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Strengthening Japanese currency keeping auto sales under pressure

Automobile sales were up nominally in December 2018, as against 17%YoY decline in November 2018, sales were up 11%MoM. This is the first time in 12 years (since December 2005) that sales have increased in December on MoM basis. This brings 1HFY19 sales number to 120,066 units, down by 3%YoY. This is also the first time in 5 years that sales have declined during the first half of a fiscal year since 1HFY13.

Despite seemingly better numbers in December, analysts fear significant slowdown in auto sales in near term due to: 1) deteriorating economy, 2) law barring tax non-filers from purchasing cars and 3) multiple price hikes in the past 12 months. The MoM increase in sales is contrary to historical trend where sales fall in the month of December due to seasonal factors. This increase is primarily due to higher sales in PSMC, up 38%MoM.

Indus Motors (INDU) recorded robust YoY growth of 16% led by 84%YoY and 10%YoY increase in Hilux and Corolla sales, respectively. On the other hand, Fortuner sales declined by 33%YoY. On a monthly basis, volumetric sales were down 3% while sales were up 8%YoY for 1HFY19. INDU has been able to maintain its volumetric growth despite the macroeconomic headwinds. This is attributable to the strong order book of the company that existed, where lead times for some variants of the company used to be as much as 5 months.

However, the lead times have now come down to a month or less for most variants as demand has slowed down and capacity constraints in the plant have been resolved. Moreover, it must be noted that the company continues to carry out capex in order to increase its production capacity to 75,000 units. Further, analysts believe that rising interest rates will benefit other income of the company where INDU has a massive Rs29 billion in net cash and short term investments (net of advances from customers).

Honda (HCAR) sales declined by 26%YoY and 31% MoM and sales for 1HFY19 were down 2%YoY. The YoY fall in sales in December 2018 was led by 50% YoY lower BR-V sales and 19% YoY lower sales of City and Civic units. HCAR had been showing a robust trend in monthly sales up until October 2018 (sales up 8%YoY for 4MFY18). However, with thinning of its order book, as depicted by decline in lead times (cars available in 15 days to a month), the company started showing slowdown in sales where in the past two months cumulatively, volumetric sales have fallen by 24%YoY.

Sales of BR-V have shown the most decline as the initial high growth phase of the new car came to an end. Although we expect monthly sales to recover slightly in January, we continue to expect falling volumes YoY. Moreover, it must be noted that the company’s cash and short term investments have fallen to Rs14.3 billion as of September 2018 as compared to Rs31.6 billion in March 2018 due to decline in advances from customers.

 

Auto sector already facing a lot of challenges is about to confront another negative event in the wake of JPY (Japanese yen) appreciation against USD (US dollar). Post indication of several global surveys of a potential economic slowdown mainly in Europe and China, JPY has strengthened by 2% against USD and 14% against PKR (Pak Rupee) FYTD since investors sought exposure in safe haven ‘JPY’. Analysts attribute the following reasons for the appreciation in JPY: 1) Deterioration in global macros, US-China trade war, Brexit uncertainty and political turmoil in the eurozone have restrained the risk appetite of investors, leading many of them to transfer their investments in safe haven investments, 2) JPY has widely been used in carry trades owing to lower yields in the country. However, during periods of uncertain global economic outlook investors become risk averse and square their carry trade positions to repay their borrowed sum, resultantly this behavior leads to JPY appreciation and 3) US Federal Reserve revised down its GDP growth rate estimate from 2.5 to 2.3 percent for CY19 and forecasted interest rate hikes twice over the same period instead of previous estimate of three times. However, as per the international agencies, the Federal Reserve may not be able to further increase the rate as it may further put the economic activity under pressure. This uncertainty is also inducing the investors to opt for currencies like JPY.

Analysts expect that it will be difficult for the domestic players to pass on the impact of appreciating JPY to consumers owing to eroding purchasing power of the consumers in the backdrop of deteriorating macros. Gross margins of local OEMs, heavily dependent on JPY denominated CKD imports, closely follow movement in the FX markets, thereby, impacting them negatively. Stark appreciation in JPY also presents a minor risk of one-off exchange losses for the industry, with PSMC being the major loser.

PSMC has emerged as the worst affected by JPY appreciation. PSMC is always at a disadvantage for any adverse movement in JPY/PKR rate due to a relatively higher exposure to the currency despite overall higher localization levels compared to peers. The calculation suggests that every 1 percent increase in JPY would result in 6.7 percent decrease in earnings for PSMC, 2.4 percent for INDU and 1.3 percent for HCAR; making PSMC the worst sufferer amongst the three OEMs, assuming the impact is not passed on.

Higher input cost owing to adverse movement in currencies and lower ability to pass on the impact would keep the margins under pressure. Additionally, 1) restriction on the purchase of vehicle by non-filers, 2) rising borrowing costs, 3) decelerating GDP growth rate and 4) rising cost of vehicles would inhibit the demand for autos in CY19.

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