Religare: Update on Auto Industry

The two-wheeler industry has registered a slowdown in volume sales during FY08 YTD, largely owing to expensive auto financing rates and a higher degree of scrutiny by financial institutions while granting loans. However, the recent budgetary announcements related to the excise duty cut on two-wheelers from 16% to 12%, reduction of CENVAT duty from 16% to 14%, and increase in the personal tax exemption slab will have a positive impact on two-wheeler manufacturers. Already Bajaj Auto (BAL) and Hero Honda (HHL) have announced price cuts on their vehicles, which will increase consumer affordability and drive demand for two-wheelers. And with a slew of new vehicle launches planned for FY09, we anticipate that volume sales of motorcycles will pick up.

Building in the positive impact of the budget on the two-wheeler industry, we have raised our volume sales estimates for BAL, HHL and TVSML. We maintain our Buy recommendation on BAL with a target price of Rs 2,947, which offers a potential upside of 38% from current levels. We continue to maintain a Hold on HHL, with a revised target of Rs 787, and a Sell on TVS Motor (TVSML) with a target of Rs 41.

Volume sales subdued during FY08 So far this fiscal, the two-wheeler industry has registered a decline in volume sales. This coupled with higher raw material costs and intense competition in the segment has eroded the overall profitability of two wheeler manufacturers.

Motorcycle volumes have decelerated The top three manufacturers of two-wheelers, namely HHL, BAL and TVSML, saw
their cumulative domestic motorcycle volume sales decline by 10.1% YoY to 4.4mn vehicles. This was primarily due to reduced sales of 75cc-125cc vehicles during the period as a result of expensive financing rates and tougher lending norms by financial institutions. While BAL’s domestic motorcycle volume sales declined 19.8% YoY during the first 10 months of the fiscal (10mFY08) to 1.4mn vehicles, HHL’s volumes declined 1% YoY to 2.6mn vehicles and TVSML recorded a drop of 22.9% YoY to 417,837 vehicles

But scooters and exports registered an increase The volume sales of scooters and exports, however, grew 7.9% YoY to 329,070 vehicles and 44.8% YoY to 558,753 vehicles respectively during the said period. In scooter sales, BAL posted the best growth amongst the three players, growing 57.8% YoY to 329,070 scooters, while TVSML recorded the highest exports growth of 79.8% YoY to 100,611 vehicles.

Shift in market share profile Despite the decline in volume sales, HHL improved its market share in the 75cc 125cc segment by more than 1,000bps to 69.8% at the end of 10mFY08. This was possible due to BAL’s conscious decision to focus on the executive and premium segments, where it commands the largest market share. Both BAL and HHL have gained market share in the 125cc-250cc segment, primarily at the expense of TVSML. While BAL and HHL improved their share by 50bps and 462bps to 61.8% and 10.9% respectively, TVSML registered a decline of 678bps to 5.4% in the executive and premium segment.

Two-wheeler volumes muted due to firm interest rates With high interest rates prevailing during the current fiscal, auto financing options grew expensive, leading consumers to defer their vehicle purchases. Considering that the economy segment forms the largest slice of volume sales, this deferment was a major contributor to the shrinking volumes and led to dealer inventory corrections in motorcycle sales during H1FY08.

The high interest rates also led to an increase in defaults on payment of vehicles already financed. Delinquency levels have increased from 3-5% in FY07 to 8-10% during 10mFY10. Consequently, many two-wheeler financing companies have

reduced exposure to certain regional markets such as Uttar Pradesh and Madhya Pradesh. The financing companies have also tightened credit norms in disbursing two wheeler loans, which has contributed to the decline in volume sales.

Favourable budget to the rescue The Union Budget of 2008-09 was favourable for two-wheeler manufacturers as it announced a reduction in excise duty on two-wheelers, a CENVAT duty cut and an increase in the limit of personal tax exemption. Excise on two-wheelers has been cut to 12% from 16%, while CENVAT rates have been reduced to 14% from 16%. Lastly, the tax exemption slab has been increased from Rs 110,000 to Rs 150,000, leading to higher personal disposable income.

All the three measures are expected to lead to a revival in sales volume, with manufacturers expected to pass on the benefit of the duty cuts to consumers. Already, BAL has announced prices cuts of Rs 1,000- 3,000 on its range of vehicles.

New launches to be skewed towards executive and premium segments FY09 will continue to witness the launch of new motorcycles, largely in the executive and premium segments as compared to economy segments. This will cater to the changing customer preferences for executive and premium segment vehicles. (Refer to Annexure I for forthcoming launches)

Interest rates unlikely to go up Interest rates have remained firm in FY08. However, the situation appears to be changing with the government’s renewed thrust on maintaining consumption-led growth. Several banks have already announced rate cuts on home loans, pointing to the likelihood of softer interest rates in the near future. If auto financing rates soften, it will act as an impetus to demand for two-wheelers, particularly motorcycles.

Change in estimates Building in the positive impact of the budget on the two-wheeler industry, we have raised our volume sales and EBITDA margin estimates for BAL, HHL and TVSML.

Factoring in the positive impact of the budget, we maintain our existing recommendations for BAL, HHL and TVSML. We recommend a Buy on BAL with a target price of Rs 2,947, continue with our Hold on HHL with a marginally higher target of Rs 787, and have a Sell on TVSML with a revised target of Rs 45.