Best Auto Stocks To Buy Now By IIFL

Indian rural economy is witnessing positive transformation led by higher government spending, greater farm financing, farm loan waiver, MSP hike and normal monsoon. Visible effects are: (a) strong tractor volume growth in FY17 (16%) and FY18 (21%), (b) pick-up in domestic 2W sales in FY17 (7%) and FY18 (15%) after low single-digit growth in FY16. We expect rural buoyancy to continue due to election-led demand stimulation, government schemes and MSP hike.

Govt. rural allocation witnessing an upward trajectory: Government allocation towards rural development and agriculture & allied activities has increased by 15% and 39% CAGR respectively over FY16-19BE. MNREGS and PMAY-R allocation has grown at 14% and 28% CAGR respectively over FY16-19BE. The upcoming state and national elections in CY18 and CY19 will further boost rural spending.

Channel checks reveal buoyancy in 2Ws, tractors and trucks: Our interaction with dealers (pan India) of companies mentioned in this report revealed following yoy volume growth expectation for FY19: (i) tractors 12-15%, (ii) scooters 20-25%, (iii) motorcycles 10-15%, (iv) bus 10-15%, and (v) light trucks 20-25%. Growth for tractors and 2Ws will be led by normal monsoon, easy financing and government schemes. Scooters are seeing growing interest in rural areas. Bus demand was mixed in recently concluded school bus season (Apr-Jun) with wide regional variations. Small trucks are seeing good demand due to pick up in construction activities and overloading ban implementation (no impact of recent axle load hike).

Our best rural bets: We prefer companies with focus on rural themes such as (1) Swaraj Engines, since M&M is a diversified player with several businesses besides tractors under its fold, we have considered SEL as it is a focused play on M&M tractors (20x FY20E EPS), (2) SML Isuzu, growing demand for small CVs (20x FY20E EPS); (3) Hero MotoCorp, strong motorcycle sales and growing scooter penetration (15x FY20E EPS), (4) VST Tillers – foray into high HP tractors (16x FY20E EPS). All these companies have low or negligible debt on their books, coupled with superior return ratios and excellent management pedigree.

Swaraj Engines
Strong earnings led by 9.8% engine volume growth in Q4
Engine volume growth due to better demand from Swaraj division of M&M
10th consecutive quarter of YoY growth in volumes
Q4FY18
Rev up 15% at 185cr
EBITDA up 18% at 28cr
OPM at 15.2% vs 14.8%
PAT up 20% at 18cr

— Sonia Shenoy (@_soniashenoy) April 24, 2018

Swaraj Engines Ltd CMP: Rs. 1,800; 1-year target: Rs. 2,037

Swaraj Engines (SEL), engine maker for M&M’s Swaraj tractors has several growth triggers; (a) demand-led capex (from 1,20,000 currently to 1,35,000 engines by FY21E), (b) assured business from M&M, (c) clear transfer pricing (100% input cost pass-through), (d) sector tailwind (double digit long term growth rate) and (e) growing proportion of high HP tractors (from 51% in FY13 to 54% in FY18). SEL enjoys zero debt, high return ratios, esteemed management, stable GPM and handsome dividend payout. We project revenue, EBITDA, PAT CAGR of 20%, 25% & 24% respectively over FY18-20E. At CMP, it trades at 18x FY20E EPS, 18% discount to average 3yr forward PE of 22x. We recommend BUY with target of Rs. 2,037 (20x FY20E EPS).

Assured business from M&M provides revenue visibility:

SEL makes engines for M&M’s Swaraj tractors and fulfills 30% of M&M’s tractor engine requirement, hence orders are assured. Engine volume supplied by SEL has grown at 13% CAGR over FY15-18 vs. 11% CAGR for M&M’s domestic tractors. We expect 20% revenue CAGR for SEL over FY18-20E, led by 17% volume CAGR and 3% price CAGR.

Clear transfer pricing policy shields margins:

SEL has clear transfer pricing policy with M&M, ensuring 100% cost pass-through. It has maintained 22-25% GPM over FY15-18. We expect transfer pricing policy to lead to 60bps GPM expansion over FY18-20E. Greater operating leverage will lead to 141bps EBITDA margin expansion.

Outlook & Valuation:

We are positive on SEL due to (a) assured business from M&M (30% market share in M&M’s tractor volumes), (b) clear transfer pricing policy (steady GPM), (c) robust balance sheet and (d) high dividend payouts.

Sml Isuzu suggested by us at 740 is up at Rs 905
Looks strong as current year will be very good https://t.co/exR7a5e8U2

— Avinash Gorakshakar (@AvinashGoraksha) June 7, 2018

SML Isuzu Limited

CMP: Rs. 884; 1-year target: Rs. 1,020

SMLI, which manufactures buses & medium-sized trucks (5-12T), will make a strong comeback in FY19 & FY20 led by new launches & sorting of inventory issues. It saw volume slump in FY18 due to unsold BS-III inventory & component supply issue from vendors. SMLI has low debt (0.6x) on books. Other than Ashok Leyland, it is the only listed pure play CV player. We forecast revenue, EBITDA & PAT CAGR of 27%, 76% & 195% respectively over FY18-20E. Numbers appear high due to low base of FY18. At CMP, it trades at 17x FY20E EPS. We recommend BUY with target of Rs. 1,020 (20x FY20E EPS).

New launches to boost top-line:

SMLI recently launched 3 truck models in its “Global Series” range of vehicles in 7-10T category. It also launched CNG bus with option of 20-31 seats. Launches will strengthen SMLI’s presence in its core segment. Led by new launches & low base of FY18, we expect SMLI to report revenue/volume CAGR of 27%/20% respectively over FY18-20E.

Operating leverage to improve led by volume uptick:

We expect strong CV demand & resurgence in bus volume to lead to 370bps EBITDA margin expansion over FY18-20E on greater operating leverage. We project bus & truck volume growth of 20% & 21% CAGR respectively over FY18-20E due to infrastructure spending, mining resurgence & high agro output. SMLI had seen steady EBITDA margin uptick over FY14-17, while FY18 was affected due to inventory issues.

Outlook & Valuation:

We are positive on SMLI due to (a) volume uptick led by new launches and robust demand, (b) margin expansion led by operating leverage and (c) robust balance sheet. We value SMLI at 20x FY20E EPS to arrive at target of Rs. 1,020.

Hero MotoCorp Limited

CMP: Rs. 3,310; 1-year target: Rs. 3,976

HMCL, India’s largest 2W maker, dominates domestic 2W market in India with 38% market share. While its peers are facing volatile export markets (Bajaj), margin disappointment (TVS) and slowing growth (Eicher), HMCL stands out due to its continued dominance, steady margins and brisk growth despite high base. Though HMCL is present in a competitive space with peers launching new products at various price points, we remain positive due to its product line-up and resonance with Indian customer. We project revenue, EBITDA and PAT CAGR of 16%, 20% and 20% respectively over FY18-20E. We recommend BUY with target of Rs. 3,976 (15x FY20E EPS).

Strong rural tailwind for top-line:

Rural India, which constitutes 55% of HMCL’s volumes, is showing signs of consumption uptick led by two successive normal monsoons, farm loan waiver, MSP hike, greater government rural spending and CY2019 elections. Hence, we expect volume/realization growth of 13%/2% CAGR over FY18-20E.

Margin stability led by product premiumization:

After cementing its leadership in entry-level motorcycles, HMCL has turned attention to higher capacity vehicles. It plans to launch two 200cc bikes and two 125cc scooters in FY19, thus plugging gaps in its portfolio. We expect these launches (along with intermittent price hikes) to offset impact of higher input costs, resulting in stable gross margin (~32%) and an upward trend in operating margin (16-17.5%) over FY18-20E.

Outlook & Valuation:

We are positive on HMCL due to (a) leadership in domestic motorcycles (52% market share), (b) capacity expansion (from 91 lakh vehicles to 1.1cr vehicles in FY20E), (c) robust balance sheet and (d) product premiumization (high capacity models). We value HMCL at 15x FY20E EPS to arrive at target of Rs. 3,976.

VST TILLERS
Weak sales in June 2018
Power tiller sales down 28% YoY at 2948 units
Tractor sales down 55% YoY at 871 units

Power tiller sales trend
June 2948
May 1751
april 668
March 5591
Feb 2525
Jan 2009​

Tractor trend
June 871
May 706
april 350
March 1808
Feb 953
Jan 813

— Sonia Shenoy (@_soniashenoy) July 4, 2018

VST Tillers Tractors Limited

CMP: Rs. 2,200; 1-year target: Rs.  2,616

VST Tillers Tractors (VSTTL) is a play on farm income growth and tractor penetration. Purchase of tillers, which happens through subsidies, will grow at 10% in FY19E for the sector and 12% for VSTTL. Tractor sector is poised for 12% volume growth in FY19E, with VSTTL’s tractor volume growing at 15% in FY19E. Consequently, we expect revenue, EBITDA and PAT CAGR of 16%, 20% and 12% respectively over FY18-20E (low PAT CAGR growth due to low tax rate in FY18). At CMP, VSTTL trades at 13x FY20E EPS. We recommend BUY with target of Rs. 2,616 (16x FY20E EPS).

Upswing in tractors, new launches to boost top-line:

Tractor growth for VSTTL will be led by strong rural demand and company’s entry into higher capacity tractors. VSTTL plans to launch two new tractors in FY19E, of which one will be in the 47HP range. We expect tractor volume and realization for VSTTL to grow at 12% and 4% CAGR respectively over FY18-20E.

Tiller segment to benefit from DBT:

Indian Government’s DBT scheme, through which tiller sales are funded, has grown at a staggering 126% CAGR over FY14-18 (DBT was introduced in FY14). About 95% of tiller sales take place via subsidy route, 55% of which is through DBT. Led by strong DBT disbursement and two successive normal monsoons, tiller volume/realization for VSTTL are expected to grow at 12%/2% CAGR respectively over FY18-20E.

Outlook & Valuation:

We are positive on VSTTL due to (a) tractor segment up-cycle and company’s shift towards higher capacity tractors, (b) strong DBT led tiller demand and (c) robust balance sheet. We value VSTTL at 16x FY20E EPS to arrive at target of Rs. 2,616.