Pakistan Automobile. New Auto Policy/August 2015 Numbers. Sector Research. HCAR model to be tubed. September 10, 2015

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1 FOCUS Equity Automobile Assembler Pakistan Automobile HCAR model to be tubed September 10, 2015 Topline Securities (Private) Limited 508, Continental Trade Centre, 5 th Floor Block-8, Clifton, Karachi, Pakistan Tel: Fax: New Auto Policy/August 2015 Numbers After the expiry of AIDP-I in 2012, various attempts have been made to make a new policy for Pakistan automobile sector. After a gap of 3 years, the draft of the new policy (AIDP-II) II) has recently been presented to Economic Coordination Committee (ECC), a key decision making body for the Govt. In that meeting, Finance Minister Ishaq Dar who is also Chairman of ECC has asked to check whether all legal aspects have been considered while formulating the policy. He also suggested that the draft should be made public to seek their opinion. As per media news, draft of new auto policy has proposed incentives for new entrants, revival of assembly plants that have been shut down and expanding existing facilities. Key points of the policy are 1) incentives for new entrants 2) predictable import policy 3) tariff rationalization 4) human resource development 5) support fund for technology acquisition and 5) safety & consumer protection. To recall, AIDP (Auto Industry Development Programme)-I had incentivized new entrants by fixing the tariff on the import of Completely Knocked Down (CKD) kits at 32.5%. Now, it has been proposed to reduce this tariff to 27.5% over the next five years to encourage investment. This is because 32.5% is still a very high rate as compared to 10% in India for new entrants. If that happens then entry of new players cannot be ruled out. It has also been proposed that 1) import of no more than 3-year old used cars under baggage 2) transfer of residence and 3) gift schemes will be allowed. Moreover, no tax amnesty scheme will be offered in future. Another proposal is to encourage existing players to launch new car models at same lower tariff that should be offered to new entrants. On the contrary, Competition Commission of Pakistan (CCP) conducted a study to gauge the level of competition and found that AIDP-I had shielded the dominant players at the expense of consumers. Thus, CCP sought liberalized import of used cars along with increasing their age limit from 3 to 5 years to induct market competition. However, we downplay any such move by the investor friendly Sharif s Govt. Key risks to our investment thesis include 1) increase in the age limit of used cars from 3 to 5 years and 2) reduction in import duties. KSE 100 Index 33, Auto Sector Capitalization Rs232.2bn (US$2.2bn) Topline Securities (Private) Limited does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Topline may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. See last page for analyst certification and other important disclosures. Muhammad Tahir Saeed AC tahir.saeed@topline.com.pk Tel: Best Local Brokerage House Topline Research is also available on Bloomberg, Thomson Reuters & Capital IQ

2 Earnings trimmed due to weak currency outlook After devaluation of Yuan by China in the month of Aug, 2015, Asian currencies fell in the range of 3-8% against US Dollar (US$). Pak Rupee (PKR) slid from to against US$ while Japanese Yen (JPY) fell from 0.82 to 0.85 against PKR from Aug 1, 2015 to date. Thus, weak currency outlook likely to erode margins of Pakistan auto assemblers. We have revised down our earnings forecast of Pak Suzuki (PSMC) by 3%/5% for 2016F/2017F and Indus Motors (INDU) by 4.6%/9.0% for FY16E/FY17F. We maintain our Hold stance on both stocks at current levels. Pakistan car sales continue to post healthy growth in Aug 2015 Pakistan car sales increased by 67% YoY (36% MoM) to 20,479 units in the month of August. During 2MFY16, volumetric sales of Pakistan automobile sector grew by 89% YoY to 36,388 units, led by taxi scheme and overall improving economic situation in the country. On the other hand, tractor segment posted a decline of 36% YoY to 3,649 units as farmers are waiting for the implementation and execution of announced subsidy schemes by provincial Govt. of Punjab and Sindh. To recall, Punjab/Sindh Govt. in Budget FY16 announced subsidy scheme of 25,000/29,000 tractors. Pak Suzuki Motors (PSMC): : Taxi Scheme provided support Amongst individual companies, PSMC sales increased by 98% YoY to 12,917 units in Aug 2015 primarily due to Punjab Govt. Taxi Scheme. During 2MFY16, volumes improved by 107% YoY to 9,783 units. We estimate profitability of PSMC to grow by 139% YoY in 2015 on the back of volumetric growth and weakening of JPY against US$. We maintain Hold stance on the scrip which is trading at 2015E PE of 7.5x. Indus Motors (INDU): New Model of Toyota Corolla is still in demand INDU sold 5,524 units in Aug 2015 compared to 4,065 units in the same month last Car Sales Numbers Units 2MFY16A 2MFY15A YoY Aug'15 YoY MoM PSMC 22,381 10, % 12,917 98% 36% INDU 9,783 5,171 89% 5,524 36% 30% HCAR 4,183 3,139 33% 2,002 23% -8% Others % 36-27% 620% Total 36,388 19,206 89% 20,479 67% 29% Source: PAMA, Topline Securities year. During 2MFY16, company sold 9,783 units, up 89% YoY. It is pertinent to note that customers were waiting for the new model of Toyota Corolla in the month of July last year which was the main reason for abnormally low base. We estimate earnings of INDU to grow by 6%/5% in FY16E/FY17F. We maintain our Hold stance on INDU which is currently trading at FY16E PE of 9.5x 2 P a g e

3 Honda Cars (HCAR HCAR): Growing sales despite new model of competitor HCAR sold 2,002 units in Aug 2015, up 23% YoY. During 2MFY16, company posted a growth of 33% YoY to 4,183 units. Our channel checks suggest that company has shelved its plan to launch Honda City in Now, it is expected that HCAR will launch new model of Honda Civic which will serve as the catalyst for volumetric and earnings growth, we believe. It is important to note that HCAR is consistently posting sales growth despite the new model of Toyota Corolla launched by its competitor INDU. This indicates that overall market size of Pakistan automobile sector is growing. Tractor sales decline due to delay in execution of subsidy schemes Millat tractors (MTL) and Al-Ghazi tractors (AGTL) both witnessed a decline in their volumes during 2MFY16. Our industry sources revealed that farmers are waiting for the execution of announced subsidy schemes by Punjab and Sindh Govt. MTL sold 1,329 units in the month of Aug 2015 versus 1,927 units last year. During 2MFY16, company witnessed a decline of 43% YoY to 2,072 units. AGTL also posted a decline e in sales to 601 units in Aug 2015 against 1,024 units in the same month last year. Tractors Sales Numbers Units 2MFY16A 2MFY15A Millat 2,072 3,630 AGTL 1,421 2,080 Orient Total Tractors 3,649 5,740 Source: PAMA, Topline Securities YoY Aug'15 YoY MoM -43% 1,329-31% 79% -32% % -27% 420% % 20% -36% 2,015-32% 23% 3 P a g e

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