Automobiles – Quarterly Results Preview: ICICI Securities report

The consumption-led segment is expected to post revenue growth (both QoQ and YoY basis) and improvement in margins on the back of volume growth.

On the other hand, commercial demand led segment is expected to struggle to make even a positive EBITDA. Hence, Maruti Suzuki India, Hero MotoCorp, TVS Motors and Royal Enfield (RE; Eicher Motors) could each see 30%+ earnings growth YoY, while commercial vehicle companies such as Ashok Leyland, Tata Motors (stand-alone) and Volvo Eicher Commercial Vehicles (VECV) could register a significant decline in earnings.

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Then, there are companies such as Bajaj Auto and Mahindra & Mahindra (M&M) which despite volume de-growth are expected to post earnings growth on the back of growth in key segments of their businesses.

In spite of the volume pick-up, we remain cautious on the sector. It is difficult to believe that both the segments will continue to perform in isolation and, in the absence of any economic trigger there is a strong likelihood that growth shown by consumption led companies may not be sustainable. Hence, our top picks remain the companies which have major international business.

Consumption based companies may see earnings growth…: Hero MotoCorp is expected to post a 7% YoY increase in volumes, Maruti Suzuki (-4.4%), TVS Motors <1% and RE whopping 70%+ volume growth. However, almost all of these companies are expected to report improvement in their margins on a YoY basis, if not on a QoQ basis. The reasons include operating leverage, currency and cost cutting, aided by stabilizing petrol prices which may have pulled some demand back. However, for earnings growth to be sustainable, demand has to truly pick up and not to be led by base effect. Our analysis of past two slowdowns indicates that repo rates have to come down by ~1.25% for growth to come back to double digits.

But performance of CV companies casts doubt on revival: Performance of CV companies indicates the economy has not really started picking up. Tata Motor’s CV business is posting a 30%+ decline in volumes in Q3FY14 vs. 16% decline in Q2FY14. Similar numbers for Eicher’s VECV are 30% decline vs. 10% decline; and Ashok Leyland a 27% decline versus a 25% decline. Our channel checks indicate that demand may have bunched up during the festive season. Also, there is apparently not much correlation between elections and increase in demand for passenger cars and two-wheelers. Thus, there is a strong likelihood that Q4FY14 can be worse for consumption led auto companies.

Remain cautious: We will wait for hints of revival in the CV business before turning bullish on India’s domestic auto story. Our top picks remain companies that have strong international businesses such as Bajaj Auto and Tata Motors, even though Bajaj’s earnings growth this quarter could be lower than other companies’. In small/mid cap space, we like Eicher Motors and Bharat Forge, the latter because it has cleaned up its business by selling stake in its Chinese subsidiary (for ~Rs1.8bn).