Hero MotoCorp & Bajaj Auto: Revving Up In Tough Times

The two industry leaders in the two-wheelers segment, Bajaj Auto and Hero MotoCorp, seem geared up to log a good performance in the coming times. Both the companies make a good option for your portfolio, say Vidrum Mehta and Shrikant Akolkar.

The auto sector is not going through a very good time presently. From inventory pile-ups to slower demand due to higher interest rates and labour unrests, nothing seems to be going the right way for this sector. With the economy in a lower gear, these companies are finding it difficult to step up their speed of growth. Many companies in the sector have started resorting to production cuts due to the slowing demand. This has led the apex industry body, Society of Indian Automobile Manufacturers (SIAM), to cut the sales growth guidance for the sector from the lower double digits to single digits in the current fiscal. Petrol price hikes and talks of deregulating diesel prices have acted as further speed breakers for the growth of the sector. A weaker monsoon may worsen the situation even more. Amid all these negatives, what is the outlook for the sector? Is there any company whose stock can be bought with better returns in mind? Or should one just wait it out for some time with regard to this sector?

Broadly speaking, the auto industry is divided into the two- and four-wheeler segments. SIAM has brought down the growth guidance for the four-wheeler segment, but has retained the earlier projected growth of around 11 to 13 per cent for the two-wheelers segment. Further, according to SIAM reports, as at the end of FY11, the domestic two-wheeler market accounts for 76 per cent of the total number of vehicles that are sold. Within the twowheelers segment, two companies, viz. Hero MotoCorp (HMCL) and Bajaj Auto (BAL), have a total of around 65 per cent of the market share between themselves. In the motorcycles segment, both these companies have a combined share of around 80 per cent. Since these two companies form the mainstay of the domestic two-wheeler market, we have analysed both of them on various parameters that will help our readers to decide on which of them should ideally form a part of their portfolio.

Business & Past Performance

One interesting fact that investors should take note of is that HMCL and BAL collectively have 2.99 per cent weight in the Sensex. At Rs 45189 crore, the market cap of BAL is higher than that of HMCL, which stands at Rs 40569 crore.

HMCL’s past performance in terms of volumes and revenues has been better than that of BAL. HMCL’s volumes have grown at a CAGR of 13 per cent over the past five years, outpacing the industry average of 11 per cent during the same period. BAL’s volumes, on the other hand, have gone up at a CAGR of 10 per cent over the same period. On the revenue front, HMCL has seen its income grow at a CAGR of 22 per cent over the past five years, while BAL’s revenues have grown at a CAGR of 19 per cent over the same period. In terms of volumes and revenues, HMCL has done better than BAL in the past.

While HMCL and BAL are bothin the two-wheelers business, BAL also makes commercial vehicles (CV) like goods carriers and passenger vehicles. The CV segment forms about nine per cent of the total volumes. BAL also derives 35 per cent of the total revenues from exports, while those in case of HMCL are less than five per cent.

A comparison between these companies is possible on the fact that BAL derives 91 per cent revenues from two wheelers, while HMCL is entirely a two-wheeler company. Besides, both the companies derive a major chunk of their revenues from the rural segment, where there is a strong demand.

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Competition & Brands

The competition in the industry is quite fierce, which requires companies to make aggressive ad campaigns. Readers would recollect the aspirational tagline of ‘Hamara Bajaj’, which now has been changed to ‘Distinctly Ahead’. Hero came back strongly with its tagline ‘Hum Mein Hai Hero’ in 2011, which was also one of the best ad campaigns of the year. The company is now advertising with the tagline ‘Vroom Vroom’, which also looks quite effective.

BAL has two brands in the 100-125 cc category – Discover and Platina. The company has many high-end bikes like Avenger and Pulsar. It also sells foreign bikes in India like Ninja and KTM Duke 200. The high-end bikes earn a premium and have a positive impact on the margins.

HMCL, on the other hand, has a wide range of brands. The company has refreshed the brands (old brands re-launched) of its earlier hit models, mainly Splendor. Except for Karizma (223cc), all of HMCL’s brands are below 150 cc. It has top brands like Passion, Hunk, Boxer and Glamour. Further, the company has tied up with US-based Erik Buell Racing (EBR) to source the technology for highend bikes, indicating its willingness to foray into the premium bikes segment and compete with international players.

Both the two-wheeler giants in the domestic market have two different business strategies. HMCL focusses on the volumes game, while BAL has highend bikes that result in higher realisations. We believe that in the current economic situation, HMCL has an edge over BAL due to its entry-level brands. BAL, on the other hand, will receive benefits from its premium brands after the economic situation of the country recovers.

One also cannot ignore the competition from the Japanese auto major, Honda, which has come in with a series of new brands. Its success can be seen from the fact that it has gained about 20 per cent of the two-wheeler market share in June 2012 and launched products in the entry-level segment.

Capacities

The three decade-old HMCL has three manufacturing capacities, two located in Haryana and one located in Uttarakhand. It has a total capacity of 6.6 million vehicles p.a. at the end of FY12. BAL is a six decadeold two-wheeler company that has four manufacturing capacities, three in Maharashtra and one in Uttarakhand. It has a manufacturing capacity of 5.1 million vehicles as of FY12.

The rationale behind having the manufacturing capacities in Uttarakhand is that 100 per cent tax exemption is available on the first five years’ profits and 30 per cent exemption on the next five years’ profit. HMCL currently gets 100 per cent tax exemption, and from FY14 onwards, it will get tax exemption on 30 per cent of the profits. BAL’s first five years’ tax exemption period was completed in FY12 and as of today, 30 per cent of its profits are exempt from tax. Hence, BAL’s tax outgo would increase this year.

HMCL is set to increase its capacity by setting up two new plants in Gujarat and Rajasthan at an approximate investment of Rs 2500 crore. Besides, it will also expand the current capacities, which will take the total capacity to nine million units in the next two years and 10 million units in five years. BAL, on the other hand, will expand its capacity to 6.36 million units by March 2013. However, from the information shared over a conference call, we are given to understand that the company is extremely cautious in this aspect and will go ahead in a step-wise manner. It is also looking to foray into the four-wheeler segment, but it is still too early to comment on the same.

Inventory Pile Up & Price Hikes

Recently, inventory pile up has been a major issue in the auto sector, and it has also impacted both these companies. In the June 2012 quarter, the inventory levels of HMCL have gone up from two weeks to four weeks, while those of BAL have increased from two weeks to three weeks. However, this is an industry-wide issue, not a company-specific one. We believe that it will get resolved once the economy shows signs of revival.

The auto sector uses various raw materials such as steel, aluminum, etc. Due the recent volatility in commodity prices, raw material costs have increased. During the Union Budget of 2012, the peak excise duty was hiked from 10 per cent to 12 per cent. To mitigate the effect of these factors, BAL and HMCL have both gone ahead with price hikes. HMCL has hiked its prices twice in this year. BAL has already brought in one price hike and has hinted towards another one later this year. Being market leaders, both the companies have the ability to pass on the prices to protect their margins.

Exports

For BAL, exports are a very vital component of its revenues, with Africa contributing to 41 per cent of its total exports, Asia contributing 40 per cent and the rest coming in from South America. Though there are some problems in Sri Lanka, Egypt and Iran, these are relatively low key markets for the company. The only pressure that the company faces is in the CV segment, which contributes five per cent of the total export volumes and hence, will have the least impact. The motorcycles segment has shown a growth of seven per cent in exports during the June quarter, which is satisfactory.

BAL has now set a target to generate 50 per cent revenues from export in the next three years. This looks achievable given its FY12 numbers, where the export volumes grew by 31 per cent and export revenues grew by 45 per cent. The company is foraying into Chile and Argentina, which will also help it to achieve its exports. HMCL, which derives less than five per cent of its revenues from exports, is now set to boost its overseas sales. Earlier, its ex-promoter Honda had imposed export restrictions on HMCL. After the split with Honda, the company has expressed its intent of growing exponentially in exports and has also set a target of 1 million vehicles or 10 per cent of the total revenues in the next five-six years.

The company is increasing its distribution network, and is considering setting up assembly bases overseas. Its prime focus is Africa and Central America, from where it will start exporting bikes from this fiscal, probably in the second half. A recent media interview hints that HMCL will also consider partnership agreements with local partners, if required.

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New Products

While there is stiff competition in the market, the companies are launching new products and also have slated to launch new products. HMCL has recently launched Ignitor, Maestro and Impulse in a successive manner. Besides, after the split, HMCL is also considering a relaunch of its premium brands using its own brand name, which we believe will give some push to the revenues.

BAL, on the other hand, has launched the Discover 125 cc in the June 2012 quarter, and will launch the model RE 60 in the second half of the current fiscal. Besides a few other models like Pulsar 200 NS, KTM 200, BM-150 and BM-100 are in the pipeline at the moment. We believe that there will about two launches during the festive season this year, which will create excitement for BAL.

Financials

Historically, HMCL has performed better than BAL. During the slowdown (2008 and 2009), the company had positive sales volume growth, while BAL’s volumes tumbled during the same period.

In the latest June quarter results too, HMCL sold the highest number of vehicles at 1.6 million units, registering a YoY growth of 7.37 per cent. BAL, on the other hand, faced headwinds in the export markets, due to which its total volumes declined by one per cent to 1.07 million.

The fact, however, is that BAL looks like a more profitable company as compared to HMCL. BAL has a better net profit margin than that of HMCL. This is also evident from the June quarter results, where BAL posted a net profit of Rs 718 crore on a topline of Rs 4865 crore. HMCL, on the other hand, posted a net profit of Rs 615 crore on a topline of Rs 6247 crore. The topline growth of HMCL was at 10 per cent, while that of BAL was muted at four per cent. The EBITDA margins of BAL were at 20 per cent, while those of HMCL were at 15 per cent. The reason behind the high margins is that BAL has an exposure to exports, the three-wheeler segment and premium bikes.

Valuation

The outlook for the auto sector in the medium-to-long term looks positive as the interest rate reversal will see an uptick in the demand for the vehicles. Further, the rise in disposable incomes will increase the demand for two-wheelers, which will be positive for both the companies.

Valuation-wise, HMCL is an industry leader and is trading at a premium to BAL. HMCL is available at a PE multiple of 17x and BAL is available at 15x its FY12 earnings. We, at Dalal Street Investment Journal, believe that both companies have aggressive plans on the exports front and have products that will grow the overall business. This will also give good capital appreciation on the stock price.

One may see a higher upside in BAL, given the fact that it is available at a slightly lower PE to HMCL. We advise readers to buy BAL at the current valuations and HMCL below the level of Rs 1950 per share to get better returns.