Research Entity Number – REP-085

Pakistan Autos

May 8, 2020

Pak Motor Co. Ltd Sell Weak sales outlook and profitability concerns; Sell PSMC PA . We resume coverage on PSMC with a Sell stance based on a December Price: PKR161.75 2021 TP of PKR143/sh. We expect a slow recovery of lost sales (post Target Price: PKR143.0 Mehran discontinuation) amid rising competition and a weak financial standing – which leads to a protracted recovery out of losses. Abdul Ghani Mianoor . A number of new entrants will inundate the Economy segment in the [email protected] near term (Kia has already entered), leading to a very competitive +92-21-111-467-000 Ext: 102 landscape for PSMC. This will diminish its pricing power and keep

profit margins low – exacerbating its susceptibility to turnover tax. Pak Suzuki Motor Company Limited

. PSMC is trading at depressed valuations (P/B 0.6x) vs. peers and its Bloomberg / Reuters PSMC PA/PKSU.KA

own historical average (0.8x). We think it requires greater visibility of Mkt Cap (US$mn) 83 profits and a big catalyst for sales (such as Taxi scheme) for it to Upside (%) -11.6 emerge out of low utilization levels and command higher valuations. Fwd D/Y (%) 0.0

Rate as Sell on slow sales recovery and persistent losses Total Return (%) -11.6 We have a Sell stance on Pak Suzuki Motor Co. Ltd (PSMC), based on a 12m Hi-Low (PKR/sh) 310.11/124.21 December 2021 TP of PKR143/sh (DCF based). Our thesis is based on slow recovery of lost sales over CY20-21f, which will keep margins low and likely 6m Avg. D. Vol ('000 shrs) 252.05 maintain losses in the next two years. PSMC’s sales declined by 23% yoy in 6m Avg. Td Val (US$mn) 0.35 CY19 and further 63% yoy in 1QCY20. The expected increase in competition in the Economy segment is a major threat to PSMC (refer Page 2), which had PSMC – Valuation Snapshot previously been the sole assembler of economy in Pakistan (after Indus PKRmn CY19A CY20f CY21f CY22f Motors discontinued Cuore in 2016). The discontinuation of Suzuki Mehran is a Sales 116,548 87,800 110,574 128,773 big blow to both sales and margins (consistent annual sales of c.40,000 units), NPAT (2,920) (2,218) (1,635) (312) and the set of recent new models is not strong enough to overcome the loss of EPS (PKR) (35.49) (26.95) (19.86) (3.79) Mehran, in our view. We think PSMC needs a big catalyst for sales such as Taxi DPS (PKR) - - - - scheme to boost sales, but such an event seems improbable in the near term. PBV (x) 0.51 0.56 0.60 0.61 ROE (%) -10.6% -8.9% -7.1% -1.4% Weak financial performance and slow new model launches EV/EBITDA (x) n.m 5.9 2.5 1.9 PSMC has resorted to significant short-term borrowing for working capital since Gross Margin 1.7% 4.5% 6.4% 7.3% Alto’s launch in CY19 (c.PKR32bn), as advances from sales and cash have Net Margin -2.5% -2.5% -1.5% -0.2% dried up. It now has a debt-to-asset ratio of 56% (compared to an average of Source: IMS Research 17% in the previous five years). This is mainly due to the substantial decline in PSMC vs. KSE100 bookings and concurrent inventory pile-up. Because of a slower-than- expected recovery in auto sales – first due to Covid-19 lockdown conditions and 40% later new competition – we expect PSMC to maintain high leverage on its books. 20% 0% In light of the new competition, PSMC may have to introduce new models or -20% revamp existing ones more frequently than it has in the past – adding burden on -40% cash-flows and undermining its ability to address competition, in our view. -60% Susceptibility to turnover tax to remain high in the next 2 years Jul-19 Oct-19 Apr-20 Jun-19 Jan-20 Mar-20 Feb-20 Besides high leverage, a number of factors will continue to make PSMC prone Aug-19 Sep-19 Nov-19 Dec-19 May-19 May-20 to turnover tax. We expect it to operate at an average capacity utilization of 55% KSE-100 PSMC during CY20-22f (5yr average of 83%), while Opex (as a percentage of sales) Source: IMS Research has risen significantly in recent years (partly due to the new model launches). We think PSMC also finds itself in a conundrum, where price increases (in response to any cost pressures) will protect margins but also hurt sales, which in turn will make turnover tax more probable. Note that there is a high possibility of a reduction in the rate from 1.5% presently in the next Budget, but we think volume growth will remain more crucial for lifting profitability sustainably. Continued on the next page… www.jamapunji.pk

Copyright©2020 Intermarket Securities Limited. All rights reserved. The information provided on this document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject Intermarket Securities or its affiliates to any registration requirement within such jurisdiction or country. Neither the information, nor any opinion contained in this document constitutes a solicitation or offer by Intermarket Securities or its affiliates to buy or sell any securities or provide any investment advice or service.

PSMC

The loss of Mehran means more than lower volumes

PSMC announced the discontinuation of the Mehran near the end of 2018, with bookings fully closed by April 2019, after a 30yr run. Mehran had the highest localization level in the industry at a whopping 70%. Not only was Mehran the most popular car for PSMC, it was also the cheapest car available in the market (consistent annual sales of c.40,000 units). The discontinuation is also a big blow to the margins and earnings of PSMC, due to the low per unit cost and price of the model. Amid low volumes, the latter factor would have reduced its PSMC Models slate & recent prices susceptibility to incurring turnover tax, in our view. We believe that PSMC needs to launch a model with similar pricing and localization level as the previous Model CC Median Price Mehran to improve its profitability. Gross margins for PSMC fell c.4ppt to 1.7% Swift 1,300 PKR 2.04mn in CY19 from 5.9% in CY18, due to a 19% yoy decline in volumes, which we think is due to the 59% yoy decline in and eventual halt of Mehran sales. Cultus 1,000 PKR 1.80mn Wagon R 1,000 PKR 1.69mn Competition in the Economy segment to hinder sales recovery

Bolan 800 PKR 1.10mn The new Alto was launched in June 2019 (previously discontinued in 2016), while the Cultus was launched in 2017. Cultus (rebranded from Celerio) Ravi 800 PKR 1.00mn replaced a predecessor which had the same shape for nearly 15 years. In light New Alto 660 PKR 1.30mn of the new competitive landscape, we believe that PSMC may be required to

Source: PSMC, IMS Research introduce new models or revamp existing ones more frequently than it has in the past. The new entrants have so far introduced many new features in their offerings, which will negatively influence consumer perception for PSMC cars, in our view. More recurring capex by PSMC for new models, however, will test an already weak cash-flow position. Kia Lucky Motors (KLM) is the first company to introduce a new model in the Economy segment with the launch of the 1,000cc Kia Picanto (September 2019), which is facing off against the Suzuki Cultus (1,000cc). We understand that the Picanto has been well received due to better build quality (perceived) compared to Cultus. Regal Automobiles launched the Prince Pearl, an 800cc car, at a cheaper price than the (660cc). The Prince Pearl is said to have more features and better build than the Alto and, according to channel checks, became fully booked in a short time span (before Covid-19 pandemic). -BAIC is also expected to launch affordable cars, with a 1,300cc in the price range of Cultus. Note that Cultus is c.17% of PSMC’s total car sales. New models which pose a threat to PSMC sales Model Price (Avg) CC Launch date Threat to Kia Picanto PKR 1.9mn 1,000 September 2019 Suzuki Cultus Baic D20 PKR 1.9mn (f) 1,300 Expected 2HCY20 Suzuki Cultus and Swift Prince Pearl PKR 1.05mn 800 February 2020 Suzuki Alto Source: IMS Research

We think PSMC may be able to hold on to the majority of its share in the Economy segment in the near term, due to greater brand familiarity among consumers and its countrywide outreach in both urban and rural centers, with over 160 dealerships across the country. What is certain, however, is that consumers will soon have more options to compare with PSMC models. A fragile financial position, as illustrated above, is a key weakness in that scenario, in our view.

2 |

PSMC

PSMC passenger cars mostly below 1,000cc (Economy) Most new models in close proximity in cc and price range Swift, 4% CC/Price 2.50 Swift, 1300, Cultus, 1000, 2.05 2.00 New Alto, 660, 1.80 Cultus, 17% 1.30 1.50 Bolan , 800, Wagon R, 1.10 1000, 1.69 New Alto, 49% Wagon R, 1.00 13% PKRmn Price 0.50 Ravi, 800, Bolan , 1.00 0.00 Ravi, 7% 10% 0 200 400 600 800 1000 1200 1400 CC Source: PAMA Source: PAMA

Utilization Levels expected below 70% without Mehran GPM expected to recover to 6-7% – barely enough to avoid turnover tax

10.0% 9.5% 100% 92% 7.3% 90% 7.5% 87% 6.4% 5.9% 80% 74% 4.5% 70% 5.0% 63% 60% 2.5% 1.7% 56% 50% 47%

40% 0.0% CY17A CY18A CY19A CY20F CY21F CY22F CY17A CY18A CY19A CY20F CY21F CY22F

Source: Company Reports & IMS Research Source: Company Reports & IMS Research

Debt to Asset ratio to remain elevated PSMC tends to trade below P/B of 1.0x amid sluggish sales periods

60% 56% 56% (x) 54% 50% 50% 2.0 40% 1.5 1.0 0.5 30% 28% Jun-12 Jan-08 Feb-18 Mar-19 Feb-09 Mar-10 Aug-13 Sep-14 Nov-15 Dec-16 May-20 20% May-11 CY18A CY19A CY20F CY21F CY22F

Source: Company Reports & IMS Research Source: IMS Research

3 |

PSMC

I, Abdul Ghani Mianoor, certify that the views expressed in the report reflect my personal views about the subject securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations made in this report. I further certify that I do not have any beneficial holding of the specific securities that I have recommendations on in this report.

Ratings Guide* Criteria Buy Total return expectation of > 15% or expected to outperform the KSE-100 index Neutral Total return expectation of > -5% or expected to match the return of KSE-100 index Sell Expected downside of more than 5% or expected to underperform the KSE-100 index *Based on 12 month horizon unless stated otherwise in the report.

Valuation Methodology: We use multiple valuation methodologies in arriving at a Target Price including, but not limited to, Discounted Cash Flow (DCF), Dividend Discount Model (DDM) and relative multiples based valuations.

Risks: (i) Significant PKR depreciation against USD and JPY, (ii) entry of new players In sedan category, and, (iii) Below expected sales due to FED on cars. Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions, and estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable where such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness, and correctness. This report makes use of forward looking statements that are based on assumptions made and information currently available to us and those are subject to certain risks and uncertainties that could cause the actual results to differ materially. No part of the compensation of the author(s) of this report is related to the specific recommendations or views contained in this report. This report is not a solicitation or any offer to buy or sell any of the securities mentioned herein. It is meant for information purposes only and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before acting on any information in this report, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. Neither Intermarket Securities Limited nor any of its affiliates or any other person associated with the company directly or indirectly accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. Subject to any applicable law and regulations, Intermarket Securities Limited, its affiliates or group companies or individuals connected with Intermarket Securities Limited directly or indirectly may have used the information contained herein before publication and may have positions in, or may from time to time purchase or sell or have a material interest in any of the securities mentioned or may currently or in future have or have had a relationship with, or may provide investment banking, capital markets and/or other services to, the entities mentioned herein, their advisors and/or any other connected parties.

RESEARCH DISCLOSURES Distribution This report is not intended for distribution to the public and may not be reproduced, redistributed or Third Party Research published, in whole or in part, for any purpose without the written permission of Tellimer. Tellimer shall This is third party research. It was prepared by Intermarket Securities Limited (IMS), with headquarters in accept no liability whatsoever for the actions of third parties in this respect. This report is for distribution Karachi, Pakistan. Intermarket Securities Limited (IMS) is authorized to engage in securities activities only under such circumstances as may be permitted by applicable law. according to its domestic legislation. This research is not a product of Tellimer Markets, Inc., a U.S. registered broker-dealer. Intermarket Securities Limited (IMS) has sole control over the contents of this This report may not be used to create any financial instruments or products or any indices. Neither research report. Tellimer Markets, Inc. does not exercise any control over the contents of, or the views Tellimer, nor its members, directors, representatives, or employees accept any liability for any direct or expressed in, research reports prepared by Intermarket Securities Limited (IMS). consequential loss or damage arising out of the use of all or any part of the information herein. Intermarket Securities Limited (IMS) is not registered as a broker-dealer in the United States and, United Kingdom: Distributed by Exotix Partners LLP only to Eligible Counterparties or Professional therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence Clients (as defined in the FCA Handbook). The information herein does not apply to, and should not be of research analysts. This research report is provided for distribution to “major U.S. institutional investors” relied upon by, Retail Clients (as defined in the FCA Handbook); neither the FCA’s protection rules nor and other “U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a- compensation scheme may be applied. 6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). UAE: Distributed in the Dubai International Financial Centre by Exotix Partners LLP (Dubai) which is Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or regulated by the Dubai Financial Services Authority (“DFSA”). Material is intended only for persons who related financial instruments based on the information provided in this research report should do so only meet the criteria for Professional Clients under the Rules of the DFSA and no other person should act through Tellimer Markets, Inc., located at Floor 36, 444 Madison Avenue, Floor 36, New York, NY 10022. upon it. A representative of Tellimer Markets, Inc. is contactable on +1 (212) 551 3480. Under no circumstances Other distribution: The distribution of this report in other jurisdictions may be restricted by law and should any U.S. recipient of this research report effect any transaction to buy or sell securities or related persons into whose possession this document comes should inform themselves about, and observe, any financial instruments through Intermarket Securities Limited (IMS). Tellimer Markets, Inc. accepts such restriction. responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor. Disclaimers Tellimer and/or its members, directors or employees may have interests, or long or short positions, and None of the materials provided in this report may be used, reproduced, or transmitted, in any form or by may at any time make purchases or sales as a principal or agent of the securities referred to herein. any means, electronic or mechanical, including recording or the use of any information storage and Tellimer may rely on information barriers, such as “Chinese Walls” to control the flow of information within retrieval system, without written permission. the areas, units, divisions, groups of Tellimer. Intermarket Securities Limited (IMS) is the employer of the research analyst(s) responsible for the content Investing in any non-U.S. securities or related financial instruments (including ADRs) discussed in this of this report and research analysts preparing this report are resident outside the U.S. and are not report may present certain risks. The securities of non-U.S. issuers may not be registered with, or be associated persons of any U.S. regulated broker-dealer. The analyst whose name appears in this subject to the regulations of, the U.S. Securities and Exchange Commission. Information on such non-U.S. research report is not registered or qualified as a research analyst with the Financial Industry Regulatory securities or related financial instruments may be limited. Foreign companies may not be subject to audit Authority (“FINRA”) and may not be an associated person of Tellimer Markets, Inc. and, therefore, may not and reporting standards and regulatory requirements comparable to those in effect within the United be subject to applicable restrictions under FINRA Rules on communications with a subject company, public States. The value of any investment or income from any securities or related financial instruments appearances and trading securities held by a research analyst account. discussed in this report denominated in a currency other than U.S. dollars is subject to exchange rate Tellimer Markets, Inc. or its affiliates has not managed or co-managed a public offering of securities for the fluctuations that may have a positive or adverse effect on the value of or income from such securities or subject company in the past 12 months, has not received compensation for investment banking services related financial instruments. from the subject company in the past 12 months, and does not expect to receive or intend to seek Frontier and Emerging Market laws and regulations governing investments in securities markets may not compensation for investment banking services from the subject company in the next three months. be sufficiently developed or may be subject to inconsistent or arbitrary interpretation or application. Frontier Tellimer Markets, Inc. has never owned any class of equity securities of the subject company. There are no and Emerging Market securities are often not issued in physical form and registration of ownership may other actual, or potential, material conflicts of interest of Tellimer Markets, Inc. at the time of the publication not be subject to a centralised system. Registration of ownership of certain types of securities may not be of this report. As of the publication of this report, Tellimer Markets, Inc. does not make a market in the subject to standardised procedures and may even be effected on an ad hoc basis. The value of subject securities. investments in Frontier and Emerging Market securities may also be affected by fluctuations in available About Tellimer currency rates and exchange control regulations. Not all of these or other risks associated with the relevant Tellimer is a registered trade mark of Exotix Partners LLP. Exotix Partners LLP and its subsidiaries company, market or instrument which are the subject matter of the report are necessarily considered. ("Tellimer") provide specialist investment banking services to trading professionals in the wholesale markets. Tellimer draws together liquidity and matches buyers and sellers so that deals can be executed by its customers. Tellimer may at any time, hold a trading position in the securities and financial instruments discussed in this report. Tellimer has procedures in place to identify and manage any potential conflicts of interests that arise in connection with its research. A copy of Tellimer’s conflict of interest policy is available at www.tellimer.com/regulatory-information. 4 |