India Autos - Margin expansion to drive profit growth - Anand Rathi

Revenue growth decent. Auto volumes in most segments were under pressure in 3QFY14, with the weak continuing to struggle. In four wheelers, CVs registered a decline of >25%, while PVs were marginally negative yoy. Two wheelers were the better performing segment due to a lower base as well as sustained scooter demand. A robust performance at JLR would result in the sector revenues growing 17.2% yoy and 7.3% qoq.

EBITDA margin improvement. A period of heavy discounting and slump in demand has led the top two CV companies to record low single-digit EBITDA margins in ytd FY14. For Tata Motors, however, the trigger is sustained sales growth and robust EBITDA margins at JLR, which would render the losses at India operations irrelevant. Hero MotoCorp. and Bajaj Auto are faring much better, with the latter's performance also being boosted by higher export realizations. Among the PV companies, M&M has been able to compensate for the slowdown in UV sales with robust performance in the lower realization but higher profitability in tractors. MSIL has had margin recovery on a favourable rate in imports and absence of labour strife this year. As a result, despite CV companies dragging down sector margins, yoy improvement in the other companies would lead to the auto sector's EBITDA margins improving 246bps yoy. Our profit growth expectation is 46.5% in 3Q (ex Tata Motors, it is 17.5%).

Our take. The sector valuations normally suffer during periods of weak demand. However, the current valuations are at a significant premium to historical averages and appear to ignore the weak underlying demand (except in Tata Motors, where domestic demand is not a factor). Other stocks like Hero MotoCorp., Maruti Suzuki, and Ashok Leyland are trading at significant premium to fair valuations. Top picks. M&M, on a favourable tractor cycle, subsidiaries adding substantial value to the SOTP and bottoming out of UV demand. On a long-term perspective, Tata Motors and Wabco India look good. Among others, we like Bajaj Auto and Motherson Sumi Systems.

Source : Equity Bulls

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