WHAT ONE SHOULD LOOK AT WHILE INVESTING IN AN AUTO STOCK?
This is very important measure for any auto company. Ultimately the sale of automobiles determines their top line (i.e. Revenues)
This measure gives you an indication of the operating profit of the company. One can determine cost efficiencies by this measure. If the raw material costs haven’t changed and Sale price is steady but the margins (Sale Price – Cost Price) have improved, this is an indication of probable improved cost efficiencies within a company.
PBT (PROFIT BEFORE TAX)
The relevance of PBT can be diluted if it has a significant portion from the sale of assets or investments or subsidiaries income. The bottom-line only has relevance if majority of the profit has come from the operations of the company and not through sale of assets. One should always discount the extraordinary or exceptional items from this factor.
PAT (PROFIT AFTER TAX)
Again the earnings indicator, it dictates a lot of investment decisions. But it might be irrelevant if the company operations element is smaller. One should be wary of the reason for sharp increases and decreases in net profits of the company. Each activity other than operational activity would have a different tax treatment.
CAPACITY UTILIZATION/ PRODUCTION
It is one important criterion to determine how efficiently the company is running its plant. If the company is running at low capacities, it means the company is running at less than expected capacities. Idle capacities incur high fixed costs. However since capacity additions happen in anticipation of future volume growth one has to consider the guided volume growth by the company versus actual volume growth. Under capacities work negatively for the company as it represents that company had failed to recognize the prospective growth.
This measure can tell you about the demand supply dynamics of the market. A high inventory level should typically show a downward sales trend for automobile companies. Unsold vehicles typically take a lot of storage space and increase company’s costs.
One of the major reasons why stock investors stayed away from Tata motors for a long time was the huge debt in its books after jaguar acquisition. A high level of debt can be comfortably serviced if there is a high growth in the sector. Else debt can be a major straggler for profitability.
The size of order booking can help one gauge the level of interest consumers have on the automobile. At-least it provides the feeler on short term prospects of the specific models. However waiting period might not be the best measure to gauge the consumer interest.
PRODUCTION SOPS/ TAX HOLIDAYS
Usually the automobile expand to areas which offer excise duty SOPs/Tax holidays (SEZ). These benefit the manufacturer as they are able to improve their margins. The companies which enjoy high level of these SOPs are better positioned to outperform than peers.
What proportion of total sales does exports constitute? Which continents it exports the autos to? One has to determine the economic scenario and demand growth, order book size at these parts of the world where the autos are exported. One also has to discount the currency movement leading to pressure on margins for the auto player. A weakening foreign currency will negatively impact the revenues. Exports can also be an important determinant of how portfolio has been diversified across different geographies.One should also analyze whether prohibitive tax / quality restrictions may be imposed in any of those exported geographies.
CURRENT MARKET SHARE
An increasing market share is a huge positive for a company whereas a declining market share should ring alarm bells for an investor. But these comparisons need to be done on segment based (Economy/ Premium / Luxury etc.) as contribution per vehicle depends on its ticket size. There can be further classification depending on which auto stock is under consideration.
A wide array of offerings across segments induces customer loyalty. It helps company retain its customer base when the customers seek to either upgrade or switch the segment. However a slight negative to it is cannibalization within its product portfolio.
The more eyeballs the company captures through advertisements, the more sales it can expect. Innovative advertisement increases re-call value and create brand imagery. The use of brand ambassadors to promote the product typically helps positioning and creates aspiration brands. However there are proponents who believe Word-of-mouth is the most essential factor in purchase of an automobile. They claim Word-of-mouth essentially drives people to make the final decision. The advise of existing users, product review on web-forums super-cede the ad campaign influence.
EXPECTED NEW LAUNCHES
New launches can be big spoilers for the existing dominant player. All new launches give the consumer to rethink his choice for the established player for the same price. All new launches come with new features and design. The economics of snob effect plays in, as many are induced to make the new model purchase. One has to discount the impact of these new launches before one makes the investment decision.
Very high level of competition leads to industry consolidation eventually, however it has been observed in the short term it impacts margins as many try to decrease prices to gain market share. Expected intense competition should alert investor about the prospects of the auto stock in focus.
A company with high level of reserves can sustain price competition for a longer time. It can also make timely acquisition without over-leveraging their balance sheets.
It is very important to note the management of the company. What their credentials are and whether they stand to benefit the company you are investing into.
The Indian auto industry more often than not has been plagued by labour union issues. One has to look at whether simmering tensions between management and union and if this tension of pull the production off-track.
It would give one a perspective on how the company expects to utilize the free cash flows it generates. Cap-ex plans are very important, it indicates company’s outlook on the current industry and scope of new operations it wants to enter into. Money into R&D and strategic acquisitions might work positively for the company.
BRAND VALUE/ RESALE VALUE AND DISTRIBUTION NETWORK
Distribution network is very important if an automobile company needs to register consistent growth. Brand value is important as it influences the consumer decisions and Re-sale value gives buyer the level of comfort make a switch faster in the future.
EMISSION / SAFETY NORMS
Emission and safety Control costs could also adversely impact auto companies. Any upgrade in technology increases cost. If the company is unable to meet the Emission & safety norms, its sales take a direct hit as the sale is restricted of such vehicles.
Raw materials like platinum and palladium which are part of catalytic converters will increases the costs for auto-companies trying to meet up the emission norms. The emission norms also imply increased cost of up-gradation of parts and processes.
RAW MATERIAL COSTS
The movement of raw material costs in case of any industry. In case of automobile industries one of the main components is Steel and rubber. The Steel and rubber price movement may positively or adversely impact the automobile prices. To be a little quicker to realize the price hikes one should track the iron ore prices. Aluminum price influence the engine prices. Copper is extensively used in wirings, bearings and radiators of the automobile.
AVAILABILITY OF FINANCE
Most of the automobile purchases done by consumers happen through auto loans. Auto loan rates have a negative correlation to auto sales. As the Banks start to increase interest rate, the auto stocks are generally seen under pressure.
Most of us are bullish on India growth story. But we are highly dependent on infrastructure development for the story to actually fructify. Better infrastructure would entail greater trade and higher GDP growth. Improvements in roads, highways should logically increase the demand for automobile as it would become a better alternative vis-à-vis other modes of transport.
India being a agrarian society still and the agriculture still highly dependent on monsoon, the incomes of rural households and their paying capacities are dependent on it.
Pre-festival time (Post Monsoon), is one the better times to play the auto stock. Usually an Indian consumer buys the stock during the festival time (Sept- Mar). It is also considered auspicious time for big –ticket purchases.
Outsourcing has been a BIG story since the turn of this decade. Outsourcing is a cheaper alternate to a critical/ non-critical work done at Developed nations. Setting up manufacturing bases in India for the export market leads to improvement in R&D work/ technology in India. This can bring down costs of production by adoption of world class standards by Indian companies (Auto ancillaries included). This can also boost the credibility of Indian auto company’s products (MADE IN INDIA) across the Globe.
ROYALTY / JVs/ TECHNOLOGY TRANSFER CONTRACTS
One has to discount the royalty payment (as in the case of Maruti Suzuki) and technology available. JVs might bring in advanced technology sharing agreements and company benefitting from the synergies of the two entities. One should evaluate how the JV might benefit the auto you propose to invest in. A limited period renewable contract technology transfer might negatively impact the auto stock closer to the contract renewal.
AUTO FUEL PRICES
One should constantly monitor the petrol and diesel prices. Any substantial rise in auto fuel rise may discourage consumers from buying automobiles. As the costs of maintaining the vehicle increase, people would look at other cheaper modes of transport instead of owning a vehicle. Also there is an indirect link. As the fuel price increases, Inflation increases. Most likely the interest rate would be hiked to contain inflation. This would result in high cost of financing hence low auto sales.
Some of the govt. scheme might benefit an auto company in specific or the auto sector in general. Schemes such as farm waiver, helps farmers purchase tractors and show them as on agriculture loans. NREGA scheme for instance provides money at the hands of rural units increasing spending power of the rural population and hence their consumption levels. Sixth pay commission and pay revision for Bank and Insurance employees might also boost sales as the arrears received by most of the employees might get diverted to discretionary spending needs. Increase in MSP (Minimum support prices) of crops also contributes to high rural income levels.
GDP estimates, Inflation, IIP numbers, the penetration levels of autos in the country, the per capita income of households, Unemployment rates might be taken into account for an overall perspective on the industry over a longer term.
If one seeks to be the number crunching enthusiast then one should look at the following ratios, compare it with peers before making a decision to invest into automobile companies.
Earnings per share, P/E ( Price to Earnings) , P/S ( Price to sales),
P/BV ( Price to Book value), EV/EBIDTA ( Enterprise Value/ Operating Profit)
EV/Sales ( Enterprise Value / Sales )
EBIDTA ( Operating Profit), ROE ( Return on Equity)
ROCE ( Return on Capital Employed), D/E ( Debt to equity ratio)
Annual Sales Growth.
For the Fin-Wizards they can make their own DCF model with relevant assumptions.