CFA Institute Research Challenge Hosted by CFA Society Team School of Business and Leadership - KSBL

The CFA Institute Research Challenge is a global competition that tests the equity research and valuation, investment report writing, and presentation skills of university students. The following report was submitted by a team of university students as part of this annual educational initiative and should not be considered a professional report.

Disclosures: Ownership and material conflicts of interest The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation Compensation of the author(s) of this report is not based on investment banking revenue. Position as an officer or a director The author(s), or a member of their household, does not serve as an officer, director, or advisory board member of the subject company. Market making The author(s) does not act as a market maker in the subject company’s securities. Disclaimer The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Pakistan, CFA Institute, or the CFA Institute Research Challenge with regard to this company’s stock.

Honda Atlas Pakistan Limited

Valuation Date: Jan 4th, 2019 Stock Exchange: TP: PKR151 Current Price: PKR 176.68 Sector: Consumer Discretionary SELL Downside: 14.5% Ticker: HCAR Industry: Automotive

HCAR Going Downhill

16 Mn 1000 14 Mn 800 12 Mn 10 Mn 600 8 Mn 400 Volume Volume 6 Mn

4 Mn 200 2 Mn SharePrice inPKR 0 Mn 0 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Table 1: Key Valuation Matrix Highlights Valuation Date Jan 4th, 2019 We initiate our coverage on Atlas Cars (Pakistan) Ltd. (HCAR:KAR) with a ‘SELL’ rating and 12-month Weight Target Price target price of PKR 151 that represents a downside of 14.5% from its January 4th, 2019 price of PKR 176.68. (PKR) Our valuation is based on a 50/30/20 mix of FCFE, Relative Valuation and Justified P/E, respectively. The FCFE 50% 211 stock is trading at MY19/20F forward P/E of 6.95x/14.3x, compared to KSE 100 Index’s P/E of 6.8x. The Justified P/E 30% 62 company is likely to witness YoY declines in earnings of 44% and 55% in MY19 MY20. Our recommendation Relative 20% 133 is primarily driven by the following key catalysts: Valuation 12 Month Target Price 151 Margins Highly Sensitive to PKR / USD Parity – Historically, we have seen that HCAR’s margins are the most sensitive to currency devaluation and increase in commodity prices, compared to its peers, Indus

Source: Team Estimates Motors Co (INDU:KAR) and Pak Co (PSMC:KAR), as it has the lowest localization level (% of parts sources by local vendors) at 55%. A massive currency depreciation usually impacts margins in the following Table 2: Stock Information year (Table 9). Standard deviation of HCAR’s margin is 6.38% (vs 4.57% of INDU and 4.16% of PSMC) during FY09-18 (Table 8). Given its limited pricing power, HCAR has been unable to fully pass on the increase in costs Stock Information to customers in the past. During MY08-12, PKR depreciated by 49.5% against USD and HCAR’s average gross 52w Price Range 389.51 margin stood at 0.13% (vs 7.28% of INDU and 2.43% of PSMC), with lowest being -1.5% in MY10. In 2018, 3-m Average Daily value of PKR has depreciated from PKR 108 to PKR 139 (28.7%) in the interbank market. We expect PKR/USD Volume 259,835 to close at PKR 155 by MY20F, pushing HCAR’s margins down to 1.7%. 1-yr Performance -65.28% Economic Slowdown – The next two years are likely to be reminiscent of the 2008-10 era which was a Market Capitlization difficult period for the automobile assembling sector with (i) 37% currency depreciation resulting in high (Mn) 25,230 price levels, (ii) economic slowdown discouraging consumer spending (GDP growth rate ranging 1.2-4.1% Free Float (Mn) 20% during FY08-10) and (iii) high interest rates (12-14% during FY08-10) restraining credit availability. During MY18 Dividend Yield 4.3% this period, HCAR’s volumetric sales declined by 21.2% during MY08-10. However, the company’s sales Source: PSX Website rebounded sharply by 33% in MY11 compared to MY10 levels, reflecting the auto sector’s ability to regain momentum once the economic condition start improving. While MY19 and MY20 may be relatively better off Table 3: Key Financials as compared to the 2008-10 era (Figure 25), we still expect a 21% decline in HCAR’s sales, owing to (i) a major portion of customers preferring auto financing, (ii) loss of market share to INDU, (iii) ban on purchase

of cars by non-filers, and (iv) low disposable incomes due to higher inflation.

Key Financials MY19 MY20 MY21 MY22 MY23 Net Sales (Mn) 96,803 80,216 88,332 105,849 120,463

Gross Margin 0.00% 0.00% 0.00% 0.00% 0.00% Other Income (Mn) 3,212 3,206 2,592 2,776 2,968 Net Income (Mn) 3,637 1,773 3,036 4,486 4,696 Cash & Cash Equivalent (Mn) 30,408 26,516 30,061 34,131 39,237 ROE 22% 11% 17% 22% 21%

Figure 1: Dealership Network Map Rising Competition Amid Regulatory Concerns – In recent years, regulatory policies for existing assemblers have tightened to provide benefits to consumers that have been exploited by unreasonable price hikes and lack of technological advancements in car models. Despite having just 10-15% non-filer customers, HCAR is likely to struggle to increase its sales numbers in the near term amid rapid currency depreciation that occurred during 2018 and the imminent economic slowdown anticipated over 2019. Over the next three years, new car models by new entrants like Volkswagen, Renault and Hyundai give tough competition to HCAR, as they will be availing the lowered import duty benefits offered through Automotive

Development Policy (ADP), 2016. Despite growth of 22% in industry size during MY18-25F, we expect HCAR to lose its market share by 3% in the increasingly competitive environment. Silence on Any Expansion Plans – HCAR ended MY18 with over 100% capacity utilization and it can

enhance its production by as much as 6,000 units through de-bottling. The company was planning to launch Honda Brio, a 1200cc compact car, in 2019 but it seems like the management has pushed back the plan due to declining economic growth prospects. Therefore, it seems like the company has no major expansion plan Source: Company Presentation chalked out for the near future. Additionally, HCAR increased its payout ratio from 30% in MY17 to 59% in MY18, indicating insignificant capex requirements in the medium term in the absence of any concrete Table 4: Model-Wise Sales Break-Up expansion plans. The company’s CAPEX per unit declined from PKR 24,828 to PKR 23,753 in 1QFY191QFY19 Car FY16 FY17 FY18 (Table 10).

Civic 4,698 20,243 19,869 Business Description City 20,998 16,580 22,943 (Pakistan) Limited was incorporated in Pakistan in Nov 1992 and a agreement BRV - 2,159 8,684 was signed between Honda Motor Co. Japan and Atlas Group of Companies in Aug 1993. HCAR launched its Source: Company Presentation operations in May 1994 by rolling off its first at its plant located in Manga Mandi, and it has been listed on Pakistan Stock Exchange (PSX) since then. Currently, HCAR has an installed production Figure 2: Model Wise Revenue Breakup (FY18) capacity of 50,000 units per annum, which was upgraded from 30,000 units in 2006. During MY18, the company invested PKR 1.3bn to raise its capacity to 56,000-57,000 units through de-bottlenecking. Although 18% HCAR has not announced any major expansion plan, it owns a large piece of land beside its production 45% facility. It achieved a production milestone of 400,000 units in Oct 2018, with contributing 53%, followed by Honda Civic (44%) and Honda BR-V (3%).

36% Subsidiary of Honda Motor Co. Japan – HCAR is a subsidiary of Honda Motor Co., Japan which is one of the top 10 global automobile manufacturers and the largest shareholder of the company with 51% Civic City BRV ownership. Shirazi Investment (Pvt) Limited, an Atlas Group company, owns 30% stake (Figure 3). Honda Japan provides technical and technological support to HCAR, as well as supplies major car components.

Source: Team Estimates & Company Presentation Business Model – The business model of HCAR encompasses manufacturing and trading segments. The Table 5: Board of Directors company’s manufacturing segment, which constitutes 98% of the revenue, involves assembling and sales of

Name Title Independent cars using completed knocked-down (CKDs) parts. It offers three locally assembled models: Honda Civic (2 Mr. Yusuf H. Shirazi Chairman of Board No variants), Honda City (6 variant) and Honda BR-V (3 variants). The remaining 2% of the revenue is contributed Source:Mr. Hironobu Team Analysis President & CEO No Yoshimura by the trading segment that offers imported completely built units (CBUs) of , Honda CR-V and Director & Senior Honda HR-V, and spare parts for all the models. To sell CBUs and locally assembled cars, HCAR uses its Mr. Aamir H. Shirazi No Advisor network of 46 franchised dealerships that also provide aftersales service and spare parts (Figure 1). Executive Mr. Kenichi Matsuo No Director/VP (Prod) Unique Selling Proposition – With market share of 25%, HCAR ranks third amongst the three locally Mr. Akira Murayama Director No Mr. Feroz Rizvi Director Yes manufactured car assembler. It operates in the 1300cc-and-above passenger car segment in which it holds Ms. Mashmooma a market share of 46%. Honda cars are well known for their luxury driving experience, futuristic design, and Director Yes Zehra Majeed innovative features. HCAR has been positioned as a premium luxury urban car maker. In 2018, Honda Japan Ms. Rie Mihara Director Yes honored HCAR with a gold award at the Best Quality Award Ceremony held in Thailand. Mr. Satoshi Suzuki Director No

Source: Company Reports Corporate Governance Figure 3: Sharehold ing Pattern Diverse Leadership Team – The Board of Directors of HCAR includes individuals who have diversified 5% 6% 6% backgrounds and rich experiences of different industries. Mr. Yusuf H. Shirazi, the Chairman of the Board, introduced Honda Japan in Pakistan through the first plant in 1963. He has over 50 years of 51% experience in the automotive sector. HCAR’s core strength lies in the diverse local and international 31% experiences of other directors (Appendix 11) who have worked in the areas of financial management, investment management, manufacturing, planning, and product development. With the presence of President and CEO Mr. Hironobu Yoshimura, VP Production Mr. Kenichi Matsuo, and three directors from Japan, HCAR receives technological and decision making support (Table 4). Honda Motors Co. Japan Associated Co. Corporate Governance Assessment – We evaluated HCAR based on ICAP/ICMAP’s evaluation General Public Mutual funds criteria for best practices on corporate governance. A score of 53% indicates modest compliance to the Others regulation. (Appendix 10) Source: Company Reports

Figure 4: Passenger Car Industry Break Up (FY18) CSR Activities – Under the slogan of “a company that society wants to exist,” HCAR has undertaken various corporate social responsibility (CSR) initiatives in order to engage with the local community. In 2017, 25% the company provided free medical treatment to over 3,800 patients through arrangement of free medical camps. Around 11,000 patients have benefited from these camps in the last four years. It also installed clean drinking water pumps in three different schools in the surrounding areas last year, as well as renovated two schools along with provision of basic facilities.

75% Industry Overview & Competitive Positioning

Locally Assembled Imported Pakistan Passenger Car Industry – The passenger car (PC) industry of Pakistan is involved in Source: PAMA, Industry Experts, & Team Analysis assembling and sale of cars and automobile parts. It can be divided into three broad segments: locally assembled (CKD), imported new (CBUs) and imported used cars (Appendix 27). The industry is characterized by high margins and differentiated products. The industry has massive growth potential, but the growth is Figure 5: KSE-100 Index vs PCA Index highly sensitive to macroeconomic variables such as GDP growth, disposable income growth and a lower 140 interest rate environment. FY14-18 can be termed as ‘golden years’ for local OEMs (Figure 7), as the sales grew at a CAGR of 18.8% owing to a stable exchange rate (6.8% depreciation), conducive macro-environment, 120 and per capita income CAGR of 6%. However, 2018 has not fared so well with the auto sector as PKR 100 depreciation has exposed the assemblers to exchange rate risk which has already impacted their margins. 80 Moreover, imminent arrival of new green field auto manufacturers availing lower duties under the 60 Automotive Development Policy (ADP) is only going to further erode the pricing power of the current Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 automobile assemblers in the years to come. With the presence of just 3 players, the current oligopolistic industry is led by Pak Suzuki Motor Company (PSMC) with a market share of 48%, followed by Indus KSE-100 PCA Motor Company (INDU) at 27% and HCAR at 25%. Source: FactSet Table 6: Regional PCA Comparison Financial Highlights – Since Dec 2017, the passenger car assemblers provided a negative return of 22.8% compared to the KSE-100 Index, which declined by 2.4% (Figure 5). HCAR’s share price saw a massive decline P/E P/B P/S EV/EBITDA of 65.1% during the same period. This can be attributed to 28% depreciation of the local currency against Regional 6.04 0.78 0.37 6.64 USD, policy rate hike of a cumulative 400bps to 10% with CPI standing at 6.02% during 5MFY19, and

Pakistan 5.99 1.23 0.35 1.40 announcements by new players like Volkswagen to join the bandwagon of Greenfield of Investment under the ADP. HCAR, being the least localized car assembler, has been impacted the most, as its gross margin fell HCAR 5.08 1.16 0.26 1.35 to 7.6% and PAT plummeted by 44% YoY to PKR 2.1bn in 1HMY19. In FY18, total revenue of the Big 3 was Source: Bloomberg PKR 352bn, with highest being contributed by INDU and the lowest by HCAR. However, HCAR’s revenue

increased at a CAGR of 23.6%, over the last five years compared to 25.2% for INDU. Figure 6: Industry & HCAR Sales vs Per Capita

Income Growth (Real) INDU HCAR PSMC Industry 250k 25% Sales (PKR/bn) 140.21 94.32 117.37 351.90 200k 20% Gross Margin 17.39% 10.18% 7.83% 12.27%

Net Margin 11.25% 5.79% 2.67% 6.9% 150k 15% PAT (PKR/bn) 15.8 5.5 3.13 24.2 100k 10% EPS (PKR) 200.66 38.23 38.06 276.95 50k 5% Price/Earnings 7.08 10.50 10.71 9.43 Prices/Sales 0.60 0.74 0.40 0.58 0k 0% Market Cap. (PKR/bn) 93.1 27.4 16.9 137.5 FY08 FY11 FY14 FY17 HCAR (LHS) Source: Company Reports and FactSet Industry (LHS) Income Per Capita Growth (RHS) Global & Regional Trends – Global auto industry growth experienced its first annual decline since 2009, Inflation Rate (RHS) as it edged down by 0.6% in 2018 (Source: Bloomberg). Weak sales in China and suggest that Source: PAMA & Pakistan Economic Survey global demand has peaked and the industry could witness another decline of 0.4% in 2019.

Figure 7: Industry Volumes From 2008 to 2017, Pakistan’s passenger car industry grew at a CAGR of 5.3%, compared to a growth of 9.24% in Asia Pacific Region (Appendix 26), where explosive growth was led by China, Brunei, Kyrgyzstan and 250 (CAGR between 18-10% respectively). Pakistan’s motorization rate is still low at 17 cars per 1,000 people (vs 200 100 regionally) as of 2015, which suggests a high future growth potential. However, this growth potential 150 may not likely be realized over the next 2-3 years as the economic growth is set to decelerate in the country.

100 Demand Drivers 50 0 Rising Per Capita Income & Population Growth – Rise in personal income coupled with population growth contributes towards sturdy automobile sales. During FY08-18, per capita income growth (nominal) outpaced inflation levels by 2.4% on average (Figure 6). Furthermore, the country’s population grew from 132mn in 1998 to 207mn in 2017, representing a CAGR of 2.4%. Given Pakistan is a developing economy, the Source: Company Presentation & Team Estimates aforementioned statistics indicate more disposable income for the middle class, which constituted approximately 38% of the population in 2014 (Source: WSJ). However, HCAR is mainly choice of the urban

Figure 8: YoY Growth in Auto Loans class, which constitute only 36% of the country’s population. Moreover, HCAR only markets higher-end models with cars in excess of 1300cc, and out of the 36% urban population, less than 10% could fall in the income groups that could afford expensive cars. With such a small base, deteriorating economic indicators 4% 2% (3.26% average per capital income MY19-25F) are likely to hamper purchasing power of consumers and impact HCAR’s sales going forward. 0% 3QFY18 4QFY18 1QFY19 2QFY19F Interest Rates & Inflation – The ‘golden period’ for the OEMs was spurred by (i) historically low inflation -2% rates of 3.6% on average (FY16-18) and (ii) stable discount rate of 6.25-6.5% (FY16-18) that made auto -4% financing readily available and affordable for consumers as auto financing constitutes 30%-35% of HCAR -6% sales (Source: Industry Experts). Auto loans increased at a CAGR of 32% to PKR 2,096bn in FY18, but it appears -8% that the phenomenal growth has reached a saturation point, as the YoY growth rate has been on a declining trend (Figure 8). We expect another 50bps increase in policy rate and inflation to be in the range of 7% during Source: SBP FY19, which can have a negative impact on HCAR’s future sales.

New Generation Launches & Facelifts – Assemblers generate high demand for their cars whenever they Figure 9: Sales Trends Pre & Post Launch introduce a new generation or facelift for their existing models. Customers usually delay their car purchases in anticipation of a new model. This trend can be seen in Honda Civic/City and . Honda Civic’s

10th generation was launched in July 16 and its sales increased from 584 units in 1QMY17 to 4,720 in

11th Corolla

Generation 2QMY17 (Figure 9).

Since HCAR skipped 6th generation of Honda City (launched in Sep 2013 globally), it is the only model that

Civic10th has been in production for 9 years. Average model life of Honda Civic is 3-5 years and it has already entered Generation into its third year of production. If HCAR does not bring in new models timely, it can likely lose its sales to

INDU and new competitors, some of whom have announced their upcoming model launches. We expect 11th

City City & Face-Lift Aspire1.5L generation Civic to be launched in MY22 and facelift of Honda City to be launched in MY21. (Appendix 15) 0 2,000 4,000 6,000 CPEC & Transportation Infrastructure Development – China Pakistan Economic Corridor (CPEC) aims to Units Sold strengthen transportation infrastructure network of Pakistan and boost economic activities (Table 7). Post-Launch Pre-Launch Though, commercial automobiles would be the biggest beneficiaries of CPEC, some positive impact on Source: Company Reports passenger cars cannot be ruled out. While there has been negligible development of transportation infrastructure in Pakistan over the past 5 year, the government plans to add over 9,000 km in length of roads Table 7: CPEC Infrastructure Projects over the next 10 years which we believe could impact sales of HCAR models that are perceived to be suitable for road with strong infrastructure. Projects under Roads Length CPEC (KM) Cost Drivers Western 2,497 Alignment Localization & Currency Exposure – Having access to cheaper auto parts and components, OEMs can curtail cost of production. Being the oldest and biggest car manufacturer, PSMC has the highest localization Central Alignment 2,417 level of 85%. On the back of successes of Corolla and City, INDU and HCAR have increased their localization Eastern Alignment 2,686 levels to 60% and 55% (Source: Institute of Development & Economic Alternatives), respectively. However, Total Length 7,600 major components like engines, transmissions, etc. are still being imported from offshore vendors. Hence, Source: Pakistan Economic Survey 2016-17 localization in terms of value remains much lower as approximately 60% of the total cost of assembling a Honda car is still imported raw materials. Figure 10: Cars Per Road During 2018, PKR against USD has depreciated by about 26% to PKR 139. Despite four price hikes already this year and another planned for Jan 2019, HCAR’s margins have declined to 6.4% in 2QMY19, from 12% in 80 70 59 64 2QMY18. Assemblers’ costs are also driven by JPY and THB, as vendors in Japan and Thailand increase prices 60 50 52 42 44 whenever their currency appreciates against the USD. During FY16-18, JPY and THB appreciated by 10% and 36 38 40 40 34 5% against USD, respectively, the partially the reason behind 275bps reduction in industry’s gross margin (Figure 12). 20 We expect currency to further depreciate by another 11.6% to PKR 155 by MY20F because the government 0

plans to secure bailout package of IMF, which will likely impose tougher conditions. By then, most of the new

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY08 assemblers like Hyundai, Kia and Renault would start local production. Thus, the need for localization of major components has now become more important amidst new government’s plans to develop domestic Source: Pakistan Economic Survey 2017-18 industries. Figure 11: PKR/USD vs Gross Margin 20% Commodity Prices - Key raw materials for production of vehicles are steel, aluminum, rubber and plastic PKR 100 that comprise of about 10% each of vehicle’s cost. During 2016-18, steel index and aluminum prices have 10% risen at a CAGR of 28% and 13%, respectively, which are partly responsible for the decline in industry-wide PKR 50 0% margins. Though, trade tensions between the US and China can reverse this trend over the coming years that would relieve margins pressures on the assemblers.

PKR 0

FY12 FY10 FY11 FY13 FY14 FY15 FY16 FY17 FY18 -10% FY09 HCAR (LHS) Industry (LHS) USD/PKR (RHS)

Source: PAMA & SBP

Figure 12: JPY/USD &TBH/USD Regulatory and Policy Framework

THB 37 JPY 130 Automotive Development Policy (ADP) 2016 – The ADP 2016 was developed by the Ministry of THB 35 JPY 120 THB 33 JPY 110 Industries and Production (MoIP) to encourage new investment in the sector to increase the level of THB 31 JPY 100 competition in the industry. New entrants will receive concessionary rates of 10% custom duty for non- THB 29 JPY 90 localized parts and 25% custom duty for localized parts. The Greenfield entrants will not have to pay import THB 27 JPY 80 duties for assemblies and equipment required for construction of assembly plants and can import 100 CBUs at 50% of the prevailing tariff rates (Appendix 16).

THB/USD (LHS) JPY/USD (RHS) Hyundai Nishat, Kia Lucky, and Sazghar Engineering plan to start assembling vehicles that will compete against Honda City and Honda Civic directly (Appendix 14). Although these OEMs may not have a large impact over Source: SBP the next two-three years, they can likely grab some market share from HCAR and other existing players over Figure 13: Steel Prices vs Margins the long-term due to cost efficiencies, and better product differentiation and quality. The policy also mandates OEMs to refund customers KIBOR +200bps on advances in case they are unable to 20% $790 $720 deliver the vehicle within 2 months. In this connection, during MY18, HCAR paid customers a discount of PKR 15% $650 1.05bn, up from only PKR 179mn in MY17 due to delivery times exceeding two months. This also contributed 10% $580 to a lower gross margin for the company. $510 5% $440 $370 Ban on Non-Filers – The government restricted booking, registration and purchase of vehicles by non-filers 0% $300 of income tax that has led to 30% cancellation in pre-orders from customers since the regulation was FY13 FY14 FY15 FY16 FY17 FY18 introduced in May 2018. HCAR was the least impacted amongst the local car assemblers only 10%-15% of the company’s customers are non-filers (Source: Management). On the other hand, a major chunk of INDU HCAR Industry Steel Index and PSMC customers reside in rural areas and thus are non-filers. PAMA estimates that OEMs revenues can

Source: Bloomberg, Company Reports be impacted by approximately PKR 50bn due to the ban on non-filers. Figure 14: Porter 5 Forces Model Relaxation for Used Imported Cars – In December, Senate Standing Committee of Industrial and Production expressed dissatisfaction over quality standards and pricing adopted by car assemblers which has been the primary reason for giving relaxation for reconditioned imported cars. Sales of imported used Japanese cars have been on a rising trend and jumped from 29,000 cars in FY14 to 68,000 in FY18 same as the one for PC industry), due to limited variety in car models and features offered by local assemblers. However, 73% of total refurbished cars fall in the 1000cc-and-below segment (Source: MoIP, GOP).

Potential Reversal in RD – Under SRO 1265 (I)/2018, regulatory duty (RD) on auto-parts manufacturers ranges 15-35% on different raw materials. Previously, auto-parts manufacturers have been availing concessionary 3% RD on raw materials under SRO 655(I)/2006. The new regulation has the complaint by

Source: Team Analysis Pakistan Association of Automotive Parts & Accessories Manufacturers (PAAPAM) and the vendors, EDB along with the support of the government has requested FBR to exclude auto vendors from RD Figure 15: Market share 1300cc-and-above imposed under the new SRO. The response from the PM Advisor has instilled confidence that this could be pulled back soon. A decision is yet to be announced on this issue. 4% Competitive Positioning

46% HCAR – HCAR emerged as a formidable player in the passenger car industry, as it increased its market share

50% from 9% in FY12 to 25% in FY18. This turnaround has been achieved thanks to successes with Honda Civic and Honda City in the 1300cc-and-above segment, in which HCAR’s market share stands at 46% (Figure 15). HCAR’s models received several accolades in PakWheels Awards 2017 and its flagship model, Civic, was named the “Pakwheels Car of the Year”. HCAR differentiates itself from its peers by offering innovation and technology and best features in its cars, as well as a top-notch aftersales service, (Appendix 23). It has wealthy HONDA IMC PSMC and highly educated urban customer-base, as opposed to rural consumers of INDU and PSMC. Source: PAMA INDU – INDU is the market leader in the 1,300cc segment (50% share). From FY14 to FY18, its revenues have

Figure 16: Positioning Matrix increased from PKR 57bn to PKR 140bn and its PAT has risen from PKR 15.8bn to PKR 3.9bn. On the back of Toyota Corolla, INDU has earned the reputation of producing highly durable car with best resale value and therefore it has the highest pricing power compared to its peers.

PSMC – PSMC is the market leader and the only local dominant player in 1,000cc-and-below segment. It leverages on its massive presence having the largest network of 100 dealerships nationwide. It has the highest localization level in the industry, so it has the least exposure to currency depreciation. PSMC cars are popular for their fuel efficiency, low ownership and maintenance costs (Figure 16).

Investment Summary

We initiate our coverage on Honda Atlas Cars (Pakistan) Ltd. (HCAR:KAR) with a ‘SELL’ rating and 12-month target price of PKR 151 that represents a downside of 14.5% from its January 4th, 2019 price of PKR 176.68.

Source: Team Survey

Our valuation is based on a 50/30/20 mix of FCFE, Relative Valuation and Justified P/E, respectively. Our Table 8: Gross Margin Statistics (FY08-FY18) recommendation is primarily driven by the following key catalysts: INDU Honda PSMC Margins Highly Sensitive to PKR / USD Parity – Historically, we have seen that HCAR’s margins are Mean 11.46% 6.83% 6.15% the most sensitive to currency devaluation and increase in commodity prices, compared to its peers, Indus SD 4.57% 6.38% 4.16% Motors Co (INDU:KAR) and Pak Suzuki Co (PSMC:KAR), as it has the lowest localization level (% of parts High 17.66% 14.94% 12.41% sources by local vendors) at 55%. A massive currency depreciation usually impacts margins in the following

Low 6.14% -0.68% -0.26% year (Table 9). Standard deviation of HCAR’s margin is 6.38% (vs 4.57% of INDU and 4.16% of PSMC) during FY09-18 (Table 8). Given its limited pricing power, HCAR has been unable to fully pass on the increase in costs Source: Company Reports to customers in the past. During MY08-12, PKR depreciated by 49.5% against USD and HCAR’s average gross Table 9: Impact of PKR / USD Depreciation margin stood at 0.13% (vs 7.28% of INDU and 2.43% of PSMC), with lowest being -1.5% in MY10. In 2018, value of PKR has depreciated from PKR 108 to PKR 139 (28.7%) in the interbank market. We expect PKR/USD Year Gross Margin Currency Depreciation to close at PKR 155 by MY20F, pushing HCAR’s margins down to 1.7%. MY09 1.20% 26.24% Economic Slowdown – The next two years are likely to be reminiscent of the 2008-10 era which was a MY10 -1.50% 4.92% MY11 0.90% 1.67% difficult period for the automobile assembling sector with (i) 37% currency depreciation resulting in high MY12 -0.30% 7.19% price levels, (ii) economic slowdown discouraging consumer spending (GDP growth rate ranging 1.2-4.1% MY18 11.40% 6.99% during FY08-10) and (iii) high interest rates (12-14% during FY08-10) restraining credit availability. During MY19F 5.01% 21.35% this period, HCAR’s volumetric sales declined by 21.2% during MY08-10. However, the company’s sales MY20F 1.65% 7.00% rebounded sharply by 33% in MY11 compared to MY10 levels, reflecting the auto sector’s ability to regain MY21F 4.56% 7.00% momentum once the economic condition start improving. While MY19 and MY20 may be relatively better off as compared to the 2008-10 era (Figure 25), we still expect a 21% decline in HCAR’s sales, owing to (i) a Source: Company Financials, SBP, Team Estimates major portion of customers preferring auto financing, (ii) loss of market share to INDU, (iii) ban on purchase Figure 17: HCAR Volumes of cars by non-filers, and (iv) low disposable incomes due to higher inflation.

60 Rising Competition Amid Regulatory Concerns – In recent years, regulatory policies for existing

50 car assemblers have tightened to provide benefits to consumers that have been exploited by unreasonable 40 price hikes and lack of technological advancements in car models. Despite having just 10-15% non-filer customers, HCAR is likely to struggle to increase its sales numbers in the near term amid rapid currency 30 depreciation that occurred during 2018 and the imminent economic slowdown anticipated over 2019. Over 20 the next three years, new car models by new entrants like Volkswagen, Renault and Hyundai will give tough 10 competition to HCAR, as they will be availing the lowered import duty benefits offered through Automotive 0 Development Policy (ADP), 2016. Despite growth of 22% in industry size during MY18-25F, we expect HCAR

to lose its market share by 3% in the increasingly competitive environment.

MY18 MY15 MY16 MY17 MY19 MY20 MY21 MY22 MY23 MY24 MY25 MY14

Silence on Any Expansion Plans – HCAR ended MY18 with over 100% capacity utilization and it can Source: Company Presentation, Team Analysis Figure 18: HCAR Market Share enhance its production by as much as 6,000 units through de-bottling. The company was planning to launch Honda Brio, a 1200cc compact car, in 2019 but it seems like the management has pushed back the plan due to declining economic growth prospects. Therefore, it seems like the company has no major expansion plan chalked out for the near future. Additionally, HCAR increased its payout ratio from 30% in MY17 to 59% in MY18, indicating insignificant capex requirements in the medium term in the absence of any concrete expansion plans. The company’s CAPEX per unit declined from PKR 24,828 to PKR 23,753 in 1QFY191QFY19 (Table 10).

Valuation

Our 12-month target price of PKR 152 per share for HCAR is a 50/30/20% blend of Free Cash Flow to Equity (FCFE) Justified P/E, and Relative Valuation respectively.

The Golden Era HCAR Stock Price and News Flow Honda BR-V Launched Economic Crisis High Consumer Confidence Shaky Investor Historically Best 1000 Stable Currency Confidence Annual Results KiaLucky/ 900 Low Interest Rates Hyundai Nishat IMF Bailout Per Income Growth Rising Inflation & 800 Announcements Consumerism 10 Gen Honda Interst Rates 700 Low Inflation Civic Launch PKRDepreciation Honda City 600 GDP Growth PM Disqualification Source: Company Presentation, Team Estimates Aspire 1.5L Launch 500 Table 10: Capex Per Unit (PKR) 400 300 1QFY18- 200 Ban on Non-Filers Assemblers FY18 1QFY19 100 0 INDUS 54,656 92,475 January-13 July-13 January-14 July-14 January-15 July-15 January-16 July-16 January-17 July-17 January-18 July-18 January-19

HCAR 24,828 23,753 PSMC 68,715 82,221 Source: Company Reports

Figure19: PE Bands We chose to assign higher weight of 50% to FCFE because it incorporates future cash flows that the company will generate for its shareholders based on going concern assumption. The Justified Forward P/E with 30% 1,500 weightage gives us a target price incorporating a market based multiple approach that also incorporates HCAR’s slow earnings growth period during MY19E/20F in which its profitability and ROE are anticipated to 1,000 significantly decline, due to which we believe the stock should trade at a lower P/E multiple compared to the

market. We believe this would be a good representation of the company’s actual value and could help us 500 derive a good entry point for the stock. 0 Free Cash Flow To Equity (FCFE) Our FCFE valuation gives us MY20 Target Price of PKR 211. Our

valuation incorporates the following key assumptions: Stock Price 6X 10X Cost of Equity: We used Capital Asset Pricing Model (CAPM) to calculate the cost of equity of 20.2% using 14X 18X 22X the following variables: (i) Current 10-year Pakistan Investment Bond (PIB) yield of 13.15% as risk-free rate, Source: FactSet (ii) 6% market risk premium (Market survey method) and (iii) 5 year adjusted beta of 1.17 (Source: Table 11: FCFE Key Assumptions Bloomberg). However, our regression analysis on five-year KSE-100 returns and HCAR returns yielded raw CAPM Rate beta of 1.25. Risk-free rate 13.15% Terminal Growth Rate: We have assumed a terminal growth rate of 5%. This is based on the assumption Market risk premium 6.00% that Pakistan’s long-term inflation will settle at 2-3% over the next 5-7 years, which means the company’s Beta (adjusted) 1.17 retained earnings will grow by 2-3% in real terms.

Cost of Equity 20.17% Justified Forward P/E We arrived at a justified forward P/E of 5x for HCAR based on its three-year Source: SBP & Team Analysis earnings CAGR of 7%, a payout ratio of 65% and cost of equity of 20.2% derived through CAPM. This suggests that HCAR is currently trading at a premium multiple compared to a P/E that justifies the earnings growth the Table 12 (a) FCFE Valuation stock presents. Our target price using justified forward P/E comes out at PKR 62. During MY13-18, which Terminal Growth Rate 5.00% was a high growth period for HCAR, the stock traded at a forward PE multiple of 11.9x on average and Terminal Value (Mn) 35,819 currently stands at 7.28x as of December 2018. Total Firm Value (Mn) 26,013 Relative Valuation To arrive at a target price of PKR 133 using relative valuation techniques, we used Add: Net Cash & Cash average Price-to-Earnings (P/E), Price-to-Sales (P/S), Price-to-Book (P/B) and EV/EBITDA ratios of local and Equivalents (M n) 4,114 regional peers for 2019 (Source: Bloomberg). We chose both the local peers (INDU and PSMC), and regional Total Equity Value (Mn) 30,128 peers that operate in the 1300cc-and-above segment as HCAR. However, as the business models and the Outstanding Shares (Mn) 143 challenges faced by the regional peers are slightly different from HCAR, we have assigned low weightage to Price 211 this method.

Weightage 50% Price-to-Earnings: P/E ratio is the basic metric to gauge the perception of investors regarding a company’s Table 12 (b) Justified forward P/E growth potential. Based on average P/E Multiple of local and regional peers, HCAR should trade at a price of DPS 8.07 PKR 75.

EPS 12.41 Price-to-Sales: Even though P/S Multiple is generally used to value consumer and high growth companies Payout Ratio 65.00% that have negative earnings, we have used this multiple to value local and regional automobile assemblers to EPS Growth (2019 – 22 assess where HCAR fares across international competition. Based on average P/S multiple of 0.42x, HCAR’s

CAGR) 7% Target Price is PKR 207. Beta 1.17 Price-to-Book: As HCAR is a cash rich company, and it is a capital intensive business, P/B multiple is also a Cost of Equity 20.17% good measure to assess whether the company is under/overvalued compared to its industry peers. The

Forward P/E 5.03 average P/B multiple of the local peers is 0.8x, and the P/B Multiple for regional peers stands at 0.5x. Taking the average P/B Multiple for the universe, the target prices comes out to be PKR 90. Justified Price 62 Weightage 30% EV/EBITDA: It is an important multiple to assess automakers’ valuation on a relative term, as it is useful for

Table 12 (c) Relative Valuation capital intensive industries. We have considered average EV/EBITDA multiple for only local peers (1.4x), as multiples of regional peers stands at 9.8x. The price target using this multiple is PKR 160. Price through P/E 75 Financial Analysis Price through EV/EBITDA 160 Price through P/Book Increasing Competition & Economic Woes to Lower Profitability value 90 Price through P/S 207 Earnings for HCAR have increased with a five-year CAGR of 93% from MY13-18, led by growth in the top-line from PKR 30.3bn to PKR 91.5bn, depicting a CAGR of 25%. This growth was mainly driven by the launch of Average price 133 10th Generation Honda Civic in July 2016 and debut of Honda BR-V in April 2017, as well as availability of Weightage 20% cheaper auto financing as discount rate hovered around 6.5% during MY16-18. Target Price 151 For MY20F, we expect the revenue and earnings to decline by 17%/51% YoY respectively on the back of (i) Source: Team Estimates higher interest rates impacting auto financing, and (ii) rising inflation and slowdown in economic growth impacting disposable incomes. We believe discount rate will peak at 11% by MY20F, up by more than 450bps from 6.5% in 2017. SBP has already raised rates by a cumulative 400bps citing rising inflation, large twin

deficit, and depleting forex reserves as the reason for this increase. Higher inflation and interest rates are Figure 20: Net Earnings likely to result in (i) slowdown in business and economic activity, (ii) lower disposable income for consumers 10000 400% to spend on durable products, and, (iii) expensive auto financing facility. From thereon, we expect growth in sales and earnings to stabilize and grow at a CAGR of 14% and 26%, respectively from MY20F to MY25F. 200% Despite an anticipated economic revival post MY22F, we do not expect HCAR sales to rebound at previous 5000 0% levels because of new competition that may be able to offer new car models at better prices due to lower applicable regulatory duties (Figure 17). 0 -200% FX Depreciation to Keep Margins under Pressure

Earnings (LHS) Growth (RHS) HCAR’s gross margins more than tripled from 4.8% in MY13 to 15.1% in MY16, largely due to stable exchange Forecasted (RHS) rate parity, low inflation, and operational efficiency. However, the margins fell to 11.4% by MY18, as commodity prices increased and JPY appreciated against USD that led to double currency impact. We expect Source: Company Reports, Team Analysis a 1.65% gross margin in MY20F because of high vulnerability of HCAR to currency devaluation and CPI Figure 21: Other Income inflation swelling to 9%. Margin will remain under pressure thereafter and will rove in the range of 4.5-5.5%, 4000 15% due to low pricing power with the presence of new competition.

3000 Other Income to Keep HCAR’s Bottom-Line in Green 10% 2000 Being a cash rich company, HCAR enjoys a considerable return on its short term investments and bank 5% 1000 deposits, as its other income soared at a CAGR of 55% during MY13/18. As interest rates are anticipated to remain in double digit till MY22, other income is likely to grow from PKR 1.88 bn in MY18 to 3.2 bn in MY20F, 0 0% depicting a two-year CAGR of 30%, supporting the company’s bottom-line, despite a seven-year-low gross margin in MY20F. We expect this additional income to be utilized in higher payouts to shareholders, as well as for capex required for anticipated new model launches of Honda City/Civic in MY21/22F, respectively. Other Income (LHS) Interest Rate (RHS) Forecasted (RHS) Increasing Payout Amid Absence of Any Expansion Plans

Source: Company Reports, Team Estimates During MY13-17, HCAR’s average payout ratio was 27% that increased to 59% in MY18. We expect the company to gradually increase its payouts to 80% of its earnings through MY25F because of high cash reserves Figure 22: Dividend Payout and absence of any concrete expansion plans. 100% DuPont Analysis 50% 0% Our analysis indicates that HCAR’s ROE improved from 17.9% in MY13 to 38% in MY18, primarily driven by growing ROA, which increased from 7.82% in MY14 to 11.78% in MY18 on the back of 4.35% improvement in NPM. Moreover, equity multiplier plunged from 11 in MY13 to 3.4 in MY18, due to increase in reserves and absence of any long-term debt. However, we expect ROE to drop to 10.8% in MY20F as a consequence of lean Series1 Series2 profit margins of 1.7%. Both the ratios will gradually improve through MY25F, as exchange rate will become relatively stable and improvement in per capita income will enable HCAR to increase the prices of its cars. Source: Company Reports, Team Estimates

Table 13: Selected Statistics

Iterations 100,000 Mean 152 STD. Dev 17

Range 152 Maximum 229 Minimum 77 Source: Team Analysis

Valuation Risk

Monte Carlo Simulation We performed a Monte Carlo Simulation to understand the impact and

sensitivity of our model to variation in key modelling assumptions. The variables that we tested are 1) Company Volumes, 2) PKR Depreciation, and 3) Selling Price. We conducted 100,000 iterations to illustrate the impact of different combinations across the changes in the aforementioned variables on the target price. The mean share price derived from our simulation model is PKR 152 for MY20F with a standard deviation of PKR 16.9. We found that 66.6% of the outcomes supported a SELL recommendation, 32.8% HOLD (between 0-10% upside) and 0.6% BUY.

12000

TP: PKR 152 Table 14: Sensitivity Variables With Outcomes 10000 Percentage Variables Deviation change in price 8000 SELL -10% -4% HOLD

-5% -2% Volumes 6000 0% 0% (Units sold) 5% 2% 4000 10% 4% -1.0% -20% 2000 -0.5% -11% BUY Selling price 0.0% 0% 0 0.5% 13% 74 84 94 104 114 124 134 144 154 164 174 184 194 204 214 224 234

1.0% 30% Sensitivity Analysis We also performed a sensitivity analysis on the key variables of our financial model, 9% -21% emphasizing on testing values for volumes, pricing and currency depreciation (Table 14). Given the volatility

8% -11% of PKR/USD parity over the past 12 months and its impact on the company’s margins, this is the biggest risk PKR 7% 0% to our model. A modest exchange rate depreciation of 5% in MY20F can ease off the margins and change Depreciation 6% 14% our recommendation to a BUY. Similarly, a 1% increase in selling price, which is dependent on real GDP growth and the prevailing interest rates, that influences HCAR’s pricing power, would lead to a target price 5% 32% of PKR 296. However, even a significant change in volumes would not change our assumption to BUY from Source: Team Analysis SELL.

Figure 23: Scenario Analysis Scenario Analysis Added to our sensitivity analysis, we performed scenario analysis on both the bull and Bear Bull bear cases to test variability of profitability and target price of HCAR (Figure 23).

Bull Case: PKR 379 12-Month TP (115% UPSIDE) PKR Depreciation -33.33% 12.43% Input Variables’ Assumptions: +10% volumes, 5% PKR depreciation, and +1% selling price

Selling price -32.20% 10.17% Assuming that the economic indicators (GDP, inflation and interest rates) will recover quickly has a positive impact on HCAR’s sales volumes and it strengthens its pricing power. Moreover, reduction in import bill due to low oil prices and development of export-based industries can significantly narrow the current account Volumes (Units sold) -16.95% deficit, resulting in stable PKR/USD parity, which will be beneficial for the company.

-40% -20% 0% 20% Bear Case: PKR 112 12-Month TP (36% DOWNSIDE)

Source: Team Analysis Input Variables’ Assumptions: -10% volumes, 9% PKR depreciation, and -1% selling price

We assumed the 2008-12 era in which the economy suffered from double-digit inflation and interest rates, and a large external deficit that decelerated economic growth. In this scenario, HCAR’s volume would decline Figure 24: Risk Matrix sharply and would restrict its ability to pass cost to consumers.

Investment Risks

Market Risk

Exchange Rate Risk [High Likelihood, High Impact]

OEMs use overseas suppliers for major car components and pay a higher price every time local currency devalues and pass the cost to end consumers. Since Jan 2018, assemblers have revised their price list upwards 4-6 times in response to 33% loss in PKR value. Yet, the overall price increase is just 14% for HCAR, 17% for INDU and 1.5% for PSMC, indicating weak pricing power of the auto assemblers. HCAR has increased car prices by 18-20% for Honda Civic and Honda City this year, but only 5% for Honda BRV.

Currency devaluation also results in exchange losses for the assemblers. In MY18, HCAR incurred exchange loss of PKR 560mn, explaining that a 1% PKR depreciation/appreciation against USD, JPY, THB, EUR, SGD and GBP would impact PAT by PKR 30mn.

Source: Team Analysis Economic Slowdown [High Likelihood, Impact High] In a worsening economic environment where economic growth is likely to slowdown, car sales and margins

Figure 25: Volumes Comparison of assemblers will likely decline in the coming years amid influx of new competition and currency devaluation. In order to keep their prices competitive in the new era of the automobile sector, assemblers would require 18,000 60,000 turning to local vendors. We believe the next five years will be reminiscent of 2008-2012 era. Therefore, we 16,000 expect GDP growth to slow down to 4% and CPI inflation to rise to 7% in FY19F and 9% for FY20F. 50,000 14,000 Interest Rate [High Likelihood, High Impact] 40,000 12,000 Today, 35-40% of customers of local auto assemblers, particularly HCAR, use auto financing to purchase cars. 10,000 30,000 Rising interest rates will discourage spending as it will be more difficult to own a car. Customers may delay their decision to purchase a new model that could result in lower automobile sales during the next two years. 2008-11 (LHS) 2019-21 (RHS) We believe that policy rate will be raised to 11.5% by FY20F in order to restrict overheating of the economy Source: Company Report, Team Estimates and hence control demand-pull inflation.

Figure26: Per Capita Income Growth Outpaces Commodity Price Risk [Medium Likelihood, Medium Impact] Inflation Rate Despite strong growth in volumes, car assemblers’ gross margins fell by 2.75% from FY16 to FY18, partly due 10.0% to rising prices of key commodity like steel, aluminum, rubber and plastic prices that constitute about 40% of production cost. International steel prices have fallen recently because of the tariff imposed by the US on China and other countries that have started dumping excess supply of their products in other countries. Any 5.0% cooperation between the US and China regarding tariffs can result in prices moving upwards. Also, Bloomberg estimates steel and aluminum prices to continue rising in 2019 and 2020 (Table 15). This can further 0.0% pressurize OEMs margins.

Global Oil Prices [Moderate Likelihood, Low Impact] Inflation CPI Per capita income growth rate Global oil prices command domestic fuel prices in Pakistan, as petroleum products and crude constitute about

Source: Team Estimates 25% of the import bill. In Oct 2018, WTI Crude hit a four-year high of $78.96 per bbl, but since then it has tumbled 41% to $48.85 per bbl. In Dec 2018, OPEC announced to cut crude supply by 1.2 million bbl a day in Table 15: Commodity Prices Impact On Margins 1QCY19. Yet, the prices have remained on the same level amid fears of the looming trade war between the Global Aluminum Industry US and China, relentless growth in US shale production, and overblown worries regarding global recession. Period Steel Index ($) Margins However WTI Crude price to rebound to $64.6/65.1 in 2019/20F (Figure 24), as US shale producers plan to Index ($) curb their spending to ease off pricing. While increasing fuel prices may dissuade consumers falling in 800cc- FY13 748 2,401 6.25% and-below segment, HCAR customers are least likely to be impacted by this. FY14 698 2,244 8.79% Regulatory Risk FY15 592 2,159 13.09% Ban on Non-Filers [High Likelihood, Impact Low] FY16 438 1,783 14.55% In Nov 2018, industry-wide sales toppled by 12% YoY and 27% MoM, mainly due to the effect of ban on non- FY17 584 1,973 13.89% filers of income tax that led to significant decline and cancellation of customer pre-orders. According to industry experts, only 10-15% of HCAR’s existing customers are non-filers, compared to industry-average of FY18 718 2,272 11.80% 35-40%. Yet, the loss of revenue from the non-filer ban can be reflected in 18% YoY decline in HCAR sales in 1QFY19 703 2,107 9.06% Nov 2018. Source: Company Reports & Bloomberg Increasing Competition Risk [High Likelihood, Medium Impact] Currently, HCAR has just one direct competitor in locally assembled car segment, INDU. Under ADP’s Figure 27: WTI Crude Oil Price Greenfield Investment plan, a number of new entrants like Kia Lucky, Hyundai Nishat and Renault, are planning to launch into the auto assembling sector with lower applicable duty structures. These auto makers 68 are capable of producing compelling cars in terms of design and features, thus increasing competition for 66 HCAR These car manufacturers, however, will take at least 3 years to scale up their production to make a significant impact on the market, but they still pose a risk of substitution for HCAR that plans to keep its 64 production capacity constant. 62 Business & Operational Risk 60 58 Natural Disaster [Low Likelihood, High Impact] FY18 FY19F FY20F FY21F FY22F In FY12, HCAR’s production nosedived 20% when Japan and Thailand were hit by tsunami and severe floods,

respectively. The disruption in supply of imported components from these countries restricted HCAR from Source: Bloomberg fulfilling its demand. Such an event in the future could severely impact the company’s market share, as unlike before customers would have more options with the likes of Hyundai and Kia.

Financial Risk

Liquidity Risk [Likelihood Low, Medium Impact]

HCAR held PKR 11bn in cash and bank balances, PKR 9.9bn in short-term financial liabilities, and available borrowing limits from banks of PKR 4.5bn, which suggests negligible risk of liquidity. However, the company’s

liquidity risk can worsen with tough economic conditions and new regulations that further penalize assemblers on late deliveries to customers. During MY09-14, HCAR’s quick ratio remained below 1.

APPENDIX 1: GLOSSARY

 PCA: Passenger Car Assemblers (HCAR, INDU, and PSMC) that assemble CKD parts.  CPEC: China Pakistan Economic Corridor is a collection of infrastructure projects that are currently under construction throughout Pakistan.  SBP: State Bank of Pakistan is the central bank of Pakistan.  PAMA: Pakistan Automotive Manufacturers Association plays the central role in all policy making process of the government for the and it is the principle source of automotive data.  PAPAAM: Pakistan Association of Automotive Parts & Accessories Manufacturers provides technical and management support to auto parts makers.  EDB: Engineering Development Board is the regulatory body under Ministry of Industries & Production (MoIP0 and is responsible to strengthen the engineering sector. It also play an important role in tariff development for automobile imports.  HHI: Herfindahl Index, also known as Herfindahl-Hirschman Index, is a measure of the size of the firms in relation to the industry and an indicator of the amount of competition among them.  Localization: % of parts sources produced and supplied by local vendors  CKD: Completely knocked-down (CKD) is a kit of non-assembled parts of a car.  CBU: Completely built unit (CBU) means that a completely assembled car is imported into the country.

APPENDIX 2: INCOME STATEMENT PKR in Millions MY13 MY14 MY15 MY16 MY17 MY18 MY19F MY20F MY21F MY22F MY23F MY24F MY25F Net Sales 30,275 39,153 37,764 40,086 62,803 91,523 96,803 80,216 88,332 105,849 120,463 134,034 153,163 Net Sales - Own manufactured goods 29,029 37,798 36,380 38,455 60,818 89,246 93,840 77,426 85,316 102,394 116,528 129,458 148,007 Net sales - Trading goods 1,245 1,356 1,384 1,631 1,985 2,277 2,963 2,790 3,017 3,455 3,935 4,576 5,156 Cost of sales (28,828) (36,296) (32,991) (34,039) (53,681) (81,074) (91,953) (78,892) (84,302) (99,566) (113,796) (126,632) (144,659) Cost of sales Own manufactured 27,848 35,314 32,041 32,945 52,345 79,570 89,864 76,808 82,116 97,109 110,992 123,359 140,970 Cost of sales Trading goods 979 982 950 1,094 1,336 1,504 2,088 2,083 2,186 2,457 2,804 3,274 3,689 Gross profit 1,447 2,857 4,773 6,047 9,122 10,449 4,851 1,324 4,031 6,283 6,667 7,402 8,505 Distribution and marketing (219) (341) (434) (333) (542) (917) (828) (802) (883) (1,058) (1,205) (1,340) (1,532) Administrative expenses (202) (287) (320) (352) (497) (678) (777) (794) (861) (930) (1,000) (1,070) (1,134) Other income 213 271 219 310 1,115 1,883 3,212 3,206 2,592 2,776 2,968 3,203 3,116 Other expenses (524) (365) (452) (486) (538) (1,245) (975) (389) (527) (644) (703) (723) (804) Profit from operations 716 2,135 3,786 5,186 8,660 9,493 5,482 2,545 4,351 6,426 6,727 7,472 8,151 Finance cost (191) (38) (19) (7) (23) (14) (14) (13) (14) (17) (19) (21) (24) Profit before taxation 525 2,097 3,767 5,179 8,636 9,479 5,469 2,532 4,337 6,409 6,708 7,451 8,126 Taxation (281) (1,024) (605) (1,623) (2,501) (2,984) (1,832) (760) (1,301) (1,923) (2,012) (2,235) (2,438) Profit after taxation 244 1,074 3,162 3,556 6,135 6,494 3,637 1,773 3,036 4,486 4,696 5,215 5,688

Common Size Income Statement As a percentage of Net Sales MY13 MY14 MY15 MY16 MY17 MY18 MY19F MY20F MY21F MY22F MY23F MY24F MY25F Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Net Sales - Own manufactured goods 95.89% 96.54% 96.34% 95.93% 96.84% 97.51% 96.94% 96.52% 96.58% 96.74% 96.73% 96.59% 96.63% Net sales - Trading goods 4.11% 3.46% 3.66% 4.07% 3.16% 2.49% 3.06% 3.48% 3.42% 3.26% 3.27% 3.41% 3.37% Cost of sales -95.22% -92.70% -87.36% -84.92% -85.48% -88.58% -94.99% -98.35% -95.44% -94.06% -94.47% -94.48% -94.45% Cost of sales Own manufactured 91.99% 90.19% 84.85% 82.19% 83.35% 86.94% 92.83% 95.75% 92.96% 91.74% 92.14% 92.04% 92.04% Cost of sales Trading goods 3.23% 2.51% 2.52% 2.73% 2.13% 1.64% 2.16% 2.60% 2.47% 2.32% 2.33% 2.44% 2.41% Gross profit 4.78% 7.30% 12.64% 15.08% 14.52% 11.42% 5.01% 1.65% 4.56% 5.94% 5.53% 5.52% 5.55% Distribution and marketing -0.72% -0.87% -1.15% -0.83% -0.86% -1.00% -0.85% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% Administrative expenses -0.67% -0.73% -0.85% -0.88% -0.79% -0.74% -0.80% -0.99% -0.98% -0.88% -0.83% -0.80% -0.74% Other income 0.70% 0.69% 0.58% 0.77% 1.78% 2.06% 3.32% 4.00% 2.93% 2.62% 2.46% 2.39% 2.03% Other expenses -1.73% -0.93% -1.20% -1.21% -0.86% -1.36% -1.01% -0.48% -0.60% -0.61% -0.58% -0.54% -0.52% Profit from operations 2.36% 5.45% 10.02% 12.94% 13.79% 10.37% 5.66% 3.17% 4.93% 6.07% 5.58% 5.57% 5.32% Finance cost -0.63% -0.10% -0.05% -0.02% -0.04% -0.02% -0.01% -0.02% -0.02% -0.02% -0.02% -0.02% -0.02% Profit before taxation 1.73% 5.36% 9.98% 12.92% 13.75% 10.36% 5.65% 3.16% 4.91% 6.05% 5.57% 5.56% 5.31% Taxation -0.93% -2.61% -1.60% -4.05% -3.98% -3.26% -1.89% -0.95% -1.47% -1.82% -1.67% -1.67% -1.59% Profit after taxation 0.81% 2.74% 8.37% 8.87% 9.77% 7.10% 3.76% 2.21% 3.44% 4.24% 3.90% 3.89% 3.71%

Source: Company Reports, Team Estimates

APPENDIX 3: BALANCE SHEET PKR in Millions MY13 MY14 MY15 MY16 MY17 MY18 MY19F MY20F MY21F MY22F MY23F MY24F MY25F ASSETS Property, plant and equipment 3,356 2,873 2,823 2,512 4,402 4,992 4,413 4,622 4,020 3,563 3,223 3,511 3,923 Intangible assets 140 86 71 71 373 305 359 354 356 393 373 365 377 Capital work-in-progress 8 81 39 1,198 199 76 102 102 102 102 102 102 102 Long term loans and advances 37 53 62 82 107 189 189 109 154 209 214 238 262 Long term deposits 4 4 4 4 4 4 4 4 4 4 4 4 4 Deferred taxation 1,043 393 378 0 0 0 0 0 0 0 0 0 0 Long term trade debts 0 0 0 0 0 0 36 36 36 36 36 36 36 Total Non-Current Assets 4,587 3,491 3,378 3,867 5,086 5,566 5,104 5,229 4,674 4,308 3,952 4,257 4,704 Stores and spares 116 116 133 123 135 139 172 179 149 123 114 130 143 Stock in trade 4,312 3,853 5,524 4,010 6,659 8,208 11,341 10,001 10,001 11,829 13,400 15,330 17,447 Trade debts 0 0 44 86 50 92 83 80 103 123 120 138 158 Loans, advances, prepayments & other receivables 2,105 2,504 1,489 1,006 9,089 13,135 8,068 6,997 8,549 11,762 12,576 12,944 15,197 Short term investments 492 0 0 1,150 20,943 20,675 17,736 11,908 13,222 14,720 16,861 18,202 18,551 Cash and bank balances 3,535 2,354 3,358 5,963 9,536 10,993 12,672 14,608 16,839 19,411 22,376 25,794 29,733 At banks on: Current accounts 8 7 16 57 60 73 73 73 73 73 73 73 73 Deposit accounts 3,525 2,346 2,940 4,903 6,474 9,917 11,596 13,531 15,763 18,335 21,300 24,717 28,657 Term deposits 400 1,000 3,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 Cash in hand 2 2 2 3 2 3 3 3 3 3 3 3 3 Total Current Assets 10,559 8,827 10,548 12,338 46,411 53,242 50,071 43,772 48,862 57,968 65,447 72,538 81,229 Total Assets 15,146 12,317 13,926 16,205 51,497 58,809 55,175 49,001 53,536 62,276 69,400 76,795 85,933 Equity Issued, subscribed and paid up share capital 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 1,428 Reserves (63) 963 3,692 6,513 11,637 15,645 15,441 15,032 16,915 19,428 20,983 22,912 24,689 Total Equity 1,365 2,391 5,120 7,941 13,065 17,073 16,869 16,460 18,343 20,856 22,411 24,340 26,117 NON-CURRENT LIABILITIES Deferred liabilities 38 44 53 83 62 93 84 76 68 61 55 50 45 Deferred taxation 0 0 0 134 367 434 390 351 316 284 256 230 207 Deferred revenue 5 12 12 9 11 13 10 7 5 4 3 2 2 Total Non-Current Liabilities 43 56 64 226 440 540 484 434 390 350 314 282 254 CURRENT LIABILITIES Current portion of deferred revenue 0 0 5 6 4 3 3 2 2 1 1 1 1 Short term borrowings - secured 0 0 0 0 0 0 0 0 0 0 0 0 0 Accrued mark up 92 14 2 1 14 1 0.04 0 0 0 0 0 0 Income tax payable 0 0 0 0 305 0 0 0 0 0 0 0 0 Unclaimed dividend 0 0 0 0 15 23 20 18 16 15 13 12 11 Trade and other payables 13,647 9,856 8,736 8,031 37,622 41,169 37,799 32,087 34,785 41,054 46,660 52,160 59,551 Total Current Liabilities 13,739 9,870 8,742 8,038 37,961 41,195 37,823 32,107 34,803 41,070 46,674 52,173 59,563 Total EQUITY AND LIABILITIES 15,146 12,317 13,926 16,205 51,497 58,809 55,175 49,001 53,536 62,276 69,400 76,795 85,933

Common Size Balance Sheet As a percentage of Total Assets MY13 MY14 MY15 MY16 MY17 MY18 MY19F MY20F MY21F MY22F MY23F MY24F MY25F ASSETS Property, plant and equipment 22.16% 23.33% 20.27% 15.50% 8.55% 8.49% 8.00% 9.43% 7.51% 5.72% 4.64% 4.57% 4.56% Intangible assets 0.92% 0.70% 0.51% 0.44% 0.72% 0.52% 0.65% 0.72% 0.67% 0.63% 0.54% 0.48% 0.44% Capital work-in-progress 0.05% 0.66% 0.28% 7.39% 0.39% 0.13% 0.19% 0.21% 0.19% 0.16% 0.15% 0.13% 0.12% Long term loans and advances 0.25% 0.43% 0.45% 0.50% 0.21% 0.32% 0.34% 0.22% 0.29% 0.34% 0.31% 0.31% 0.30% Long term deposits 0.03% 0.03% 0.03% 0.02% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01% 0.00% Deferred taxation 6.88% 3.19% 2.72% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Long term trade debts 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.07% 0.07% 0.07% 0.06% 0.05% 0.05% 0.04% Total Non-Current Assets 30% 28% 24% 24% 10% 9% 9% 11% 9% 7% 6% 6% 5% Stores and spares 0.76% 0.94% 0.95% 0.76% 0.26% 0.24% 0.31% 0.36% 0.28% 0.20% 0.16% 0.17% 0.17% Stock in trade 28.47% 31.28% 39.67% 24.74% 12.93% 13.96% 20.55% 20.41% 18.68% 18.99% 19.31% 19.96% 20.30% Trade debts 0.00% 0.00% 0.32% 0.53% 0.10% 0.16% 0.15% 0.16% 0.19% 0.20% 0.17% 0.18% 0.18% Loans, advances, prepayments & other receivables13.90% 20.33% 10.69% 6.21% 17.65% 22.34% 14.62% 14.28% 15.97% 18.89% 18.12% 16.86% 17.68% Short term investments 3.25% 0.00% 0.00% 7.10% 40.67% 35.16% 32.15% 24.30% 24.70% 23.64% 24.30% 23.70% 21.59% Cash and bank balances 23.34% 19.11% 24.12% 36.80% 18.52% 18.69% 22.97% 29.81% 31.45% 31.17% 32.24% 33.59% 34.60% Total Current Assets 70% 72% 76% 76% 90% 91% 91% 89% 91% 93% 94% 94% 95% Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Equity Issued, subscribed and paid up share capital 9.43% 11.59% 10.25% 8.81% 2.77% 2.43% 2.59% 2.91% 2.67% 2.29% 2.06% 1.86% 1.66% Reserves -0.42% 7.82% 26.51% 40.19% 22.60% 26.60% 27.98% 30.68% 31.60% 31.20% 30.24% 29.84% 28.73% Total Equity 9% 19% 37% 49% 25% 29% 31% 34% 34% 33% 32% 32% 30% NON-CURRENT LIABILITIES Deferred liabilities 0.25% 0.36% 0.38% 0.51% 0.12% 0.16% 0.15% 0.15% 0.13% 0.10% 0.08% 0.06% 0.05% Deferred taxation 0.00% 0.00% 0.00% 0.83% 0.71% 0.74% 0.71% 0.72% 0.59% 0.46% 0.37% 0.30% 0.24% Deferred revenue 0.03% 0.10% 0.08% 0.05% 0.02% 0.02% 0.02% 0.01% 0.01% 0.01% 0.00% 0.00% 0.00% Total Non-Current Liabilities 0% 0% 0% 1% 1% 1% 1% 1% 1% 1% 0% 0% 0% CURRENT LIABILITIES Current portion of deferred revenue 0.00% 0.00% 0.03% 0.04% 0.01% 0.01% 0.01% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Short term borrowings - secured 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Accrued mark up 0.61% 0.11% 0.01% 0.00% 0.03% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Income tax payable 0.00% 0.00% 0.00% 0.00% 0.59% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Unclaimed dividend 0.00% 0.00% 0.00% 0.00% 0.03% 0.04% 0.04% 0.04% 0.03% 0.02% 0.02% 0.02% 0.01% Trade and other payables 90.10% 80.02% 62.73% 49.56% 73.06% 70.00% 68.51% 65.48% 64.98% 65.92% 67.23% 67.92% 69.30% Total Current Liabilities 91% 80% 63% 50% 74% 70% 69% 66% 65% 66% 67% 68% 69% Total EQUITY AND LIABILITIES 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

APPENDIX 4: FINANCIAL RATIOS

MY13 MY14 MY15 MY16 MY17 MY18 MY19F MY20F MY21F MY22F MY23F MY24F MY25F Quick Ratio 0.72 0.88 1.19 1.46 1.08 1.10 0.85 0.98 1.02 1.05 1.04 1.04 1.05 Liquidity Current Ratio 0.77 0.89 1.21 1.53 1.22 1.29 1.32 1.36 1.40 1.41 1.40 1.39 1.36 Working Capital Ratio -0.23 -0.11 0.21 0.53 0.22 0.29 0.32 0.36 0.40 0.41 0.40 0.39 0.36 Total Liabilities to Equity 10.10 4.15 1.72 1.04 2.94 2.44 2.27 1.98 1.92 1.99 2.10 2.16 2.29 Solvency Total Equity to Assets 0.09 0.19 0.37 0.49 0.25 0.29 0.31 0.34 0.34 0.33 0.32 0.32 0.30 Total Liabilities to Assets 0.91 0.81 0.63 0.51 0.75 0.71 0.69 0.66 0.66 0.67 0.68 0.68 0.70 Total Assets Turnover 2.00 3.18 2.71 2.47 1.22 1.56 1.75 1.64 1.65 1.70 1.74 1.75 1.78 Fixed Assets Turnover 6.60 11.22 11.18 10.37 12.35 16.44 18.97 15.34 18.90 24.57 30.48 31.48 32.56 Efficiency Stock Turnover Ratio 8.89 7.04 7.14 10.06 10.91 9.41 7.39 8.43 9.12 9.02 8.82 8.83 Number of Days Stock 41.05 51.87 51.11 36.27 33.47 45.02 46.27 43.30 43.36 42.98 44.19 44.02 Interest Coverage Ratio (AT) 2.28 29.20 170.42 509.62 262.70 449.64 264.11 140.72 218.27 268.96 247.45 247.01 235.81 Gross Profit Margin 4.78% 7.30% 12.64% 15.08% 14.52% 11.42% 5.01% 1.65% 4.56% 5.94% 5.53% 5.52% 5.55% Operating Profit Margin 2.36% 5.45% 10.02% 12.94% 13.79% 10.37% 5.66% 3.17% 4.93% 6.07% 5.58% 5.57% 5.32% Profitability EBT Margin 1.73% 5.36% 9.98% 12.92% 13.75% 10.36% 5.65% 3.16% 4.91% 6.05% 5.57% 5.56% 5.31% Net Profit Margin 0.81% 2.74% 8.37% 8.87% 9.77% 7.10% 3.76% 2.21% 3.44% 4.24% 3.90% 3.89% 3.71% Return on Assets 1.61% 8.72% 22.71% 21.94% 11.91% 11.04% 6.59% 3.62% 5.67% 7.20% 6.77% 6.79% 6.62% Return on Equity (AT) 17.90% 44.90% 61.77% 44.78% 46.96% 38.04% 21.56% 10.77% 16.55% 21.51% 20.95% 21.43% 21.78% Earnings Per Share (AT) 1.71 7.52 22.15 24.90 42.96 45.48 25.47 12.41 21.26 31.42 32.88 36.52 39.84 Earnings Price to Earning Ratio 17.06 7.34 8.28 10.14 17.50 10.50 Price to Book Ratio 3.05 3.29 5.12 4.54 8.22 3.99 Price to Sales Ratio 0.14 0.20 0.69 0.90 1.71 0.74 EV/EBITDA 3.04 2.56 5.37 5.42 11.23 6.29 Source: Team Estimates

APPENDIX 5: CASH FLOW

PKR in Millions MY19F MY20F MY21F MY22F MY23F MY24F MY25F Cash Flow from Operations Net Income 3,637 1,773 3,036 4,486 4,696 5,215 5,688 Add: Depreciation 1,069 1,182 973 817 703 812 963 Add: Amortization 144 141 141 156 147 143 147 Less: Interest received (3,051) (3,046) (2,462) (2,637) (2,819) (3,043) (2,960) 1,798 50 1,686 2,821 2,727 3,128 3,839

Add: change in Working Capital (1,551) (3,356) 1,108 1,193 3,197 3,136 2,960 Stores and Spares (33) (7) 30 25 9 (16) (14) Stock in Trade (3,133) 1,340 (0) (1,828) (1,571) (1,930) (2,117) Trade Debt 10 3 (23) (20) 3 (18) (20) Loans, advances, prepayments and other receivables 5,067 1,071 (1,552) (3,213) (814) (368) (2,253) Trade and other payables (3,370) (5,713) 2,699 6,268 5,606 5,500 7,391 long term trade debt (36) 0 0 0 0 0 0 Change in Deferred liabilities (9) (8) (8) (7) (6) (6) (5) Change in Deferred taxes (43) (39) (35) (32) (28) (26) (23) Change in Deferred revenue (3) (2) (2) (1) (1) (1) (1) Change in Current portion of Deferred revenue 0 (1) (1) (0) (0) (0) (0) Change in Accrued Mark up (1) (0) 0 0 0 0 0 Net cash generated from operating activities 247 (3,306) 2,795 4,015 5,923 6,265 6,799

Cash Flow from Investing Activities Purchhase of property, plant and equipment (529) (1,442) (438) (427) (431) (1,168) (1,464) Purchase of Intangible Assets (198) (137) (143) (192) (127) (135) (159) Proceeds from sale of property, plant and equipment 39 51 68 68 68 68 89 Purchase of Short Term Investment 2,939 5,828 (1,314) (1,498) (2,141) (1,341) (348) Change in Capital work in progress (26) 0 0 0 0 0 0 Long term loans and advances to employees (0) 80 (45) (55) (5) (25) (24) Interest Received 3,051 3,046 2,462 2,637 2,819 3,043 2,960 Net cash used in investing activities 5,276 7,426 591 532 183 441 1,054

Cash Flow from Financing Activities Dividend Paid (3,844) (2,184) (1,154) (1,975) (3,142) (3,288) (3,913) Net cash outflow from financing activities (3,844) (2,184) (1,154) (1,975) (3,142) (3,288) (3,913)

Net increase/(decrease) in cash and cash equivalents 1,679 1,936 2,231 2,572 2,965 3,418 3,940

Cash and cash equivalents at the beginning of the year 10,993 12,672 14,608 16,839 19,411 22,376 25,794 Cash and cash equivalents at the end of the year 12,672 14,608 16,839 19,411 22,376 25,794 29,733 Source: Team Estimates

APPENDIX 6: REGIONAL VALUATIONS

Companies Ticker P/E P/B P/S EV/EBITDA Honda Atlas Cars (Pakistan) Ltd HCAR PA 5.08 1.16 0.26 1.35 Pak Suzuki Motor Co Ltd PSMC PA 6.06 0.46 0.13 0.71 Indus Motor Co Ltd INDU PA 6.82 2.08 0.65 2.14 DongFeng Automobile Co Ltd 600006:CH 3.64 0.36 0.45 20.52 Honda Motor Co Ltd 7267:JP 6.74 0.57 0.32 7.23 Toyota Motor Corp 7203:JP 7.05 0.78 0.67 9.52 Hyundai Motor Co 005380:KS 6.93 0.41 0.24 9.2 Kia Motors Corp 000270:KS 6.01 0.43 0.23 2.43 Source: Bloomberg

APPENDIX 7: SWOT ANALYSIS

Strength Weakness

Prestigious Brand Image: Based on our survey, we found that Most Sensitive Margins: HCAR's margins are most sensitive to consumers perceive Honda as a premium/prestigious brand, owing to currency devaluation, due to lowest localization level of 55%. The superior features and technology in City/Civic standard deviation of its gross margins is 6.4% (vs 5% industry Lowest Exposure to Non-Filer Ban: HCAR's non-file customers average) during the period FY09-18 constitute only about 10-15% of its customers base (vs about 50% No Expansion Plan: Despite owning a vacant land next to its Lahore industry-wide). Thus, we think that HCAR's sales will be least affected factory, HCAR has shared no expansions plans. This indicates that by this regulation. HCAR management does not expect growth in the near future. Superior Car Design: PakWheels awarded Honda Civic as the best car Inefficient Distribution Network: HCAR transports its imported in terms of interior and exterior design in 2017. That is the main components from Karachi port to Lahore and then delivers finished reason behind brand loyalty of its customers towards HCAR. goods back to Karachi. Customers have to pay a because of the Highest Sales Growth FY14-18: HCAR's sales increased at a CAGR location of the factory of HCAR. of 21% (vs 19% industry average), thanks to 2016 Honda Civic and production constraints faced by INDU.

Opportunities Threats

Expanding Reach : HCAR can reap greater benefits by tapping into the Limited Product Line: HCAR operates only in the 1300cc to 1800cc rural areas that make up 64% of the total population. It could follow segment, offering just three locally manufactured models. In fact, it INDU's footstep and establish a foothold in Rural Pakistan. did not launch 6th Generation Honda City due to absence of Widening Customer Base: The Company has the opportunity to enter competition. Now, as new competitors are gearing up to release their 1000cc-to-1300cc segment, which had highest volumetric CAGR of cars, it is essential for HCAR to introduce new vehicles and upgrade 32% during FY14-FY18. Hence, we believe Honda Brio, a 1200cc the existing ones. compact car, could be a great addition to the product line mix. Toughening Regulation: Hefty regulatory duties are compelling Strategic Alliance with Banks: Since 35-40% of HCAR customers opt assemblers to move towards local vendors, who may not be able to for auto financing, having strategic alliance with more local banks to meet the quality standards. This could impact HCAR's reputation offer exclusive financial solutions would help in retaining them. Unfavorable Economic Condition: The biggest threat to HCAR's Currently, it is on-board with Al-Falah, JS and . earnings and valuation is unfavorable economic conditions due to Strong Ties with Local Vendors: In order to enhance its localization currency devaluation, high inflation and interest rates. level and reduce its exposure to currency devaluation, HCAR can Spare Parts' Black Market: Smuggled auto parts are readily available develop close ties with local vendors by entering into long-term deals and cheap as compared to those offered by HCAR. This is supported and frequently transferring knowledge and technology. by our research in which 77% of respondents rated Honda's spare parts as expensive.

Source: Team Analysis

APPENDIX 8: RISK MATRIX

Market Risk Regulatory Risk

Business & Operation Risk Financial Risk

M1 Exchange Rate Risk

R2 R1 M1 M2 Economic Slowdown

M2

M3 M3 High Interest Rate

M5 M4 Commodity Price Risk

M4 M5 Global Oil Prices

Probability Medium Medium

R1 Increasing Competition Risk

BO1

F1 R2 Ban on Non-Filers Low Low BO1 Natural Disaster Low Medium High Liquidity Risk F1 Impact

Source: Team Analysis

APPENDIX 9: STAKEHOLDER MANAGEMENT

Customers Customer satisfaction surveys, new Local Experts & local model launching Communities governments events, parts CSR Activities, Dialogs concerning exhibitions etc. employment policies & creation, Factory technology etc. Study tours

Suppliers Media Supplier briefings, Journalist meetings, technical & Stakeholder Management new model events, management support press releases etc. etc.

Policy Makers Associates Participation in Associate satisfaction government council surveys, education and bodies & Industrial trainings. Shareholders & groups like PAPAAM Investors etc. General shareholders meetings, IR meetings, factory visits.

Source: Company Reports

APPENDIX 10: CORPORATE GOVERNANCE ASSESSMENT

Evaluation criteria of 2016, developed by ICAP & ICMAP, has been used to rate HCAR’s performance in the domain of Corporate Governance. HCAR’s Annual report of 2018 and Six-month report of 2019 has been

studied for the assignment of marks.

Max Criterion Performance Score Marks Date of authorization of financial statements by Board of An average of 48 days from 2014-2018 4 6 Directors(BOD) Compliance with the Best Practices of Code of Corporate As per requirements of the Listed Companies (Code 1 1 Governance of Corporate Governance) Regulations, 2017. Disclosure of policy for actual and perceived conflict of Not Mentioned 0 1 interests relating to BOD Disclosure of IT Governance Policy Not Mentioned 0 1 Whistle blowing policy and disclosure of incidents Not Mentioned 0 1 reported to the Audit Committee Human resource management policies including Mentioned 1 1 succession planning Social and environmental responsibility policy Mentioned 1 1 Policy for stakeholder management and relationship Mentioned 3 3 management Investors' grievance policy Not Mentioned 0 1 Policy for safety of records Not Mentioned 0 1 Organizational chart Mentioned 1 1 Board structure and its committees (4 conditions must be None of the independent director has relevant 1.5 2 satisfied) industry experience Shariah Advisor's profile Not mentioned 0 1 Chairman of the board is not the CEO Yes, both are different individuals 1 1 Salient features, TOR and attendance in meetings of Mentioned 1 1 board committees Details of board meetings held outside Pakistan There's no mention of venue/s 0 2 Audit committee report not found specifically. Report of the Audit Committee (The report must contain However, HCAR meets three requirements except 3 4 4 points) point 'c'. Shariah Advisor's report Not mentioned 0 1 Independent non-executive directors on the Human 2 out of 5 members are Executive directors 0 1 Resources Committee Annual evaluation of BOD's performance Not mentioned 0 1 CEO performance review by the BOD Not mentioned 0 1 A brief description about role of Chairman and the CEO Mentioned 2 2 Formal orientation at induction and names of directors Orientation record not mentioned & no training 0 2 who have completed training program arranged during the year. Total 19.5 37 Source: Company Reports

APPENDIX 11: BOARD OF DIRECTORS Overall Name Title Background Independent Experience • Law Graduate & AMP Harvard • Finance Services Academy • Former President of KCCI Mr. Yusuf H. Shirazi Chairman of Board 50+ Years No • Founding member of KSE,LSE & ICCI • Served on board of , FFIMCS & SUPARCO • Recipient of Sitara-e-Eisaar & Sitara-e-Imtiaz • Service Technology Division, Honda Motor Company, Japan. Mr. Hironobu President & CEO • Several Planning Division 30+ Years No Yoshimura • Automobile Marketing Planning Office • General Manager Asian Honda Motor Co. Ltd, Thailand • OPM from Harvard Business School Director & Senior • Former CEO - 11 Years Mr. Aamir H. Shirazi 32 Years No Advisor • Appointed on Board of LSE by SECP • On Board of Brewery Company Ltd • Automobile Assembly & Business Planning Operations, HM Executive Japan Mr. Kenichi Matsuo 38 Years No Director/VP (Prod) • Technical Advisor, Honda Cars India Limited - 4 years • Vice President of Honda Malaysia Sdn Bhd - 2 years • Financial Management and Business Planning operations • Staff Manager in Honda Motor Limited for four Mr. Akira years & Manager HM, Japan Director 29 Years No Murayama • Director of Honda Motor Europe - 2 years • General Manager, HM Europe region operations • GM - Asian Honda Motor Limited, Thailand • Chartered Accountant • ICI Pakistan Ltd • Petromin Refinery Riyadh • Involved in ICI PLC’s strategic shift from Industrial to Mr. Feroz Rizvi Director 38 Years Yes consumer chemical • CEO - Pakistan Institute of Corporate Governance • Serving on Board of Engro Chemicals and Polymer Ltd., and Pakistan Oxygen Ltd • Chartered Financial Analyst (CFA) • Financial Risk Manager (FRM) • Investment and Capital Markets Ms. Mashmooma Director • Atlas Asset Management Limited 19 Years Yes Zehra Majeed • ABAMCO Ltd (Now JS Investments Ltd) • Crosby Asset Management Ltd • CEO - Mutual Funds Association of Pakistan (MUFAP) • Customer Centre Manager - Recruit Staffing Co., Ltd • Director Human Resource - Development in Welcome Co., Ms. Rie Mihara Director Limited, Japan 17 Years Yes • CEO & Founder of Makotoya Co., Limited, Japan and Makotoya Pakistan (Pvt) Ltd • Sales Planning & restructuring business plan Honda Canada Inc., Toronto, Ontario • Chief of North America Automobile Sales Department • Sales Large Project Leader of Civic Group, In charge of CIVIC Mr. Satoshi Suzuki Director 27+ Years No and CR-V. • Director Sales - Honda Motor RUS LLC, Moscow, Russia • Vice President for Automobile Operations Division American Honda Motor Co., Inc. Source: Company Reports

APPENDIX 12: AUDIT COMMITTEE Name Title Independent Mr. Feroz Rizvi Chairman Yes Mr. Aamir H. Shirazi Member No Mr. Akira Murayama Member No Ms. Mashmooma Zehra Member Yes Majeed Mr. Satoshi Suzuki Member No Source: Company Reports

APPENDIX 13: HUMAN RESOURCE & REMUNERATION COMMITTEE Name Title Independent Ms. Mashmooma Zehra Chairperson Yes Majeed Mr. Aamir H. Shirazi Member No Mr. Hironobu Yoshimura Member No Mr. Kenichi Matsuo Member No Mr. Akira Murayama Member No Source: Company Reports

APPENDIX 14: NEW ENTRANTS TIMELINE

Prospective Prospective Competition 12K Competition 30K ● Cerato Prospective ● 1300cc ● Niro 8K Competition ● Tivoli

2019 2019 2019

Prospective Prospective Competition Competition 50K ● Captur ● Elantra 30K ● Duster ● Kona ● Lodgy

2020 2020

Source: Team Analysis

APPENDIX 15: HONDA CIVIC & HONDA CITY MODEL LAUNCHES – TIMELINE Honda Civic:

Honda City:

Source: Team Analysis

APPENDIX 16: CBU TARIFF STRUCTURE

TARIFF SYSTEM FOR CARs, SUVs, LCVs (HS CODE 8703 & 8704)

DESCRIPTION EXISTING RATES 2016-17 2017-18 2018-19 2019-20 2020-21

COMPLETELY-BUILT UNITS (CBUs) 1 CBU upto 800cc 50% 50% 40% 40% 50% 50% 2 CBU 800-1000cc 55% 55% 45% 45% 55% 55% 3 CBU 1001-1500cc 60% 60% 50% 50% 60% 60% 4 CBU 1501-1800cc 75% 75% 65% 65% 75% 75%

5 CBU above 1801cc 100%+50% RD 100%+50% RD 100%+50% RD 100%+50% RD 100%+50% RD 100%+50% RD

Upto 1800cc = Upto 1800cc = Upto 1800cc = Upto 1800cc = Upto 1800cc = Upto 1800cc = 50% 50% 50% 50% 50% 50% exemption exemption, exemption, exemption, exemption, exemption, 6 CBU Hybrid Electric Vehicles (HEVs) , Exceeding Exceeding Exceeding Exceeding Exceeding Exceeding 1800cc = 25% 1800cc = 25% 1800cc = 25% 1800cc = 25% 1800cc = 25% 1800cc = 25% exemption exemption exemption exemption exemption exemption

7 CBUs Plugged-in Electric Vehicles (PEVs) 50% 50% 50% 50% 50% 50% Source: ADP, 2016-21

APPENDIX 17: EARNING MANIPULATION TEST

M-Score was introduced by Professor Messod Beneish and is a mathematical tool that helps in identifying manipulation in earnings reported by a company. It uses financial ratios to calculate the M-Score metric and then compares that metric with a Benchmark is -1.78 (Source: CFA Level II Curriculum). Companies with M-Scores higher than -1.78 are considered as potential manipulators. Following is the M-Score equation as proposed by Dr. Beneish.

M-score = −4.84 + 0.92(DSRI) + 0.404 (AQI) + 0.115(DEPI) + 4.679(TATA) + 0.528(GMI) + 0.892(SGI) − 0.172(SGAI) − 0.327(LEVI) s Input Variables (in Millions) MY15 MY16 MY17 MY18 Net Sales 105,849 120,463 134,034 153,163 Cost of Sales 99,566 113,796 126,632 144,659 Receivables 11,885 12,696 13,082 15,355 Current Assets 57,968 65,447 72,538 81,229 Property, Plant & Equipment 3,563 3,223 3,511 3,923 Depreciation 19 22 28 72 Total Assets 62,276 69,400 76,795 85,933 Operating Expenses 2,633 2,907 3,133 3,470 Net Income 4,486 4,696 5,215 5,688 Cash from Operations 1,858 5,553 25,192 3,989 Current Liabilities 41,070 46,674 52,173 59,563 Long-Term Debt 0 0 0 0 Depreciation Rate 0.45 0.37 0.32 0.53

Variables to Calculate M-Score MY15 MY16 MY17 MY18 Y-Intercept -4.84 DSRI = Days Sales Receivable Index 0.67 5.34 0.99 GMI = Gross Margin Index 1.19 0.96 0.79 AQI = Asset Quality Index 2.10 0.16 0.74 SGI = Sales Growth Index 1.06 1.57 1.46 DEPI = Depreciation Index 1.27 1.39 0.81 SGAI = SGA expenses Index 0.91 0.86 1.24 LVGI = Leverage Index 0.79 1.49 0.95 TATA = Total Accruals to Total Assets -0.12 -0.37 0.04

M-Score Index -2.64 -0.16 -2.14 Source: Company Reports & Team Analysis According, to M-Sore, HCAR is not a potential manipulator in MY16 and MY18. However, there might have been potential earnings management in MY17.

APPENDIX 18: ALTMAN Z-SCORE

The Altman Z-Score, as proposed by NYU Stern Finance Professor Edward Altman, is used to calculate the probability of bankruptcy being filed by a publicly listed company. It measures the score on the basis of profitability, leverage, liquidity, solvency and activity metrics of the company. A score of less than 1.8 indicates that the company is likely to go bankrupt. However, a score of 3 or more indicates that the company is far from bankruptcy. Equation for Z-Score is; Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Input Variables (in Millions) MY16 MY17 MY18 Net Sales 40,086 62,803 91,523 Total Assets 16,205 51,497 58,809 Current Assets 12,338 46,411 53,242 Current Liabilities 8,038 37,961 41,195 Working Capital 4,300 8,451 12,047 Retained Earnings 2,557 4,276 2,650 EBIT 5,186 8,660 9,493 Market Value of Equity 34,415 75,116 89,677 Total Liabilities 8,264 38,401 41,735

Derived Variables Coefficients MY16 MY17 MY18 A = working capital / total assets 1.2 0.27 0.16 0.20 B = retained earnings / total assets 1.4 0.16 0.08 0.05 C = earnings before interest and tax / total assets 3.3 0.63 0.23 0.23 D = market value of equity / total liabilities 0.6 4.16 1.96 2.15 E = sales / total assets 1 2.47 1.22 1.56

Z-Score Index 7.58 3.45 3.91 Source: Company Reports & Team Analysis

As HCAR’s Z-score is not only more than 1.8 but also close to 3, we can say that HCAR’s chances of going bankrupt are nearly non-existent.

APPENDIX 19: AUTO LOANS VS INTEREST RATES

PKR 2,500,000 18% 16% PKR 2,000,000 14% 12% PKR 1,500,000 10% 8% PKR 1,000,000 6%

PKR 500,000 4% 2% PKR 0 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18

Auto Loans (LHS) Interest Rates (RHS) Inflation (RHS)

Source: SBP/Pakistan Economic Survey

APPENDIX 20: RUBBER PRICES VS. MARGINS

16.00% $210.00

14.00% $190.00 12.00% $170.00 10.00% $150.00 8.00% $130.00 6.00% $110.00 4.00% 2.00% $90.00 0.00% $70.00 FY13 FY14 FY15 FY16 FY17 FY18

HCAR Industry Rubber Index

Source: Bloomberg & Company Report

APPENDIX 21: PLASTIC PRICES VS MARGINS

16.00% $1,600

14.00% $1,500 12.00% $1,400 10.00% $1,300 8.00% $1,200 6.00% $1,100 4.00%

2.00% $1,000

0.00% $900 FY13 FY14 FY15 FY16 FY17 FY18

Industry HCAR Polyproplene (per ton)

Source: Bloomberg & Company Report

APPENDIX 22: ALUMINUM PRICES VS MARGINS

Source: Bloomberg & Company Report

Appendix: Honda Cars Consumer Survey

APPENDIX 23: Consumer Survey

The most important factors consumers take into Consumers think Honda’s best offers are: consideration when purchasing a car are: Driving Experience

Safety Standards

After Sales Service

Features & Accessories

Prestigious Brand Image

81.9% of respondents have owned 80% said Honda has a Honda car in their life least resale value

66% of consumers said Civic has prestigious brand image 45% of consumers think City offers best value for money

Sample of Survey: 224 respondents Age Range: 25 - 50 Geographic Location: Punjab (40%), (57%), KPK (3%), Balochistan (0%)

Source: Team Survey

APPENDIX 24: Porter’s Five Forces

Force 1: Industry Competition The structure of the passenger car industry is oligopolistic, with only three local assemblers. Thus, the rivalry amongst the competitors is low (HHI: 0.367), which is reflected in high industry-wide net margins of 6.9%. While PSMC operates in 1,000cc-and-below segment, INDU and HCAR compete against each other on product differentiation in 1,300cc-and- above segment. Also, all the car manufacturers are already operating at or near their installed capacities. However, with imminent arrival of fresh competition due to the relaxed duty structure laid out for the new entrants in the ADP, we expect the competition to intensify amid deteriorating economic environment. Force 2: Threat of New Entrants The oligopoly in the passenger car segment is under threat, thanks to ADP 2016-17, under which at least 12 of new OEMs, including Hyundai, Kia, Renault, Nissan and Volkswagen, plan to enter the passenger car segment. New players can leverage on regulatory support and low switching cost of customers, who are not getting their desired features in locally assembled cars and thus are opting for imported used Japanese cars. Force 3: Bargaining Power of Buyers For decades, Pakistan’s car assemblers have been minting money on advances by customers because of lack of regulations and a growing number of buyers served by only 3 companies. HCAR’s other income, 95% of which is earned on bank deposits and Short-term investments purchased from customer advances, stood at PKR 1.88 bn in MY18 that makes up 29% of net earnings. Thus, the bargaining power of buyer is low, which is likely to increase in the next two years with the increase in competition. Force 4: Bargaining Power of Suppliers OEMs are highly dependent on suppliers that provide key inputs which have low substitutability. Moreover, parent companies like Honda Motors Co, Japan restrict car assemblers to buy major components directly from them. On the other hand, there is no threat of vertical integration, as local auto-parts manufacturers are SMEs and since OEMs transfer technology and skill to local vendors they buy raw materials from them on favorable terms. In FY18, HCAR’s trade payables days were 185. Bargaining power of suppliers is moderate. Force 5: Threat of Substitutes In Pakistan, other mode of transportation, like local railways and buses, are not at par in quality with locally produced passenger cars; however, the rise of ride railing services that usually use imported reconditioned cars have become a popular platform for commuting in urban areas. Thus, threat of substitutes is neutral as they are readily available and a bit cheaper than owning and using a passenger car for short distance commutes.

Appendix 25: Local vs Imported Cars

Table 1: Passenger Car Industry Sales Break Down Locally Imported Imported Total % of L. A Cars % of U. I Cars % of N. I Cars Assembled Used New FY08 161,388 145,249 12,911 3,228 90.00% 8.00% 2.00% FY09 79,329 73,776 4,363 1,190 93.00% 5.50% 1.50% FY10 119,440 112,274 5,375 1,792 94.00% 4.50% 1.50% FY11 124,601 114,633 8,099 1,869 92.00% 6.50% 1.50% FY12 192,550 134,785 55,840 1,926 70.00% 29.00% 1.00% FY13 152,430 106,701 44,205 1,524 70.00% 29.00% 1.00% FY14 133,656 104,252 29,070 334 78.00% 21.75% 0.25% FY15 161,288 128,224 32,258 806 79.50% 20.00% 0.50% FY16 204,846 151,586 52,236 1,024 74.00% 25.50% 0.50% FY17 229,823 170,069 58,605 1,149 74.00% 25.50% 0.50% FY18 277,224 207,918 67,920 1,386 75.00% 24.50% 0.50%

Appendix 26: Domestic vs Regional Sales

250 45 40 200 35 30 150 25

20 Millions

Thousands 100 15

50 10 5 0 0 FY13 FY14 FY15 FY16 FY17

Domestic PC Sales (LHS) HCAR Sales (LHS) Regionall PC Sales (RHS)

Source: OICA