Two Wheelers Changing Trends

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Dennis McCoy
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1 March 12, 21 Two Wheelers Changing Trends Sector: Automobiles Hero Honda Reco: MP CMP (Rs): 1,911 Target price (Rs): 1,894 Downside (%):.9 52 Week h/l (Rs): 194 / 935 Market cap (Rscr) : 38,161 Bajaj Auto Reco: BUY CMP (Rs): 1,828 Target price (Rs): 2,1 Upside (%): Week h/l (Rs): 1931 / 486 Market cap (Rscr) : 26,447 TVS Motors Reco: SELL CMP (Rs): 73 Target price (Rs): 66 Downside (%): Week h/l (Rs): 82 / 19 Market cap (Rscr) : 1,738 Prices as on 11 Mar, 21 Shareholding pattern (%) December '9 HH BAL TVS Promoters Institutions Non prom Corp Public & others Performance rel. to sensex (%) 1m 3m 1yr Bajaj Auto (4.) Hero Honda (5.3) TVS (1.) Share price trend Sensex HH BAL TVS Mar-9 Jul-9 Nov-9 Mar-1 During FY1, 2-wheeler industry witnessed a sharp recovery in volumes after witnessing a marked slowdown in H2 FY9. Companies have intermittently reported their highest ever monthly volumes in YTD FY1. During this phase, vital trends for the segment have witnessed material change impacting performance for various companies differently. Hero Honda gains market share within scooters segment: For FY9, scooters contribution to total 2-wheeler volumes was at 15.4%. However, during FY1 the contribution slipped to 12.3% during October 29 before jumping to 17.4% in February 21. Hero Honda s market share in the segment increased from 13.4% in FY9 to 14.2% for YTD FY1. Rising proportion of <125cc motorcycles: Proportion of <125cc vehicles to total motorcycle volumes increased from 7.2% in FY9 to 74.1% in YTD FY1. Surprisingly, Bajaj Auto lost market share in cc segment by 4.2ppts from FY9. Increasing rural penetration: Robust agriculture growth during the past few years along with pro-agriculture reforms has led to increased penetration of 2-wheelers in the rural areas. Constrained credit availability: Credit availability continues to remain weak for the segment, as proportion of sales from rural as major banks continue to avoid exposure to the segment. Increasing raw material prices: Commodity prices have increased from the low s witnessed in FY9 on back of improving economic environment globally. This rally is expected to continue as the demand outlook for commodities remains strong. Volumes to witness steady growth but margins to weaken With the recent budget increasing disposable income and laying stress on rural employment, we believe 2-wheeler volumes will continue to witness steady growth. However, operating margins would be under pressure as prices of key raw material prices continue to rise. We believe, Bajaj Auto with success of its recent launches and higher margins will outperform its peers. We maintain our rating on Bajaj Auto (BUY) and Hero Honda (MP), and downgrade TVS Motors to SELL from MP. Valuation summary Hero Honda Bajaj Auto TVS Motors Y/e 31 Mar FY1E FY11E FY1E FY11E FY1E FY11E Revenues (Rs m) 155, , ,19 136,679 42,235 47,672 yoy growth (%) Operating Profit 26,895 28,121 24,858 24,756 3,8 3,88 OPM (%) Reported PAT (Rs m) 21,277 21,842 15,196 17, ,87 yoy growth (%) EPS (Rs) P/E (x) Price/Book (x) EV/EBITDA (x) RoE (%) RoCE (%) Source: Company, India Infoline Research

2 Changing trends of the Indian two wheeler Industry Higher proportion of cash sales in scooters segment driving penetration of scooters Suzuki and Mahindra 2-wheelers are the major gainers with rising trend in market share of scooters Share of scooters bounce back from lows in October 29 Sale of scooters increased 23.1% yoy during YTD FY1 as against growth of 24.6% yoy in total two wheeler sales during the same period. The growth for scooters was lower compared to the total two wheelers on account of slew of launches in the motorcycle segment. Contribution of scooters to two wheeler volumes have recovered from ~12% to 15% in Aug-Oct 29 to 17.4% in February 21. However, on YTD basis the share of scooters of two wheelers remained flat at 15.4%. The share was higher by 75bps when compared to 16.7% in Jan 1. While Hero Honda has gained marginally from this trend with its market share increasing from 13.4% in FY9 to 14.2% during YTD FY1, Suzuki (market share increasing from 7% to 12%) and Mahindra 2-wheelers (nil to 6%) were the major gainers. Honda was on the losing side with its market share falling from 57.1% to 5.8%. On a monthly trend, Hero Honda has been gaining market share in the scooter segment for past 4 months, which increased from 12.5% in November 29 to 15.5% in February 21. Yearly trend in 2-wheeler volume breakup Monthly trend in 2-wheeler volume breakup 1 Motorcycles Scooters Mopeds Electric scooters 1 Motorcycles Scooters Mopeds Electric scooters FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 YTDFY Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9 Jun-9 Aug-9 Oct-9 Dec-9 Feb-1 Yearly trend in scooter market share Monthly trend in scooter market share Hero Honda Bajaj Auto TVS Honda Others FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 YTDFY Apr-8 Hero Honda Bajaj Auto TVS Honda Others Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9 Jun-9 Aug-9 Oct-9 Dec-9 Feb-1 2

3 Reduced share of motorcycles in total two wheeler sales Hero Honda has lost market share in both <125cc category Bajaj Auto has seen increase in <125cc market share but surprisingly has lost market share in >125cc category Increasing share of <125cc vehicles in motorcycle segment Share of motorcycles to total two wheeler volumes has remained flat at 78.5% in YTDFY1. However, the share has declined from 79.6% in FY8. On a monthly basis, the share decreased from 77.9% in February 29 to 76.7% February 21. Amongst motorcycles, share of <125cc vehicles increased to 74.1% in YTD FY1 from 7.2% in FY9. This was led by the new launches by Bajaj Auto and Honda. Commensurate decrease was seen in share of cc motorcycles to 25.2%. The market share of Bajaj auto has increased to 16.8% in YTD FY1 from 1.6% in FY9 in <125cc segment. The increase in the market share could be attributable to the successful launch of Discover DTS-Si (1cc segment) in July 29. During the same period Hero Honda has lost market share by about 488bps Honda Motors and Hero Honda have gained market share in the cc category, while Bajaj Auto surprisingly lost market share to the tune of 423bps. Yearly trend in motorcycle volume breakup Monthly trend in motorcycle volume breakup 1 <125cc 125cc-25cc >25cc 1 <125cc 125cc-25cc >25cc FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 YTDFY Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9 Jun-9 Aug-9 Oct-9 Dec-9 Feb-1 Market share in <125cc category Market share in cc category 1 Hero Honda Bajaj Auto TVS Others 1 Hero Honda Bajaj Auto TVS Honda Others FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 YTDFY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 YTDFY1 3

4 Higher penetration of executive category is driven by rural areas Hero Honda with its deep penetration in rural areas has been the major beneficiary Increasing presence in rural areas Amongst the price categories, share of executive segment has increased from 57% in FY9 to 64.2% in YTD FY1. During the same period the share of economy segment has fallen from 29% to 19.5%. The growth in the executive category was primarily driven by increasing penetration in the rural areas. The government in its recent budget has focused on rural development in the next few years to push India s GDP growth rate above 1. To spur the growth in this sector, the Government plans to focus on higher agricultural production, reduction in wastage of produce, higher credit support to farmers and thrust to food processing sector. This initiative along with the lower dependence on agricultural income and higher allocation to NREGS will lead to strong growth of two wheeler sales from the rural areas. As per Crisil, over the next five years rural penetration of 2- wheelers will increase from 22% to 26%, while urban penetration will rise from 29% to 31%. During the same period, contribution of rural sales to total two wheeler volumes will increase from 45% to 49%. Share of rural areas in motorcycles is estimated to increase from 51.5% to 64.2% during the same period. Hero Honda with its deeper rural penetration would be the primary beneficiary of the change in trend. Penetration of two wheelers Proportion of rural and urban sales 35 (%) Urban Rural 6 (%) Urban Rural FY8E FY13E FY8E FY13E Source: Crisil, India Infoline Research Break up of motorcycle volumes (%) FY8E Urban Rural FY13E Economy Executive Premium FY6 FY7 FY8 FY9 Source: Crisil, India Infoline Research 4

5 Continued reluctance of banks to impact credit availability for the industry Decreasing credit availability Share of two wheelers purchased through finance route are expected to decline from 56% in FY8 to about 25% in FY14 as banks continue to avoid exposure to the segment due to high delinquencies rate. The impact would be primarily on demand from urban areas as majority of volumes in rural areas are driven by cash sales. Trend in proportion of 2-w financed 8 LTV Financing penetration FY8 FY9 FY1E FY11E FY14E Expected trend in 2-w finance New TW finance New TW market 5 (Rs bn) FY8 FY9 FY1E FY11E FY14E Source: Crisil, India Infoline Research Rising demand across the globe have led to sharp rebound in metal prices Trend in Aluminum prices 3,5 3, 2,5 2, 1,5 1, 5 US$/ton Rising raw material prices With the financial crisis impacting economic growth across the globe, demand for commodities had slumped in FY9. This had led to sharp decline in prices of these commodities in FY9. However, since then the prices have been on the rising trend. The prices of aluminium and steel have recovered by 61.2% and 4.2% respectively from FY9. We believe the prices of commodity will rise going ahead which is expected to put pressure on margins of two wheeler companies. The companies might not be able to pass on the full increase in the cost on account of rising competition in the industry. Trend in Steel prices 1,2 1, US$/ton Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Source: Bloomberg, India Infoline Research 5

6 Impact of the changing trends on companies Increasing share of scooters Hero Honda Market share increase of 3bps in 3 months Bajaj Auto Nearly exited out of the segment TVS Motors Market share remained flat Increasing share of <125cc vehicles Hero Honda Has recently lost market share to Bajaj Auto and others Bajaj Auto Gaining market share on success of Discover DTS-Si TVS Motors Losing market share across segments Increasing share of rural sales Hero Honda Deepest penetration and huge success of Splendor Bajaj Auto Success in executive segment to increase rural sales TVS Motors Average performance Decreasing credit availability Hero Honda Rural areas less dependent on credit Bajaj Auto High end models mainly financed TVS Motors Rural urban mix to cushion fall Impact of rising raw material prices Hero Honda Margins might be sustained with higher production Uttarakhand plant Bajaj Auto Already passed on higher raw material prices TVS Motors Mix towards lower end models to impact performance Future growth Hero Honda Volumes to be driven by deeper rural penetration Bajaj Auto Success of new models will continue to drive growth TVS Motors Needs to improve product mix Valuations Hero Honda Valuations fair at current levels Bajaj Auto Earnings outperformance to drive stock performance TVS Motors Expensive valutation relative to its earnings profile Source: India Infoline Research Volumes will continue to remain strong In the recent budget, government raised excise duties by 2%. On back of the rise in excise duty two wheeler companies are expected to raise the prices. On the other hand, government revised personal income tax slabs, substantially increasing disposable income for individuals. We believe this will more than offset the impact of higher prices on demand for two wheelers. Furthermore, government continued its stress on rural employment generation, which will fuel demand growth. Two wheeler companies would be major beneficiary of this continued growth momentum. Maintain ratings on Bajaj Auto (BUY) and Hero Honda (MP), but downgrade TVS to SELL Bajaj Auto has been consistently outperforming peers in terms of financial performance over the past couple of quarters aided by the success of its new launches. We believe the trend will continue and thus maintain our BUY rating on the stock. While valuations appear fair for Hero Honda, TVS Motors looks expensive. We maintain our MP rating on Hero Honda but downgrade our rating on TVS Motors from MP to SELL. 6

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