How one can analyse the automobile industry and companies

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Care for a speed demon?
Jitendra Kumar Gupta / Mumbai May 16, 2010, 0:50 IST

Though it is growing very fast, the auto sector needs constant innovation and cash.

If the Indian economy grows 7-8 per cent annually, along with the growing number of middle class families, there are a lot of opportunities for the automobile industry. That’s why many foreign companies are eyeing the Indian market in a big way.

On the back of economic growth and higher income, the two-wheeler industry has grown at over 10 per cent yearly in the last decade and passenger car segment by 15.7 per cent.

The confidence increases primarily due to the low ownership of automobiles as compared to some other countries. According to the estimates, in India only 20 out of every 1,000 people own cars (of driving age), in sharp contrast with US and UK, where the ratio is 600-900 per 1,000.

Here are a few points which could help investors analyse the industry and companies.

STRUCTURE
The Indian automobile industry comprises mainly of companies making two-wheelers, passenger cars and commercial vehicles. The company may operate in more than one segment, like Tata Motors, into both passenger and commercial vehicles (CVs).

During the economic slowdown, CV sales dropped 57.8 per cent in December 2008 and another 52.5 per cent in January 2009. However, in January 2010, growth in CV sales was a whopping 134.2 per cent. Here, interest rates and financing plays key role, as most CVs are sold on credit. Unlike CVs, the impact of slowdown was not as severe in the case of passenger vehicles and two-wheelers. These segments are largely influenced by income levels and economic growth.

BUSINESS MODEL
Factors like government taxes (excise duty, income tax, etc) and metal prices, which are key inputs for manufacturing, also influence this industry. Companies procure raw materials like metals and convert these into the basic automobile structure. The final assembling of an automobile requires a lot of parts like tyres, lighting systems, engines, glass, wheels, brakes and much more. Only a few components are manufactured by the auto companies themselves; a lot of parts are outsourced from auto ancillaries.

To maintain revenue growth and gain market share, companies cater to different segments and categories within these segments. A good company will have several well-known products targeted at different needs of the customers. Customer loyalty is also very important, which is possible if a company is known for its product quality and services. A large distribution and service network is always a plus point.

OTHER FACTORS
Some companies keep on inventing in new technologies and products, critical for survival. Investors should look at different products in a company’s portfolio and assess the volume growth, market share in those categories. Also, look for companies with better pricing and mileage. Some may have tie-ups or joint ventures for superior technology and good product profile. Investors can compare realisations and share of high-margin products to understand the pricing advantage and profitability.

There is immense competition in this sector. In no time of launching a new technology or product, competitors follow. Like after Tata Motors launched Nano, many others announced similar product. One can also look at the expected product launch and its categories. Sometimes, successful launches have a huge impact on the company’s revenue and help understand growth, profitability.

Higher competition also impacts revenue, market share and margins. For instance, Maruti Suzuki, still a dominant player, with market share of 51 per cent (2009-10), has in the past seen share erosion.

VALUATIONS
The industry is highly capital-intensive and has to keep investing in new brands, capacities and technologies. Profitability could be hit if a company is not able to generate enough volumes to take care of fixed expenditure. Over a period of time, a successful automobile company will tend to accumulate huge cash, which is why most of these companies give good dividends. Generally, analysts value the automobile companies on the basis of the price to earnings ratio. Given the business cycles, they also do so on the basis of the price to cash per share and price-to-book value.


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