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Bajaj Auto: All-round growth! - Views on News from Equitymaster
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Bajaj Auto: All-round growth!
Jan 13, 2006

Performance summary
Bajaj Auto has delivered an all-round performance in the third quarter and nine-month period ending December 2005. Due to a better product mix, the topline has recorded a robust growth of 25% YoY during 3QFY06, outperforming the volume growth of 14% YoY during the period. Similarly, on the operating front, due to efficient management of raw material requirements and other operating costs, margins have expanded by 290 basis points. Net profits have registered a 53% YoY growth on the back of strong topline growth and higher other income.

(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Net sales 16,057 20,009 24.6% 42,801 55,020 28.5%
Expenditure 13,645 16,428 20.4% 36,150 45,707 26.4%
Operating profit (EBDITA) 2,412 3,581 48.5% 6,651 9,313 40.0%
EBDITA margin (%) 15.0% 17.9%   15.5% 16.9%  
Other income 869 1,064 22.4% 2,816 3,354 19.1%
Interest 3 1 -53.3% 5 1 -72.0%
Depreciation 468 491 4.8% 1,393 1,443 3.6%
Profit before tax 2,810 4,153 47.8% 8,069 11,223 39.1%
Extraordinary income/(expense) (163) (118) -27.4% (327) (143) -56.2%
Tax 820 1,245 51.8% 2,470 3,315 34.2%
Profit after tax/(loss) 1,827 2,790 52.7% 5,272 7,765 47.3%
Net profit margin (%) 11.4% 13.9%   12.3% 14.1%  
No. of shares (m) 101.2 101.2   101.2 101.2  
Diluted earnings per share (Rs)* 72.2 110.3   69.5 102.3  
Price to earnings ratio (x)**         20.1  
(*annualised **trailing twelve months)            

Company background
Bajaj Auto Limited, with a market share of 27% in FY05 (23% in FY04) is the second largest player in the two-wheeler industry. In FY05, the sales mix (in volume terms) consisted of 79% motorcycles, 12% three-wheelers and the rest 9% step-thrus, ungeared scooters and geared scooters. Though the company has traditionally been a key player in the geared scooter segment, aggressive pricing coupled with a slew of new launches has resulted in a rise in market share in the motorcycle segment from 16% in FY00 to 27% in FY05. It has also entered into an agreement with Kawasaki for export of motorcycles to emerging markets.

What has driven the performance in 3QFY06?
Improving product mix: When compared to the nine-month performance, topline in the third quarter has grown at a slower pace. However, it has outpaced the volumes growth considerably. It should be noted that the 29% YoY topline growth during the nine-month period has been backed by a strong 24% growth in volumes, which is not the case in 3QFY06. The improved performance in topline can be attributed to two factors. Firstly, improved product mix resulted in better price realisations due to higher sales of ‘Discover’ in the executive segment and also steady performance of the recently launched ‘Avenger’ in the premium segment. Secondly, company resorted to marginal price increases during the current year as a way to pass on rising input costs to customers.

Volume break-up…
(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Motorcycles 441,355 511,106 15.8% 1,053,570 1,379,206 30.9%
Scooters-Geared 24,291 16,518 -32.0% 82,344 55,329 -32.8%
Scooters-Ungeared 7,661 15,628 104.0% 26,113 46,603 78.5%
Step thrus 4,175 - -100.0% 14,804 870 -94.1%
Three wheelers 49,501 57,572 16.3% 168,262 179,368 6.6%
Total 526,983 600,824 14.0% 1,345,093 1,661,376 23.5%

On the volumes front, a relatively subdued performance can be attributed to high base effect of the comparable quarter last year in the motorcycle segment. As a result of this, Bajaj Auto has reported only a marginal increase in its motorcycle numbers in the month of November and December 2005 (see adjacent chart). It should be noted that automobile industry is seasonal in nature. Hence month on month performance can be misleading. The adjacent chart can be said to be just a representative of the fact.

In the ungeared scooter segment, a 100% YoY growth in the current quarter is the result of low base of the last year. It should be noted that the company has been losing ground in this segment over the last few years, primarily due to its focus on motorcycles. However, going forward, the management is considering ungeared scooter segment as a key growth driver and hence has started focusing on this segment with the launch of ‘Wave’ in the current fiscal. Bajaj is planning to introduce two new models in the next 12 months to regain lost ground.

Going forward, for Bajaj Auto, we do not foresee any problem on the volumes front. We expect the company to outperform its peers in the next two years. On the pricing front, we do expect that competitive pressures will restrict the company from raising prices. Having said that, we do not foresee any pricing war in the two-wheeler industry.

Operating margins – a surprise: Bajaj Auto reported an improvement in operating margins not only on a YoY basis but also on a QoQ basis (see adjacent chart). While we did expect the margins to improve, a 290 basis points expansion comes as a surprise. This expansion in margins is primarily on account of reduction in raw material costs (see table below). This appears to be the result of an efficient vendor management and active participation by the company in improving the efficiency of its suppliers. Apart from this, a reduction in steel prices (accounting for around 70% of the raw material costs) also benefited the company. It should be noted that average steel prices during the current quarter have declined by 6% YoY. Also, the three-wheelers registered steady growth in the current quarter. The margins in the three-wheeler business are much better than in the two-wheeler business. Similarly, the management’s efforts on the restructuring front have started paying dividends as evident from a reduction in staff cost and other expenses (as percentage of sales).

Cost break-up…
(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Raw materials 11,624 13,979 20.3% 29,681 38,552 29.9%
% sales 72.4% 69.9%   69.3% 70.1%  
Staff cost 610 676 10.8% 1,892 2,060 8.9%
% sales 3.8% 3.4%   4.4% 3.7%  
Other expenses 1,635 1,774 8.5% 4,745 5,314 12.0%
% sales 10.2% 8.9%   11.1% 9.7%  

On a long-term basis we expect Bajaj Auto’s operating margins to stabilise in the range of 16.5% to 17% of net sales.

Other income effect: A 22% YoY increase in the other income further aided the net profit growth, which grew at faster pace as compared to operating profits. The increase in other income should be viewed in light of strong investment portfolio of around Rs 50 bn, most of which is invested in government and trust securities.

What to expect?
At Rs 2,013, the stock is trading at a price to cash flow of 12.4 times our FY08 estimates, which is on the higher side of our valuation band. We have factored in a 27% CAGR growth in our estimated profits for the period FY05-FY08 with 16.6% operating margins in FY08. The 9MFY06 performance of the company has been more or less in line with our FY06 estimates. Having said that, we have not considered in the value of the insurance business of the company. Though currently these businesses are at a nascent stage, we expect them to start yielding returns in the next 24 to 30 months. To that extent, there is an upside to our projections.

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