 both MHCV and LCV reported subdued growth resulting to 20% YoY decline in
overall CV segment. The ban on iron ore mining, fleet underutilization, fall in resale value and low
economic activities were major contributors to depressed demand during this period.
Recovery in MHCV: The M&HCV segment recorded a dip of 25.3% YoY in FY14 vs. decline of
23.1% YoY in FY13 in its sales volume. However, over the past few months, the government has
been making an effort to revive the sector with announcements like extension of reduction in
excise duty. This has brought some cheers to MHCV segment. In November 2014, MHCV
reported a strong 40.1% YoY growth, the third straight month where it has reported a double digit
growth. This early signs of improvement in commercial vehicle cycle is due to host of factors like
partial lifting of mining bans, improvement in freight rates and due to revival in construction activity
led by improved focus on infrastructure development.

Source: Bloomberg

LCV segment still lagging: While MHCV segment was struggling, the LCV segment had reported
14.0% YoY growth in FY13 due to shift of customers in low capacity vehicles on the back of
subdued demand. However, the subdued economic growth started pinching LCV segment as well

December 18, 2014

and consequently, it reported a decline of 17.6% YoY in FY14. So far in FY15 (till November), it
declined by 12.9% YoY. The fall in LCV segment is mainly due to drop in sales of Small
Commercial Vehicle (SCV) where fund availability is the main concern. The high default rates in
loans prompted the financiers to tighten lending norms and reduce the Loan-to-value (LTV) ratio.
The financiers are still cautious while funding to SCV buyers due to their weak credit profile which
is further delaying growth in LCV segment. However, LCV segment is indicating some signs of
bottoming as the rate of decline in LCV segment have reduced to 2.1% YoY in November as
against decline of 13.1% YoY in October 2014. According to Society of Indian Automobile
Manufacturers (SIAM), the growth in domestic sales of four-wheelers is expected to be around 33.5% for FY15 which will be driven by strong growth in MHCV segment whereas LCV is expected
to report a negative growth due to stringent lending norms.

Key drivers of improvement in CV cycle

The extension of benefit from excise duty cuts (to 8% from 12%) has given some relief to bleeding
CV segment. However it has started to improve in past few months on the expectation of revival in
economy. There are few other factors which are indicating further improvement in overall CV cycle
and are expected to drive strong growth for H2FY15. Some of these factors are mentioned below

Recovery in Mining and quarrying activity

The ban on mining activity in Karnataka in

2011 and followed by ban in Odisha and Goa
has taken a significant toll on the mining
activity in India and which was also reflected
in demand for commercial vehicles. However
partial resumption of mines in Karnataka with
the production cap of 30 million tonne in April
2013 has given some relief to mining sector.
From there on mining and quarrying activity
showed reduction in de-growth and for the
past two quarters it has started posting
positive growth. Further, the government is in
process of finalizing coal block allocation
policy which may provide clear direction for
mining activity and is expected to register a

Source: Bloomberg

Construction GDP growth of close to 5% YoY for second consecutive quarter

Construction sector which contributed ~7.4%

of the total GDP in Q2FY15 has grown close
to 5% YoY for second consecutive quarter.
This reflects strong demand for cement
sector. Further, it is expected to improve in
H2FY15 given the improved focus on
infrastructure from the government. Improved
demand from cement players is likely to
increase the utilization levels for freight
operators and thereby increase in demand
for commercial vehicles.

robust growth due to expected pickup in

demand.

Source: Bloomberg

Improvement in utilization rate and stable freight rates

In November 2014, truck rentals have come down by about 5% which has raised some question
on the strong growth depicted in MHCV sales. However, as per industry experts, rentals have
come down due to sharp fall in diesel prices and not due to overall slowdown. Despite reduction in
truck rentals, the freight rates have remained stable in 11 truck routes. Further, industry wide
many big fleet operators have seen an improvement in truck utilization level to 70% in August

December 18, 2014

2014 from 60% in April 2014. Going forward, the utilization level is expected to improve further
post a hike in rail haulage charges by 25-41% as road freight charges are about 15-20% cheaper
than rail freight charges. This indicates that with increasing utilization level demand for new
commercial vehicle is expected to rise.

Discount levels are still at high but slowly stabilizing

During the time of slowdown and falling demand, industry saw withdrawal of small fleet operators
(having five trucks or less) from the market. This forced CV manufactures to either curtail
production or announce heavy discounts to avoid inventory pile up. As a result discounts had shot
up to all time high levels. However, with early signs of pick up in MHCV segment discounts are
showing some sign of stabilizing (although at higher levels) and are expected to come down
gradually. OEMs are still cautious on reducing discounts levels and are rather working on
mitigating negative effects of discounts.
According to Ravindra Pisharody, executive director at Tata Motors, discounts are still at
unreasonably high but are stable and we are working on ways to bring down the negative effect of
discounts. (Source: Business Standard article dated November 18, 2014)
We think that high level of discounts may help OEMs to maintain high growth rate depicted in
recent months.

Fleet operators looking to replace the ageing trucks

During the economic slowdown in past two fiscal years, many fleet operators have prolonged their
new buying of trucks by one to two years which had severely impacted the CV sales. This ageing
truck have higher maintenance cost than new vehicles. According to media reports, with
improvement in capacity utilization levels majority of fleet operators are looking to replace the
ageing trucks due to high cost of maintenance. According to industry experts, close to 100,000
aged trucks were scrapped during the last four quarters. Further, the customers have also started
demanding for younger fleets which may pressurize fleet operators to place orders for new
vehicles.

View
The CV segment is showing early signs of improvement led by strong growth in MHCV sales
while LCV dragging the overall growth rate for the segment. We believe that H2FY15 may
see an accelerated growth rate for MHCV segment on the back of reform push by
government to promote investments, develop infrastructure, revive mining activities,
declining interest rate and demand for goods carrier vehicles. Apart from these factors, the
growth of LCV segment will largely depend on the easy availability of finance for new
buyers. Overall we remain positive on the sector from the long term perspective on the
expected pickup in infrastructure activity and on the expectation of interest rate cut in near
to medium which may bring new buyers and lead to stronger growth in overall CV segment.
We are looking for opportunities to take part in the CV revival story and would look to add
such stock in the model portfolio as and when valuation of individual stocks starts looking
attractive. However as a quasi play we have Mahindra & Mahindra in our model portfolio
which deals largely in LCV segment.

December 18, 2014

Mahindra & Mahindra Limited

CMP:Rs.1220

Background
Mahindra & Mahindra Limited operates in multiple segments directly or via holding in other
companies. Automotive Segment consists of sales of automobiles, spare parts and related
services. Farm Equipment Segment consists of sales of tractors, spare parts and related services.
Information Technology (IT) Services consists of services rendered for IT and Telecom. Financial
Services consists of services relating to financing, leasing and hire purchase of automobiles and
tractors. Steel Trading and Processing consists of trading and processing of steel. Infrastructure
consists of operating of commercial complexes, project management and development. Hospitality
consists of sale of vacation ownership. Others consist of Logistics, After-market, Two wheelers and
Investments.
Key Details
52 week H/L(Rs)
Book Value/ Share (Rs) YTD
FV (Rs)
PE (TTM)
Dividend Yield (%)

1421/847
375.3
5.00
17.4
1.14

Shareholding Pattern (%) on 30 September

2014
Promoter
25.78
FII
40.21
DII
16.40
Others
17.61
Total
100.00

Valuations
FY14
20.3

PE
FY15E

FY16E

18.5

16.3

Sources: Bloomberg

View: Due to deficient monsoon tractor industry growth was flat and is not expected to
improve drastically; however M&M continues to be a leader in the segment and has gained
market share marginally on YoY basis with the launch of new tractor. While the Company is
facing slowdown in Auto segment due to absence in Compact UV segment, new Scorpio is
expected to support the volume growth in the segment. Further, UV volumes are expected
to improve from H2FY15 on the back of improvement in the economy and new launches in
Q3FY15. With the new launches are on the expected to bring revenue growth, the margin
would be the key monitorable for the stock. We remain positive on the stock on the
expected new launches on both product and engine side in Q3FY15 and on good return
ratios of over 20%. At CMP the stock is trading at 16.3x FY16E earnings. We maintain our
BUY rating on the stock with revised target price of Rs.1502 (15x FY16E EPS of Rs.75.0 +
Rs.377 as value of subsidiaries at 30% holding company discount).

December 18, 2014

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