December 18, 2014

Indian Automobile Industry - Recovery in Commercial Vehicle Sector Update

India is seventh-largest vehicle producer in the world with an average annual production of 17.5 Million vehicles, of which ~13% are exported. The overall vehicle sales in India grew at a CAGR of 9.87% during FY05-FY14 while commercial vehicle (contributing 3.4% of total sales in volumes terms) grew at CAGR of 10.7% over the same period. However, the demand for Commercial Vehicle (CV) is closely linked to economic growth rate and with Indian economy struggled to post GDP growth rate above 5% for seven (excluding 5.2% YoY in Q2FY14) out of eight quarters till FY14, the CV segment saw a decline of 2% YoY in FY13 and 20% YoY in FY14.

CV registering ~20%YoY decline for two consecutive years started show early signs of improvement

Source: Bloomberg

Recovery in MHCV whereas LCV struggles due to lag effect The overall CV demand in India remained depressed throughout FY13 and FY14. During FY13, the overall CV sales dipped by ~2% due to weak performance by Medium and Heavy Commercial Vehicles (M&HCV) segment which was partially offset by Light Commercial Vehicle (LCV). However, in FY14 both MHCV and LCV reported subdued growth resulting to 20% YoY decline in overall CV segment. The ban on iron ore mining, fleet underutilization, fall in resale value and low economic activities were major contributors to depressed demand during this period.

Recovery in MHCV: The M&HCV segment recorded a dip of 25.3% YoY in FY14 vs. decline of 23.1% YoY in FY13 in its sales volume. However, over the past few months, the government has been making an effort to revive the sector with announcements like extension of reduction in excise duty. This has brought some cheers to MHCV segment. In November 2014, MHCV reported a strong 40.1% YoY growth, the third straight month where it has reported a double digit growth. This early signs of improvement in commercial vehicle cycle is due to host of factors like partial lifting of mining bans, improvement in freight rates and due to revival in construction activity led by improved focus on infrastructure development.

Source: Bloomberg

LCV segment still lagging: While MHCV segment was struggling, the LCV segment had reported 14.0% YoY growth in FY13 due to shift of customers in low capacity vehicles on the back of subdued demand. However, the subdued economic growth started pinching LCV segment as well

HDFC Bank Investment Advisory Group

December 18, 2014

and consequently, it reported a decline of 17.6% YoY in FY14. So far in FY15 (till November), it declined by 12.9% YoY. The fall in LCV segment is mainly due to drop in sales of Small Commercial Vehicle (SCV) where fund availability is the main concern. The high default rates in loans prompted the financiers to tighten lending norms and reduce the Loan-to-value (LTV) ratio. The financiers are still cautious while funding to SCV buyers due to their weak credit profile which is further delaying growth in LCV segment. However, LCV segment is indicating some signs of bottoming as the rate of decline in LCV segment have reduced to 2.1% YoY in November as against decline of 13.1% YoY in October 2014. According to Society of Indian Automobile Manufacturers (SIAM), the growth in domestic sales of four-wheelers is expected to be around 3-3.5% for FY15 which will be driven by strong growth in MHCV segment whereas LCV is expected to report a negative growth due to stringent lending norms. Key drivers of improvement in CV cycle

The extension of benefit from excise duty cuts (to 8% from 12%) has given some relief to bleeding CV segment. However it has started to improve in past few months on the expectation of revival in economy. There are few other factors which are indicating further improvement in overall CV cycle and are expected to drive strong growth for H2FY15. Some of these factors are mentioned below

Recovery in Mining and quarrying activity

The ban on mining activity in Karnataka in 2011 and followed by ban in Odisha and Goa has taken a significant toll on the mining activity in India and which was also reflected in demand for commercial vehicles. However partial resumption of mines in Karnataka with the production cap of 30 million tonne in April 2013 has given some relief to mining sector. From there on mining and quarrying activity showed reduction in de-growth and for the past two quarters it has started posting positive growth. Further, the government is in process of finalizing coal block allocation policy which may provide clear direction for mining activity and is expected to register a

robust growth due to expected pickup in demand.

Source: Bloomberg

Construction GDP growth of close to 5% YoY for second consecutive quarter Construction sector which contributed ~7.4% of the total GDP in Q2FY15 has grown close to 5% YoY for second consecutive quarter. This reflects strong demand for cement sector. Further, it is expected to improve in H2FY15 given the improved focus on infrastructure from the government. Improved demand from cement players is likely to increase the utilization levels for freight operators and thereby increase in demand for commercial vehicles.

Source: Bloomberg

Improvement in utilization rate and stable freight rates In November 2014, truck rentals have come down by about 5% which has raised some question on the strong growth depicted in MHCV sales. However, as per industry experts, rentals have come down due to sharp fall in diesel prices and not due to overall slowdown. Despite reduction in truck rentals, the freight rates have remained stable in 11 truck routes. Further, industry wide many big fleet operators have seen an improvement in truck utilization level to 70% in August

December 18, 2014

2014 from 60% in April 2014. Going forward, the utilization level is expected to improve further post a hike in rail haulage charges by 25-41% as road freight charges are about 15-20% cheaper than rail freight charges. This indicates that with increasing utilization level demand for new commercial vehicle is expected to rise.

Discount levels are still at high but slowly stabilizing During the time of slowdown and falling demand, industry saw withdrawal of small fleet operators (having five trucks or less) from the market. This forced CV manufactures to either curtail production or announce heavy discounts to avoid inventory pile up. As a result discounts had shot up to all time high levels. However, with early signs of pick up in MHCV segment discounts are showing some sign of stabilizing (although at higher levels) and are expected to come down gradually. OEMs are still cautious on reducing discounts levels and are rather working on mitigating negative effects of discounts. According to Ravindra Pisharody, executive director at Tata Motors, discounts are still at unreasonably high but are stable and we are working on ways to bring down the negative effect of discounts. (Source: Business Standard article dated November 18, 2014) We think that high level of discounts may help OEMs to maintain high growth rate depicted in recent months.

Fleet operators looking to replace the ageing trucks During the economic slowdown in past two fiscal years, many fleet operators have prolonged their new buying of trucks by one to two years which had severely impacted the CV sales. This ageing truck have higher maintenance cost than new vehicles. According to media reports, with improvement in capacity utilization levels majority of fleet operators are looking to replace the ageing trucks due to high cost of maintenance. According to industry experts, close to 100,000 aged trucks were scrapped during the last four quarters. Further, the customers have also started demanding for younger fleets which may pressurize fleet operators to place orders for new vehicles.

View

The CV segment is showing early signs of improvement led by strong growth in MHCV sales while LCV dragging the overall growth rate for the segment. We believe that H2FY15 may see an accelerated growth rate for MHCV segment on the back of reform push by government to promote investments, develop infrastructure, revive mining activities, declining interest rate and demand for goods carrier vehicles. Apart from these factors, the growth of LCV segment will largely depend on the easy availability of finance for new buyers. Overall we remain positive on the sector from the long term perspective on the expected pickup in infrastructure activity and on the expectation of interest rate cut in near to medium which may bring new buyers and lead to stronger growth in overall CV segment. We are looking for opportunities to take part in the CV revival story and would look to add such stock in the model portfolio as and when valuation of individual stocks starts looking attractive. However as a quasi play we have Mahindra & Mahindra in our model portfolio which deals largely in LCV segment.

December 18, 2014

Mahindra & Mahindra Limited CMP:Rs.1220 Background Mahindra & Mahindra Limited operates in multiple segments directly or via holding in other companies. Automotive Segment consists of sales of automobiles, spare parts and related services. Farm Equipment Segment consists of sales of tractors, spare parts and related services. Information Technology (IT) Services consists of services rendered for IT and Telecom. Financial Services consists of services relating to financing, leasing and hire purchase of automobiles and tractors. Steel Trading and Processing consists of trading and processing of steel. Infrastructure consists of operating of commercial complexes, project management and development. Hospitality consists of sale of vacation ownership. Others consist of Logistics, After-market, Two wheelers and Investments.

Valuations

Sources: Bloomberg

View: Due to deficient monsoon tractor industry growth was flat and is not expected to improve drastically; however M&M continues to be a leader in the segment and has gained market share marginally on YoY basis with the launch of new tractor. While the Company is facing slowdown in Auto segment due to absence in Compact UV segment, new Scorpio is expected to support the volume growth in the segment. Further, UV volumes are expected to improve from H2FY15 on the back of improvement in the economy and new launches in Q3FY15. With the new launches are on the expected to bring revenue growth, the margin would be the key monitorable for the stock. We remain positive on the stock on the expected new launches on both product and engine side in Q3FY15 and on good return ratios of over 20%. At CMP the stock is trading at 16.3x FY16E earnings. We maintain our BUY rating on the stock with revised target price of Rs.1502 (15x FY16E EPS of Rs.75.0 + Rs.377 as value of subsidiaries at 30% holding company discount).

Shareholding Pattern (%) on 30 September 2014 Promoter 25.78 FII 40.21 DII 16.40 Others 17.61 Total 100.00

Key Details 52 week H/L(Rs) 1421/847 Book Value/ Share (Rs) YTD 375.3 FV (Rs) 5.00 PE (TTM) 17.4 Dividend Yield (%) 1.14

PE FY14 FY15E FY16E

20.3 18.5 16.3

December 18, 2014

Disclaimer: This communication is being sent by the Investment Advisory Group of HDFC Bank Ltd., registered under SEBI (Investment Advisors) Regulations, 2013 This note has been prepared exclusively for the benefit and internal use of the recipient and does not carry any right of reproduction or disclosure. Neither this note nor any of its contents maybe used for any other purpose without the prior written consent of HDFC Bank Ltd, Investment Advisory Group. In preparing this note, we have relied upon and assumed, without any independent verification, accuracy and completeness of all information available in public domain or from sources considered reliable. This note contains certain assumptions and views, which HDFC Bank Ltd, Investment Advisory Group considers reasonable at this point in time, and which are subject to change. Computations adopted in this note are indicative and are based on current market prices and general market sentiment. No representation or warranty is given by HDFC Bank Ltd, Investment Advisory Group as to the achievement or reasonableness or completeness of any idea and/or assumptions. This note does not purport to contain all the information that the recipient may require. Recipients should not construe any of the contents herein as advice relating to business, financial, legal, taxation, or other matters and they are advised to consult their own business, financial, legal, taxation and other experts / advisors concerning the company regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this note and should understand that statements regarding future prospects may not be realized. It may be noted that investments in equity and equity-related securities involve a degree of risk and investors should not invest any funds unless they can afford to take the risk of losing their investment. Investors are advised to undertake necessary due diligence before making an investment decision. For making an investment decision, investors must rely on their own examination of the Company including the risks involved. Investors should note that income from investment in such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Neither HDFC Bank nor any of its employees shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this material. This note does not constitute an offer for sale, or an invitation to subscribe for, or purchase equity shares or other assets or securities of the company and the information contained herein shall not form the basis of any contract. It is also not meant to be or to constitute any offer for any transaction. HDFC Bank and its affiliates, officers, directors, key managerial persons and employees, including persons involved in the preparation or issuance of this material may from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein. HDFC Bank may at any time solicit or provide commercial banking, credit, advisory or other services to the issuer of any security referred to herein. Accordingly, information may be available to HDFC Bank, which is not reflected in this material, and HDFC Bank may have acted upon or used the information prior to, or immediately following its publication. Disclosures: Research analyst or his/her relatives or HDFC Bank or its associates may have financial interest in the subject company in ordinary course of business. Research analyst or his/her relatives does not have actual/ beneficial ownership of 1% or more securities of the subject company at the end of the month immediately preceding the date of publication of research report: HDFC Bank or its associates may have actual/beneficial ownership of 1% or more securities of the subject company at the end of the month immediately preceding the date of publication of research report. Subject company may have been client of HDFC Bank or its associates during twelve months preceding the date of publication of the research report. HDFC Bank or its associates may have received compensation from the subject company in the past twelve months. HDFC Bank or its associates may have managed or co-managed public offering of securities for the subject company in the past twelve months. HDFC Bank or its associates may have received compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months. HDFC Bank or its associates may have received compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months. HDFC Bank or its associates has not received compensation or other benefits from the subject company or third party in connection with the research report. Research analyst has not served as an officer, director or employee of the subject company. Neither research analyst nor HDFC Bank has been engaged in market making activity for the subject company. Three year price history of the daily closing price of the securities covered in this note is available at www.nseindia.com and www.bseindia.com.