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JS Securities Limited – JS Research (November 18, 2022)

Karachi, November 18, 2022 (PPI-OT): Autos: Struggling on multiple fronts; sector returns to losses

We review Auto sector’s performance for 1QFY23 results and discuss outlook where the sector dived into negative territory owing to sharp decline in sales volume, bleak margins and pile up in compensation to customers on late deliveries. The differing account treatments means the impact of this compensation was seen in different line items for respective companies.

Sales volume more than halved to 31k units, down 54% QoQ owing to subdued demand and ongoing production issues amid quota placement on CKD imports.

We expect sales volume to decline by up to 50% YoY during FY23 and with subdued volumes, we expect margins to face pressure in the coming quarters as well, amid higher cost of production.

1QFY23: Auto sector dives into negative territory

Auto space (INDU, HCAR, PSMC) dived into negative territory on a cumulative basis posting a combined LAT of Rs1.6bn as compared to a PAT of Rs1.6bn during the previous quarter. Sector profits depleted owing to sharp decline in sales volume, bleak margins and pile up in compensation to customers on late deliveries. Other income on the other hand remained stable whereas tax expenses declined on a QoQ basis due to absence of one-time super tax.

Volumes shrink as demand and supply issues continue

Sales volume more than halved to 31k units, down 54% QoQ owing to subdued demand and ongoing production issues amid quota placement on CKD imports by SBP as a way to contain the country’s import bill. To recall, INDU announced its plant shutdown for 15 days of both Aug-2022 and Sept-2022 while PSMC announced shutdown of its plant for half of Sept-2022. HCAR on the other hand witnessed 3-4 Non-Production Days. As a result, net sales dropped to Rs87bn, down 48% QoQ.

Margins fall into the red zone, struggling to bounce back

Sector margins were dragged back into negative territory once again since 4QFY20 (COVID quarter) as a result of lower sales volume and rising cost of production. A relatively pronounced impact was witnessed in INDU as the company posted a gross loss of 6.3% for 1QFY23 due to adjustment in its net sales for compensation paid to customers unlike other players. Aggressive price hikes of up to 20% in Mar/May-2022 proved to be insufficient to cover the combined impact of PKR devaluation and inflation. As a result, sector margins clocked in at -0.1% as against 3.4% during previous quarter.

Higher delivery times bite back

Albeit visible in various line items due to different accounting practices, charges on late deliveries to customers swelled significantly driving down profits further. For the same reason, INDU’s margins fell into negative territory whereas for PSMC, the impact was witnessed in higher finance cost to Rs4.8bn (+6x QoQ). Other income which has been lending support to sector profits over the past few quarters, remained stable, up 3.7% QoQ to Rs7bn owing to robust cash balances with higher interest rates.

Outlook

We expect challenges on the supply side to continue during 2QFY23 as well, normalizing in 3QFY22 followed by subdued demand for vehicles for the remaining part of the year owing to higher car prices, higher interest rates, measures taken by the regulators and impact of floods. On a cumulative basis we expect sales volume to decline by up to 50% YoY during FY23.

With subdued volumes, we expect margins to face pressure in the coming quarters as well compounded by higher cost of production. Other income is expected to witness a downward trend in the coming quarters as advances from customers dry up due to low demand whereas compensation paid to customers is expected to normalize as well as delivery times normalize with lower order intake. We have an Underweight stance on the sector.

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