CFA Institute Research Challenge Hosted by CFA Society Pakistan Team Karachi 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. 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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 Cars Pakistan Limited Valuation Date: Jan 4th, 2019 Stock Exchange: Pakistan 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 Share Price in PKR 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 Honda 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 Suzuki 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 car 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 will 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 Honda Atlas Cars (Pakistan) Limited was incorporated in Pakistan in Nov 1992 and a joint venture 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 Honda Civic at its plant located in Manga Mandi, Lahore 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 Honda City 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.