AUTOMOBILES 
CAPACITY EXPANSION TO HELP BRIDGE DEMAND-SUPPLY GAP

According to some estimates, as a result of these expansions the overall capacity is expected to exceed 230,000 units annually

By SHABBIR H. KAZMI
Nov 14 - 20, 2005

In the rising interest rates environment and POL prices touching historic highs analysts often tend to paint a grim outlook for the automobile industry but most of the time their forecast proves incorrect. One may wonder whether the analysts are not able to understand the local market dynamics or the consumers' behaviour is irrational. A few of the analysts are of the view that most the reports prepared are often prejudiced, either aimed at protecting the interest of assemblers or the dealers (importers) but certainly ignoring the most important stakeholder, the customer. The single factor supporting this argument is the 'on money' being charged by the car dealers, which is also tax-free.

A lot has been said and written about the record sale of cars and motorcycles during the last couple of years in the country. However, all these reviews seem to have been done in isolation and without taking into account the real factors. Sale of around 125,000 cars in a year is a dismal figure for a country having population of more than 150 million. In the absence of a decent public transport system in the urban areas, people have no option but to maintain their own transport and auto financing has provided the right impetus. Bulk of the cars sold pertains to urban area, Karachi being the biggest market.

Even a cursory look at the public transport system in Karachi tells a lot. There is an acute shortage of buses, particularly during the peak hours. Tariff of taxis is not only high but also most the taxis either have faulty meters or drivers are not ready to accept fare according to the installed meters. Added to this is long distance between homes and work places. Therefore, people are forced to use either motorcycles or old cars of smaller engine capacity. Lately, the surge in car sales has been because of improving purchasing power and availability of auto loans at relatively affordable interest rates.

However, the rising number of cars results in frequent traffic jams on roads, increased POL import bill and higher pollution. It may be true that traffic jams are due to more cars plying on the roads, but many analysts are of the view that the jams are due to encroachments and improper parking. These traffic jams are not only a nuisance but also result in burning extra fuel and creating more pollution. Traffic jams and environmental pollution are also responsible for growing frustration and lowering tolerance among the people. A large number of people suffer from hypertension, which also causes cardiac and mental disorder. The worst hit people are those riding on motorcycles and passing through roads suffering from worst congestions.

Another factor often being overlooked is per capita income of people living in large cities. It is often said that the per capita income in Pakistan is around US$ 500. However, some of the estimates done by analysts indicate that monthly income of hundreds and thousands of people living in large cities is above this stated average. One may say that the number of tax returns submitted annually does not support this point. It is a pity that the people grossly under-state their income. Another point to ponder is that most of these returns pertain to salaried-class. One may arrive at a conclusion that most of the people having fabulous monthly income are still outside the tax net.

A closer look at the types (engine capacity) of cars sold indicates that most of the cars are of 1000cc or blew. These are the cars being bought by most of the Pakistanis because of being affordable and fuel-efficient. The latest figures show that nearly 60% of the cars sold in the country have factory fitted CNG kits. In a way it may be inferred that middle-income group is using these cars, which is also conscious about monthly fuel bill. This point is also substantiated by long queues of cars at CNG filling stations.

Though the talk has been going on for a long time regarding import of second hand cars, not much progress has been made. Initially the government was reluctant to allow import of second hand cars. Now the government has allowed import of used cars but dealers seem to be less interested. The single largest reason being that there is enormous demand for 800cc and 1000cc cars but these are not available in large quantities in second hand condition. The preference for lower engine capacity is due to rising gasoline price.

The other point is that most of the cars available in the Middle East markets are left hand drive and of 1500cc and above engine capacity. These cars also have higher fuel consumption. Spare parts of most of these cars are either not available or available at very high price in Pakistan. Therefore, demand for second hand but locally assembled cars is high. Similarly, European and American cars do not enjoy major attraction because of higher fuel consumption and being heavy on maintenance.

As regards import of CBUs of higher engine capacity, their share in the total market is still low and will also remain low for some time. There are two reasons for this 1) higher cost of luxury cars and 2) higher fuel consumption. As stated earlier lower engine capacity cars are purchased out of necessity but higher engine capacity cars still bear status symbol. It may be true that a large number of people can afford to buy these expensive and luxury cars but they often abstain from doing so for a number of reasons, including car snatching.

Auto financing has been the driving engine for the automobile industry. On the one hand it has facilitated in achieving higher sales and on the other hand it is responsible for major investment both in the assembling as well as auto parts manufacturing. According to some estimates billions of rupees have been invested in parts manufacturing. The level of expansion in the parts manufacturing can be gauged by the increase in the number of vehicles assembled. The vendor was providing components when annual production of cars was less than 50,000 and at present it is supporting production of nearly 125,000 cars annually.

Another sector, which has benefited substantially from increase in number of cars sold, is the insurance sector. Recently SITE branch of EFU General Insurance has achieved a milestone, collecting one billion rupees premium in 10 months. Out of this 60% was collected from car insurance. One can recall that in the past insurance companies were not keen in underwriting car insurance business. As against this they now draw a significant percentage of total premiums from car insurance. It may be said that car insurance is acquired due to potential theft. Since most of the cars are being sold under lease/auto finance scheme the insurance cover has to be acquired. Though, the burden is on the customer, it is a win win situation for all.

MAJOR PLAYERS

A new chapter in the history of Pakistan's automobile industry was written when the government decided to ban import of second hand cars and tariff on new cars was brought down in early nineties. At present three out of four major assemblers are big Japanese names working in collaboration with local investors. The fourth assembler is working in collaboration with Korean giant. The latest entrants are the assemblers of Chinese cars and commercial vehicles. Recently the government has further reduced the tariff on CBUs but import duty on CKD kits was not reduced.

According to Faiza Naeem of AKD Securities, "Although the share of imported cars has certainly increased, growth in locally assembled cars has remained intact, which is obvious from 23% YoY growth in car sales for the first two months of current financial year". According to her Pakistan has very low car penetration ratio, 6.1 cars per 1000 people as compared to 8 in India and 15 in China. At an average, 28 out of 1000 Asians (excluding the Middle East) own a car. This offers immense growth potential.

Car demand, being income elastic, is largely dependent on per capita income. Improving macroeconomic indicators suggest further growth in demand, expected to remain robust due to auto financing on attractive terms. As against general perception, the demand has not showed down due to recent hike in interest rates. Banks still have surplus liquidity and are willing to continue to finance car purchases.

Lately, there was a fear that in the rising interest rates scenario, there could be some defaults. However, the prediction of some analysts that borrowers could not afford to become delinquent has come true. There may be some sporadic defaults but most of the payments are being made in time and in full. According to an analyst, "The borrowers cut other expenses but just cannot dream about committing a default because they have become so used to the lifestyle".

According to the data available at present Pak Suzuki emerges to be the market leader, in terms of number of units produced. During 2005 it produced about 76,000 units or 41% of total vehicles. It was followed by Indus Motor with total production of 35,000 units. Honda Atlas produced 24,000 units and Dewan Farooque Motor accounted for 15,000 units. The installed capacity in 2005 was 165,000 and capacity utilization was recorded at 84%.

Keeping in view the insatiable demand for cars, all the auto assemblers have either already undertaken expansion plan or are busy in finalizing the details. According to some estimates, as a result of these expansions the overall capacity is expected to exceed 230,000 units annually. Till recently the total installed capacity was 140,000 units, which had already touched 183,000 units. After the expansion Pak Suzuki would have the largest capacity to produce 100,000 units. Indus' capacity would be about 50,000 units. Similarly, Honda Atlas' capacity would be enhanced to 50,000 units. Dewan's capacity would also be raised to 25,000 units.

OUTLOOK

Almost all the analysts are of the view that the demand for cars will remain robust in the near future, despite hike in interest rates and historic high POL prices. The higher POL prices has become of lesser consequence because of growing use on CNG in the country. However, CNG prices and long queues at CNG filling stations are cause of concern. The problem is being further aggravated because of rise in LPG price and prices of CNG and LPG kits.

The hype regarding adverse impact of imported CBUs is uncalled for a number of reasons. The demand for locally assembled cars is expected to remain intact. While the quantum of imported CBUs is expected to increase the demand for locally assembled cars will remain on growth trajectory owing to their cheaper maintenance, easy parts availability and better dealership network. The cars produced locally have a higher indigenization level than the imported cars. Therefore, the provision of after sales service and replacement of parts is much more efficient in case of locally assembled cars. On top of this, local assemblers would continue to enjoy 19% duty protection on cars up to 1000cc. Increase in import of CBUs is expected to result in additional revenue for the local franchise holder. The added advantage is availability of wider product range.

Since three assemblers of Japanese brands import 40% of the parts from Japan, any fluctuation in yen-dollar parity is very crucial. The positive point is that in the past nine months yen has depreciated by 9% against the dollar. This depreciation along with stability of rupee against dollar has resulted in 11% depreciation of yen against rupee. This means lower cost of imported Japanese parts. Though the impact has not been visible in terms of any reduction in prices of cars, margins of assemblers have certainly improved.

Yet another factor expected to improve margins of local car assemblers is declining steel prices. According to some estimates an increase of one percent in steel price results in a 25bps dent in the auto companiesí cost of production. It is heartening to note that since January this year steel prices have come down by 20% YoY. This will further improve the margins of local assemblers.