Background:

Indus Motor Company Limited (PSX: INDU) was incorporated in 1989 through a joint venture agreement between House of Habib of Pakistan, Toyota Motor Corporation and Toyota Tsusho Corporation of Japan. The company is in the business of assembling, selling and marketing of the Toyota brand vehicles in Pakistan. The company has some of the most popular cars in the world being assembled in Pakistan with Corolla on top as the most sought-after model in the country. Recently, with Yaris replacing some of the smaller models of Corolla, and armed with multiple variants, both the models are garnering market interest, grabbing a major chunk of the sedan “B” and “C” segments. Together with the pickup Hilux and SUV Fortuner, the average annual volumetric sales over the past decade for the company is 54,000 units; occupying an average market share of 28 percent. Even with new entrants in the market, Toyota’s market share has not really been dented, though individual variants may have suffered. Since its inception, spanning three decades, the company’s lifetime volumes stand at 1.03 million vehicles. The daily production capacity meanwhile, has grown from 90 units a day to 288 units a day (including overtime) which comes around to 86,000 units (considering 300 working days). The annual report for 2022 quotes the given capacity to be 66,000 units (on double shift) but argues that actual production relates more to the demand. According to the company’s annual report, the company has a strong network of 52 independent authorized dealerships spread across the country, and over 50 vendors supplying hundreds of parts.

Majority stakes in the company are held by Overseas Pakistan Investors AG (34.8% of all shares). Meanwhile, 25 percent of the company is held by Toyota Motor Corporation; 12.5 percent with Toyota Tsusho Corporation while 6.2 percent are held by Thal Limited.

Financial and Operational Performance:

At roughly 54,000 units produced a year (an average of the past 10 years), the company’s capacity and production has not grown dramatically, but given its consistent market share—this is mainly because of the overall market pie that has not grown too much. The primary reason for this is the high level of taxation and limited localization which makes the industry rely heavily on imported content which itself is vulnerable to the exchange rate. The more expensive inputs being imported abroad; makes vehicles substantially expensive and only becoming pricier over time.

The trajectory of the company’s revenue and its estimated revenue per unit sold indicate a consistent increase in prices, the more pronounced rise witnessed over the past two years. Costs too have risen due to with rising commodity prices, higher inflation worldwide for most goods and rupee’s depreciation against the dollar. The closing gap between revenue and costs (per unit sold) does explain the drop in margins over the past few years—from 18 percent in FY17 to 7 percent in FY22. Margins have more or less always been in this range.

The company keeps its overheads and charges at a low threshold of 3 percent of revenue, maintaining it at this level over the years without much deviation. Over the past two years, these expenses have dropped further to 2 percent of revenue. With negligible finance costs, the net margins are very close to gross margins. A real substantially buttressing of earnings comes from “other income” which on a 10-year average stands at 27 percent of pre-tax earnings but has recently grown significantly. In FY22, other income was 51 percent of pre-tax earnings.

Latest result and outlook:

In 1QFY23, revenues dropped 43 percent which resulted in the company incurring a gross loss, higher than the one it incurred during the covid-quarter when sales had dropped dramatically. However, INDU earned Rs1.3 billion in after-tax earnings for the quarter, up 2.5x from the previous quarter. The revenue drop was expected as the government has enforced demand-curbing measures by placing restrictions on the import of CKD kits and assigning informal quotas across the industry for the import of these inputs. This has triggered a shortage in supply. The company’s volumes shrank 52 percent in 1QFY23, but the sales mix and higher car prices allowed revenue per unit sold to increase 19 percent. Meanwhile, rupee devaluation and higher freight caused costs to balloon—up 42 percent per unit sold. This prompted margins to plunge.

Once again, the company’s “other income” more than made up for it with investments and cash balances, making money for the company that is not coming from its primary business operations. During the quarter, other income as a share of before-tax earnings stood at Rs5.2 billion, 2.8 times of before-tax earnings, or nearly 4 times the size of the company’s current after-tax earnings.

Finance costs remain negligible while overheads and other charges stay at 3 percent of revenue, matching the average expenditure incurred by the company over the past 20 quarters. The company is at 3 percent net profit margins during the quarter but likely to signal confidence, a final cash dividend was announced which was a pay-out ratio of 50 percent. For the past 20 quarters, the average payout ratio is roughly 57 percent. This does not take into account the covid quarter where the dividend per share was 6 times the earnings. The current payout is also higher than last full year’s payout of 47 percent which by company standards is low.

With the precarious economic situation and depleting reserves, it is likely that the government would double down further on imports. Restrictions are unlikely to be eased very soon which would ensure that the company takes more non-production days. However, on the demand side too, consumers are likely to stay far away from car dealerships with surging inflation and reduced buying power. The cost of bank borrowing has also ballooned making car financing that much more costly to attain.