Dear Clients,

We are about to witness another major development with a new auto policy. AIDP 2026 is expected to be finalized by the 1st week of Aug’21 with relevant concessions eyed for setting up HEV and EV plants (major components already announced with the budget 2022). We see the policy to enable grounds for an expansionary cycle for the sector. The ‘Japanese 3’ and ‘Korean 2’ can likely venture into Hybrid electric vehicles (HEV) effectively increasing the industry capacity by 54% in our view. We eye sector volumes to reach 264k units and 291k in FY22 and FY23, respectively. We reiterate our OVERWEIGHT stance on the sector where INDU and PSMC stand as preferred plays.

The automotive sector is abuzz with concessions in duties and taxes. FED is slashed by 2.5% across the board effectively eliminating it for vehicles under 1000cc. Additionally, sales tax is being lowered to 12.5% from 17% for the same category. New vehicle prices have been revealed by OEMs, extending customers the relaxations announced as a part and parcel of the budget. We see the biggest beneficiary is Pak Suzuki Motor Company Limited (PSMC), offering a healthy margin of 9% which should directly encourage volumetric upside.

Focusing on better affordability: The government has targeted the affordability of entry-level vehicles by shaving off excessive taxation (taxes make up to 40% of the vehicle price) on the auto sector. FED is reduced by 2.5% for all vehicles and sales tax is reduced by 4.5% for vehicles under 1000cc. Citing the concessions, manufacturers have reduced car prices by 85k-155k for cars up to 1000cc. This has brought an indirect benefit of 9% lower prices to the segment. This does not hamper manufacturer margins and can likely translate to an uptick in volumes.  Consequently, we cite Pak Suzuki Motor Company (PSMC) as the biggest that offers 5 vehicles (95% of its volumes) under 1000cc.

AIDP 2026; What to expect? We are looking towards a pro-growth automotive policy. This should set grounds for long-term investment. It can further bring in renewed focus to Hybrid Electric Vehicles (HEVs) and Electric Vehicles (EVs) from the conventional Internal Combustion Engine (ICE) vehicles. This should come in courtesy of large concessions for HEVs and EVs that are expected to be finalized by the 1st week of August’21.

Interestingly, the major framework of the policy has been introduced as part and parcel of the Federal Budget FY22. This includes a marked reduction in import of CKD duty for new vehicles introduced under 850cc to 15% from 30%, reduction in customs duty on sub-assemblies to 10% from 20% previously, and reduction in sales tax to 8.5% for HEVs under 1800cc and 12.75% for 1800cc plus vehicles. Hybrids would also attract a reduced duty rate of 4% from 30% on HEV-specific parts. Main takeaways further include 1% customs duty on local assembly/manufacturing of EVs parts, reduced GST of 1% on EVs and zero duty on import of plant and machinery for EVs.

Who should benefit? We’re seeing PSMC as a major beneficiary of the relaxation offered. We now expect PSMC to record 9% higher vehicle sales of 120k units in CY21 from our earlier expectations of 109k units. For CY22, PSMC can deliver volumes of 132k. Our earnings are now PKR 63.7/sh and PKR 64.1/sh for CY21 and CY22E, respectively. We reiterate our BUY stance for the scrip. It currently trades at an inexpensive PE of 5.7x. We cite the potential for an uptick in margins from a lower CKD duty on vehicles (for new model launches) under 850cc. We think the market has grossly discounted the potential uptick in volumes and margins and aggressively priced in unappealing margins. So far price reductions only reflect the relaxation of FED and ST and we do not rule out price increments in response to raw material rate hikes.

Our understanding from available information with regards to AIDP 2026 is that it would prompt expansion from the domestic OEMs. The policy does not signify a distinction between a new entrant and an existing player making a level playing field for all. That said, the concessions are focused on Hybrids and EVs where INDU, PSMC, and HCAR are ready to make strides. PSMC had previously intended to expand by 100k units for a cost of USD 450mn. We think the plan is likely to be adopted with some inherent changes. On the other hand, Indus Motor Company (INDU) is expected to capitalize the AIDP 2026 with first-mover advantage into HEVs. The company has declared intentions to utilize the concessions for venturing into HEVs that can add to the company’s existing lineup and add to valuations.

Our back of the envelope calculations suggests it can generate an additional equity value of 659/sh at an investment CAPEX of c.USD 5,000/car. This should help uplift the market share of the company. A long-term outcome would be the company capturing gaps left in the market left by the exit of Chinese OEMs. Lastly, Honda Atlas Pakistan (HCAR) may likely follow footsteps with City Hybrid and capacity expansion. Kia and Hyundai may likely roll out their EV and PHEV line up which is the core focus of the company strategy globally.

What to buy? A clear preference for INDU and PSMC emerges as we incorporate and model out these developments in our estimates. We see a potential upside of 42% in PSMC with a revised TP of PKR494/sh. We await the release of AIDP 2026 to formally incorporate and pen fresh estimates for INDU’s venture into HEVs.  That said, INDU trades at a PE of 5.7x and implied volumes of 43k units. PSMC trades at a PE of 5.5x and implied volumes of 89k units. HCAR trades at a PE of 5.9x and implied volumes of 25k units. We reiterate our Outperform stance on the sector. 

Regards,
KASB Research