Budget Expectations: Automobile sector
The Indian auto industry is saddled with stiff competition, low switching costs, high operating leverage and cyclical auto industry demand which makes it very difficult for any vehicle manufacturer to carve a moat for itself, except Bajaj Auto which we believe is an exception in this regard (narrow moat with negative trend)
Even so, the industry’s overall unit volume sales have more than doubled to 20 million units in fiscal 2012 at a compound annual growth rate, CAGR, of over 13% in the past six years, and India is deemed to be one of the fastest growing auto markets in the world.
While improved infrastructure, rising per capita income, availability of finance, changing lifestyles, favourable demographics, and low vehicle penetration are some of the key drivers of growth for the industry, favourable government policy initiatives, especially during the crisis year of 2008, and hence thereafter have also played an important role by providing much needed structural support for the industry’s growth. However, in the last annual budget for fiscal 2013, the government’s proposals of raising excise duty on all types of vehicles by 2%-3%, on commercial vehicle chassis by 3%-5%, and on steel and other auto parts have proven to be detrimental to the industry as witnessed by a mere 4.5% growth in overall domestic volume sales, and a 3% decline in overall export volume sales in the first ten months of fiscal 2013 year over year.
With the impending annual budget for fiscal 2014, the government can take certain corrective steps to arrest this fall in the auto industry demand as well as retain the attractiveness of the Indian auto market. In order to pave the way for the Goods and Services Tax, GST, system, the government can propose a road map for early introduction of GST, while at the same time reduce excise duty rates to align them with the proposed GST plan.
A reduction in excise duty rates from 12% to 10% for small cars, commercial vehicles, three-wheelers and two-wheelers, and from 25% and 27% to 22% for large cars and utility vehicles respectively will help spur demand and boost sales of auto manufacturers since these rate cuts will be effectively passed on to the consumers.
Further, the much talked-about diesel tax on diesel-powered vehicles will only be detrimental to the growth of the overall industry as it will lead to increased prices and further reduced demand for diesel vehicles. No such additional tax burden will benefit Mahindra and Mahindra, Maruti Suzuki and Hyundai who have augmented their diesel vehicle capacities.
The government can also introduce special schemes to boost the commercial vehicle sector such as the one done in 2008-09 under the Jawaharlal Nehru National Urban Renewal Mission that supported purchase of new buses by state transport undertakings for fleet upgrades. Similar schemes can also be announced for the passenger vehicle sector where under certain scrappage programs, similar to the ones adopted in Europe and China, consumers can be incentivized to scrap vehicles ten years and older, and purchase new lower-emission better-technology vehicles.
These schemes will not only support the growth of the overall auto industry, but will also be beneficial from the environment and public health cost standpoint. Other positive measures taken during the last budget such as reduction in taxes and duties for hybrid and electric vehicle components, and extension of weighted deduction of R&D by five years also seem to be steps in the right direction.
We believe the auto industry has the potential to grow at a CAGR of 11%-12% in the next five years and with the right policy initiatives this is achievable. We think Mahindra and Mahindra, Maruti Suzuki, Bajaj Auto and Tata Motors (owing largely to the success of its Jaguar Land Rover business) will continue to perform well going forward and are the best performing automakers in India. However, we think the market has already recognized this and rewarded these stocks with higher valuations. For example, Bajaj Auto is currently trading at a premium of over 11% to our fair value estimate of INR 1,823 while Mahindra and Mahindra is trading at a discount of over 1% to our fair value estimate of INR 906, making them three-star rated stocks based on our uncertainty bands.
The author is an equity research analyst with Morningstar India