Nearly all the carmakers have planned to increase their existing capacity and would be investing over Rs 2.2 billion down the road

Nov 14 - 20, 2005

The auto sector in the last couple of years has recorded significant boost mainly because of increase in demand following the low interest scenario, encouraging consumers to borrow cheaper money from banks and leasing companies. Higher car prices also helped increase the earnings of carmakers in the country and imports failed to make any dent in their upward trend.

Nearly all the carmakers in the country - Pak Suzuki Motors, Indus Motors, makers of Toyota cars and Honda Atlas Motors, planned to increase their existing capacity and would invest more than Rs 2.2 billion down the road to achieve the new expansion level. Indus planned to increase its capacity from 42,000 to 50,000 units, Pak Suzuki 80,000 to 100,000 and Honda Atlas from 30,000 to 50,000 units by mid 2006.

During the preceding two years, the car prices recorded an appreciable jump but consistent demand from the consumers failed to create craters in the revenue side of the automakers.

"We believe that the reduction in import duty on CBUs in FY06 Budget does not pose a major threat to the local car industry. With duties on cars up to 1300cc segment kept unchanged, no major threat to local car manufacturers is expected as cars below 1300cc occupy 85 percent of the cars sold in the country," said Faraz Farooq, research analyst at Jahangir Siddiqui Capital Markets Ltd. On the other hand, local car assemblers would benefit from this as they have also started importing cars thereby trying to benefit from that also.

Regarding increase in deprecation rate to 2% on used cars' import and allowing import of 3-year-old car under the gift and baggage schemes, "we believe that the share of used cars will increase but this will not dampen the local car sales as the overall pie is growing and the prices of locally assembled cars are still lower than the imported second hand cars", he said. Brand loyalty, resale value, after sales and spare parts availability are major considerations that keep customer preference skewed towards local cars. For FY06, we expect local car sales to touch 180,000, an increase of 20 percent.

Car assemblers' profitability took a hit in the first three quarters of FY05 due to the sharp squeeze in margin. Higher steel prices and appreciation of Japanese yen were the two exogenous factors that had adversely affected the margins of car assemblers in that period. However, margin took a U-turn in the 4th quarter of FY05 following the reduction in international steel prices and the depreciation of yen.

Going forward, we believe that margins will further improve as steel prices are expected to decline due to low demand from China, the world's largest consumer of steel. China is expected to become a net exporter of steel in 2005 as rising production capacity will outpace demand.

Rising interest rates was sought to have a negative impact on car demand in terms of rising financing cost. However, this hasn't had any dampening on auto demand as car sales continue to post decent growth. With the holding of huge cash balances, the rising interest rate scenario would result in robust increase in other income of car assemblers by way of higher interest income. Thus, interest income would be a major contributor in future earnings of cash rich car assemblers.

After posting a declining trend during the first three quarters of FY05, profitability of car manufacturers depicted a turnaround in the last quarter (Apr-Jun 2005). The cumulative profitability of the listed car manufactures increased by 35 percent and reached Rs 1,341 million in 4QFY05 compared to Rs 992 million in the corresponding period of last year. Though, margins of the sector squeezed by 140 basis points to 8.7 percent, bottom-line showed significant improvement mainly due to volumetric growth in sales, increased product prices and higher other income.

Combined net sales of companies during the period grew by 43 percent to Rs 26,951 million from Rs 18,802 million previously. The growth in rupee sales arrived from higher sales volume coupled with the increased car prices by the manufacturers. Car manufacturers sold 46,892 vehicles during Apr-Jun 2005, a jump of 38% from same period of last year. From previous quarter (Jan-Mar 2005), sales volume during April-to-June period of 2005 was 27 percent higher.

In the light of latest data released, car sales during 1QFY06 stood at 36,242 units as against 28,850 units sold in 1QFY05, depicting a growth of 26 percent. Alone in September 2005, sales showed 31 percent growth to 12,712 vehicles over sales of 9,681 vehicles in September last year. On a MoM basis, September sales also compare favorably with August sales of 12,027 vehicles - a growth of 6 percent.

However, while comparing with the preceding quarter figures, car sales have declined from 39,207 vehicles, showing a decline of 8 percent on QoQ basis. The likely reason for this decline is the fact that car assemblers (Indus & Pak Suzuki) observed shutdowns during 1QFY05 on account of maintenance. Moreover, Dewan Farooque had abnormal sales in June 2005 (3,308 units vs avg. sales of 1,800 units during 1st 11 months of FY05) as their supply of some parts was resumed.

An analyst from First Capital Equities said that the auto sector revenues continue to grow on the back of growing demand, economic growth and easy availability of financing. SBP has now increased markup rates that would ultimately lead to pressure on new car financing.

Apart from this there is increase in the cost of inputs such as steel and inflation, which is around 9 percent. This trend is not likely to change and currently most sector players are going in for expansions to meet the increasing demand of which Indus and Honda Car is coming up with new capacities by the end of this year. According to Trade Policy 2005-06 the Ministry of Commerce has further allowed the import of cars under the gift and personal baggage up to three years old for parents, spouses and children, brothers and sisters.

However, these drastic changes made in the trade policy, coupled with the increase in depreciation rate and reduction of duties on the import of CBU cars, would cause colossal damage to the growing local auto manufacturing industry.

The investment in auto industry hinders on the back of the government policies regarding relaxation in import duties of new and used cars. Imported cars have now reached to around 7,000 units which is 5 percent of total auto sales for the year that is imposing strong threat to local auto industry.