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A few months ago, management at Indus Motors (PSX: INDU) believed demand within the automobile industry would contract by 15-20 percent as buyers grapple with rising inflation, and increase in interest rates. Now the company believes demand would weaken by as much as 25-30 percent. This rather bleak outlook is in contrast to the company current profitability—earnings at their highest ever—and the industry’s sales performance in 10MFY22 expanding by 61 percent year on year.

If the company’s financial statements are explored, Indus Motors 9M performance is pretty solid despite margins dropping from peaks of FY17 and FY18. The company has been raising prices unabashedly citing global commodity prices, rupee depreciation and fright rates. None of these reasonings are wrong and the company’s financial statements corroborate that with the fast increase in its cost of sales.

Comparing the per unit sold revenue (up 17% year on year) and cost (up 16% year on year) for Indus Motors (estimated using volumetric sales for assembled units only), the two variables follow a similar nearly parallel upward trajectory where the gap between the two has narrowed since FY17 and FY18. Good times they were! That is also when gross margins for the company had peaked. The narrowing itself is an indicator that there will be more price hikes if the company can manage it.

Indus Motors has certainly not come slow with price increases despite a visible discontent of masses evidenced by social media posts and tweets, as well as, the government mulling over a price freezing mechanism under the legal cover of Price Control and Prevention of Profiteering and Hoarding Act, 1977. Can the government do that, should the government do that, how exactly will the government do and will it be fair (and to whom) are important questions that need to be asked and will determine not only the future of industry’s growth but the level of investment that will flow into the sector and consumer welfare, something that has always somehow never been achieved in the country when it comes to cars.

But the price increases have thus far not affected demand. A major portion of the company’s before-tax earnings comes from “other income” which constitutes of advance payments from customers. This has certainly come down from 45 percent back in 2009 but has remained above 30 percent in recent years. In 9MFY22, the company’s profits were buttressed by “other income” to the extent of it contributing 36 percent to earnings, increasing from 33 percent last year. This shows demand may not be slowing down as fast as one would think even with price increases and higher cost of borrowing.

The average revenue per unit sold for Indus Motors right now is roughly Rs3.6 million. At this average price, a consumer would have to pay Rs 66,000 per month on a 5-year loan at prevailing interest rate (assuming 20% down-payment). That is significant for a middle-class individual but perhaps not for a buyer of Corolla who is certainly not in the middle-class. An individual earning around Rs 250,000 a month would have to put aside 30 percent of their income to get this vehicle on financing.

This space has been predicting a slowdown in demand but evidently there is a delayed response of demand to price increases and higher cost of borrowing for a number of reasons. One: cars are now being considered a store of value and a good investment to make given their sharp price accretion. Used and second-hand cars market mirror the pricing patterns in the new car market. Now, not later is the time to buy a vehicle from any idle cash lying around. Two: there is a general expectation in the market for further price hikes. This arguably has been a reason for demand upsurge every time the company has preceded a phased price increase with a public announcement. But even without a public announcement, just the “expectation” is often enough persuasion when folks have cash and are looking for a savings instrument.

While Indus Motors is investing in the production of hybrid EVs to utilize the benefits under the new auto policy, it is all business-as-usual on the combustion engine front. Prices can be raised even more if it suits the bottom-line. That may affect demand but not earnings that much. That is a margins game.

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