Karachi, March 22, 2023 (PPI-OT): Autos 2QFY23: Second consecutive quarter in losses

We review Auto sector’s performance for 2QFY23 results wherein the sector remained in negative territory despite sequentially higher sales volume driven by higher operating days along with partial recovery in margins.

While margins showed some improvement, a key factor for losses was the higher finance costs that swelled to Rs5.3bn, up by 10% QoQ. This was not due to higher debt, but due to late payments on deliveries made to customers, demurrage charges and exchange losses amid supply chain issues caused by delay in opening of LCs.

With the ongoing demand and supply side issues, we expect demand slowdown during FY23 to settle close to 50% YoY extending into 1HFY24 as well restricting profits for the automakers maintaining our underweight stance on the sector.

2QFY23: Sector fails to deliver profits

Auto sector’s listed space (INDU, HCAR, PSMC) remained in negative territory during 2QFY23 (LAT: Rs1.7bn vs LAT: Rs1.6bn last quarter) despite a sequential bounce back on the operating level to Rs4bn vs an operating loss of Rs2.8bn previous quarter. Although the core business improved QoQ owing to higher operating days and impact of higher pricing, lower support from other income, exchange losses and tax charges weighed in heavy on sector profitability.

Volumes post short-lived recovery

Sales volume rebounded 50% QoQ to 47k units owing to relatively better raw material supply during the quarter. To recall, INDU and PSMC underwent plant closure for 10 and 7 days respectively during 2QFY23 vs 29 and 21 days during previous quarter HCAR witnessed lower operating days during the same time (11 days in 2QFY23 vs all operational days in 1QFY23). Together with the full impact
of price hikes announced in Aug-22, the sector’s net sales shot up to Rs133bn, up 53% QoQ.

Support from price hikes pulls back margins into green zone

Sector margins bounced back into profits during 2QFY23 after returning losses on the gross level during previous quarter clocking in at 5.4% vs -0.1%. The improvement came on the back of higher prices and volumes along with relative stability in currency. INDU managed to contain its gross losses to -1% vs -6% during previous quarter whereas HCAR and PSMC posted improved margins of 8% and 10% respectively.

Finance costs continue to drag down profits

Although the 3 OEMs remain largely debt free, finance costs further swelled to Rs5.3bn, up by 10% QoQ primarily owing to late payments on deliveries made to customers, demurrage charges and exchange losses owing to supply chain issues caused by delay in opening of LCs. To note, PSMC accounts for the aforementioned in its finance costs. Support from other income showed a decline as well owing to declining cash balances amid lower advances from customers while higher tax charges of Rs4.4bn on a PBT of Rs2.7bn largely recorded by PSMC further weighed down on sector profits.

Outlook: Demand and Supply side issues to stick around

With pressure on the demand side post escalation in car prices, rising interest rates, higher GST on 1400c+ vehicles and overall slowdown in the economy, the situation for auto makers is expected to worsen in terms of supply chain issues with further contraction in quotas for import of CKD kits post Jan-23. To recall, the SBP had shifted the process for opening of LCs to banks under directions to follow a priority list which had no mention of autos. We expect demand slowdown during FY23 to settle close to 50% YoY extending into 1HFY24 as well restricting profits in the sector.

Gross margins for OEMs are expected to remain under pressure in the near term considering the rapid devaluation as the economy shifted from a fixed exchange rate to a free floating one. As a result, exchange losses are expected to shoot up in the upcoming quarters as well. For perspective, exchange losses for PSMC stood at Rs1.3bn as of Sept-22 which escalated to Rs3.6bn as of Dec-22 and currently stand at Rs9bn.To counter the impact, automakers have increased prices 4-5 times during CY23TD which is expected to partially contain the impact.

In light of above mentioned factors we maintain our ‘Sell’ stance on the sector citing any earlier than expected resolution of supply side issues as an upside to our investment thesis.