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Management at Indus Motors (PSX: INDU), the assembler that sells Toyota vehicles in Pakistan believes that automobile demand would weaken in the coming seasons, declining by an estimated 15-20 percent as folks at home grapple with inflation and increase in interest rates. Expected margins for the company, meanwhile, would remain subdued because of high commodity prices, skyrocketing freight costs and currency depreciation. In 2QFY22, the company’s gross margins dropped to 8 percent, nothing unprecedented but certainly lower than peaks achieved in FY18 and FY17 when volumes were lower compared to the current period.

Mapping out the company’s financial standing, there is a visible and “almost” parallel growth in revenues and costs. Because of significant dependence on imported kits and auto components from abroad—which are then sensitive to changes in rupee-dollar parity—the company’s costs have rapidly increased. So have the revenues, as Indus Motors, together with other assemblers have hiked up prices every opportunity they could. The gross profit per unit sold shows the gap between revenue and costs narrowed in the last quarter, having remained in the same range for many years. This is a clear indication that there are more price hikes in the horizon.

Demand for Indus Motors has more or less remained flat. There have been dips during covid times and before when the economy was undergoing a downturn, but there has not been significant upward changes in volumes. Given Indus Motors’ product portfolio, the market it is serving and hopes to serve is not huge. Today, the average revenue per unit sold for the company is roughly Rs3.6 million. At this average price, a consumer would have to pay Rs66,000 per month on a 5-year loan at prevailing interest rate (assuming 20% down-payment).

That alone demonstrates the kind of market Indus Motors is happy tapping. Future plan for Indus Motors is to edge into the crossover-SUV market, which is the space where all new and old players are flocking to. Soon that space will be crowded and everyone would be gasping for breath. But Indus Motors enjoys market acceptability, brand recognition and loyalty so its confidence to get that edge may not be entirely unjustified.

Quarterly volumes for the company in the past five years have grown and declined between 10,000 and 20,000 (except for outliers) and in fact, the last recorded quarter was the highest sales achieved for the company. Evidently, there doesn’t seem to be a huge pursuit for volumes—as much as assemblers would have the government believe otherwise—as they are happy selling high-margin, low-volume products.

Changes in policies have been too abrupt to take any substantial affect. In fact, many policies have proven to be counterproductive and short-sighted. When the SBP loosened monetary policy to spur growth, it led to higher car volumes being sold, with a quick succession expansion in auto credit. That was natural. At the time, the government was starting to get bold and there were talks about introducing a mark-up subsidy on auto financing.

Then suddenly, FED and sales tax on vehicles of all sizes were lowered. The rationale was that the government would make up for tax cuts through greater volumes. That step—myopic as it may be—brought down prices for cars, momentarily, only to be hiked again due to a new bout of currency depreciation. It was inevitable. Can cars become “affordable” through tax cuts? Maybe, if everything else remained constant. But that has never been the case. The government might have seen more volumes if they were assured by automakers that prices would not be raised so soon after the tax cuts. But no such agreements were made. The policy was unsustainable and could never achieve the desired outcomes.

The comical thing is, the mini-budget revoked the earlier reduced taxes ever so boldly. The subsidy on auto financing also never came. In fact, the SBP decided to slap restrictions on financing for high-end vehicles as well as impose an all-out ban on banks to offer lending products to buyers of CBU vehicles. This was part of the Central Bank’s larger plan to reduce the import bill and keep current account from slipping dangerously.

Right now, freight costs are high, rupee is weakening, there are persistent supply chain issues due to semi-conductor chip shortage which may exacerbate given the ongoing Russia-Ukraine war. Commodity prices are spiralling. Demand is certain to get affected but that does not mean Indus Motors’ future is precarious. In fact, the company will continue selling similar-ish volumes in the coming quarters. It may lose some earnings with demand slowdown, but nothing too dramatic. It will be selling on cash in rural areas and make money off of high-margin products where price sensitivity for car buyers is not high. Other income (fed by advances) continues to support the bottom-line—in 2QFY22, other income was 39 percent of before-tax profits which is substantial—and the company’s overheads and borrowing costs are minimal at 2-4 percent historically.

The larger question on market expansion however is the one no automaker can satisfactorily answer. The automobile industry depends on imported auto-grade commodities (steel, aluminium, copper, plastics) on the lower-end and expensive components such as engines and transmission on the higher-end that make domestic price for cars highly sensitive to international prices, freight rates and rupee value. Volumes to achieve enough localization are too low, and prices to achieve enough volumes are too high. Not that this space advocates for completely localization—that is simply not possible—but the underlying foundation of the industry and how it functions does not signify the possibility of a huge expansion in the market, even at times when the economy is expanding. When the economy is slowing down, demand for cars would shift into reverse gear. And by all reckoning, this economy is in slow-mo.

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