Volume to See Recovery in FY15 with Uptick in CVs by H2FY15E

Over the past 12 months, the BSE Auto Index has outperformed the Sensex by 11% owing to decent volume performance of Two-wheelers & PVs though growth tapered down in FY14 YTD. However, lower volume growth coupled with margin pressure has led to contraction in multiples of the companies from their historical highs, which is a common phenomenon during down cycle of the economy. We expect sturdy volume performance across segments over next two years backed by beginning of new business cycle and economic recovery. We believe that double digit CAGR in volumes would translate into strong margins and improvement of return ratios.

Bounce Back Expected after Two Years of Decline; Pent-up Demand & Cyclical Recovery to Fuel Growth: Domestic auto industry – sans two-wheelers – began declining since past two years due to multiple economic factors, which continued in Q4FY14 as well. However, after completing second consecutive year of downfall, M&HCV & PV segments are set to enter into new up-cycle in FY15E. We envisage new investment cycle to begin after General Elections, which coupled with pent-up demand, would kick in volume for the sector over FY15-FY16. We believe that beginning of interest rate down-cycle and less inflationary pressure would translate into double digit growth in auto volume over next two years.

Regional Disparity of Vehicle Penetration to Drive Growth: Lower vehicle penetration in Central & Eastern regions vis-à-vis Northern region would be one of the key factors for volume growth, going forward. We expect intra-regional penetration gap would shrink with higher growth in Eastern, Western & Central regions.

Introducing FY16 Estimates & Roll Forward Our Target Price: As we are approaching end of FY14, we introduce our estimates for FY16 and roll forward our target price based on FY16E. We expect the four-wheeler segment to outperform the two-wheeler segment due to lower base of last two years. Within four-wheeler segment, we expect strong bounce-back in M&HCV volume vis-à-vis PVs. On exports front, though we see moderate volume in FY15E, we expect higher growth in FY16E.

Outlook & Valuation

We reiterate our “BUY” recommendation on Tata Motors (TTML), M&M, Escorts, Maruti Suzuki (MSIL) & Bajaj Auto (BAL) and reiterate our “SELL” stance on Hero MotoCorp (HMCL) & TVS Motor (TVSL). We downgrade Ashok Leyland (ALL) from “BUY to “SELL” due to price run-up and limited upside from CMP. However, we have revised our target prices of BAL, HMCL, M&M, MSIL & ALL by -2.3%, 8%, 6%, 19% & 14% to Rs. 2,150, Rs. 2,210, Rs. 1,100, Rs. 2,050 & Rs. 24 per share, respectively, while maintaining target price of TTML, Escorts & TVSL at Rs. 462, Rs. 165 & Rs. 75 per share.