Bajaj Auto: Other income saves the day

Performance Summary

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Bajaj Auto, India's second largest manufacturer of two-wheelers reported its third quarter and nine month ended December 2006 results today. The company has continued to witness pressure at operating level, thus once again nullifying the strong volume growth it had witnessed during the quarter. On a robust topline growth of 28% YoY, the net profit of the company has grown by 24% YoY, due largely to a 370 basis points contraction in operating margins. Infact, had it not been for the 51% jump in other income, net profit growth would have been an extremely muted 4%. The performance on a nine month basis was also affected by input cost pressure, with the bottomline growing at a considerably slower pace of 20% YoY on the back of a strong 31% YoY jump in the topline.

Financial performance: Standalone snapshot

(Rs m)	3QFY06	3QFY07	Change	9mFY06	9mFY07	Change
Units sold	601,324	738,219	22.8%	1,661,900	2,093,438	26.0%
Net sales	20,009	25,682	28.4%	55,020	72,069	31.0%
Expenditure	16,428	22,046	34.2%	45,707	61,174	33.8%
Operating profit (EBDITA)	3,581	3,636	1.5%	9,313	10,895	17.0%
EBDITA margin (%)	17.9%	14.2%		16.9%	15.1%
Other income	1,064	1,610	51.3%	3,354	3,979	18.7%
Interest (net)	1	2	57.1%	3	30	953.6%
Depreciation	491	472	-3.8%	1,443	1,445	0.2%
Profit before tax	4,153	4,771	14.9%	11,221	13,400	19.4%
Extraordinary income/(expense)	(118)	(120)		(143)	(362)
Tax	1,245	1,200	-3.6%	3,315	3,750	13.1%
Profit after tax/(loss)	2,790	3,452	23.7%	7,763	9,288	19.6%
Net profit margin (%)	13.9%	13.4%		14.1%	12.9%
No. of shares (m)	101.2	101.2		101.2	101.2
Diluted earnings per share (Rs)*	110.3	136.5		102.3	122.4
Price to earnings ratio (x)**					22.0

(* annualised, ** on trailing twelve months earnings)

What is the company's business?

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Bajaj Auto Limited, with a market share of 32% in FY06 (23% in FY04), is the second largest player in the two-wheeler industry. In FY06, the sales mix (in volume terms) consisted of 82% 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 32% in FY06. It has also entered into an agreement with Kawasaki for export of motorcycles to emerging markets

What has driven performance in 3QFY07?

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Sales break-up…

Domestic	3QFY06	3QFY07	% change	9mFY06	9mFY07	% change
Motorcycles	467,280	578,265	23.8%	1,267,297	1,620,541	27.9%
Scooter/scooterette	28,932	173	-99.4%	94,229	11,482	-87.8%
3 Wheelers	40,253	44,162	9.7%	123,609	135,686	9.8%
Total	536,465	622,600	16.1%	1,485,135	1,767,709	19.0%
Exports
Motorcycles	43,826	74,141	69.2%	112,779	223,114	97.8%
Scooter/scooterette	3,214	-	n.a.	8,227	1,103	-86.6%
3 Wheelers	17,819	41,478	132.8%	55,759	101,512	82.1%
Total	64,859	115,619	78.3%	176,765	325,729	84.3%
Grand total	601,324	738,219	22.8%	1,661,900	2,093,438	26.0%

Source: SIAM

Motorcycles – Continue to surprise: The 28% YoY growth in topline was powered by a 23% YoY growth in total volumes, where like the previous quarter, domestic sales constituted 84% of total units sold and managed to grow by 16% YoY. Exports once again recorded a stellar performance, growing at a strong 78% YoY and forming 16% of total sales as against 11% during the same quarter last year. It should be noted that the company's motorcycles have gained immense popularity in some key Latin American and African markets and as a result, exports have seen some real spurt in recent times. Further, after setting up assembly units in Indonesia and Nigeria, the company is also planning to set up a third assembly plant in China, the largest two-wheeler market in the world. If successful, this is likely to give further boost to the company's volumes.

Motorcycle sales, which accounted for 93% of domestic sales and 64% of exports, continued with their dream run by notching up growth of 24% YoY and 69% YoY in the domestic and exports segments respectively. This is significantly higher than the industry growth rate of 11% YoY and 42% YoY in both the markets under consideration. The success of its ‘Platina' in the entry-level segment has ensured that the company now has successful products straddled across all the three segments of motorcycles and this seems to be aiding its market share-gaining streak. With competitors furiously breathing down its neck, it remains to be seen how far the streak will last.

On the three-wheeler front, Bajaj Auto continued to witness robust growth in exports as they improved by a huge 133% YoY, while domestic sales grew at a much muted 10% YoY.

Motorcycles market share

Margin woes continue: Raw material costs as a percentage of sales have increased by 360 basis points (3.6%), and this is once again the primary reason why the company's operating margins have contracted by 370 basis points. Had it not been for the savings on the wages front, the fall in operating margins would have been even higher. The fall in margins could also be attributed to a shift in its product mix towards price and value segment bikes, where realisations are on the lower side as compared to the premium segment bikes. The intensifying competition also makes it difficult for the company to pass on hikes in raw material costs to the end user.

Cost break up

(Rs m)	3QFY06	3QFY07	Change	9mFY06	9mFY07	Change
Raw materials	13,979	18,856	34.9%	38,385	52,092	35.7%
% sales	69.9%	73.4%		69.8%	72.3%
Staff cost	676	757	12.1%	2,060	2,339	13.6%
% sales	3.4%	2.9%		3.7%	3.2%
Other expenditure	1,774	2,433	37.2%	5,263	6,743	28.1%
% sales	8.9%	9.5%		9.6%	9.4%

The other income has improved by a sizeable 51% and this has really helped lend some respectability to its bottomline numbers. As mentioned earlier, if one excludes impact of the same, the jump in net profit stands at a mere 4%, highlighting the kind of inflationary pressure the company's performance is under.

What to expect?

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At the current price of Rs 2,776, the stock is trading at a price-to-cash flow multiple of 18 times our estimated FY08 cash flow. We do not foresee the margin pressure to ease any time soon and despite expectations of robust volume growth, courtesy its attractive product pipeline, we believe the current valuations fully reflect the fundamentals from a medium term perspective. Hence, the risk reward ratio at the current juncture seems to be skewed towards the former.