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Bajaj Auto: On a strong footing...

May 11, 2005

<>Bajaj Auto, the second largest two-wheeler company, announced its FY05 results. For FY05, burdened by rising input costs, the company faced pressure on its operating margins, which fell by 190 basis points to 15.4%. A significant increase in tax outgo impacted its bottomline further, which registered a decline of 1% YoY. For 4QFY05, the topline and bottomline grew by 28% and 4% respectively. Had it not been for a 97% increase in other income, the bottomline growth would have been much lower in 4QFY05.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 12,836 16,470 28.3% 49,168 59,271 20.5%
Expenditure 10,577 13,987 32.2% 40,640 50,137 23.4%
Operating Profit (EBDIT) 2,259 2,483 9.9% 8,528 9,134 7.1%
Operating Profit Margin (%) 17.6% 15.1%   17.3% 15.4%  
Other Income 643 1,266 96.8% 3535 4081.3 15.5%
Interest 1 2 70.0% 9 7 -25.6%
Depreciation 465 460 -1.1% 1799 1853.6 3.0%
Profit before Tax 2,436 3,287 34.9% 10,255 11,355 10.7%
Extraordinary items (194) (156) -19.6% (582) (509) -12.6%
Tax 279 1,084 288.6% 2289 3554 55.3%
Profit after Tax/(Loss) 1,963 2,047 4.3% 7,384 7,292 -1.3%
Net profit margin (%) 15.3% 12.4%   15.0% 12.3%  
No. of Shares (m) 101.2 101   101.2 101.2  
Diluted earnings per share (Rs)* 77.6 81   73.0 72.1  
P/E ratio (x)         15.5  

What is the company's business?
Bajaj Auto Limited (BAL), with a market share of 27% (last year 23%) is the second largest player in the two-wheeler industry. The company's sales mix (in volume terms) consists of 79% (last year 67%) motorcycles, 12% (last year 15%) three-wheelers and the rest 8% (last year 18%) from step-thrus, ungeared scooters and geared scooters. Though BAL has traditionally been a key player in the geared scooter segment, aggressive pricing coupled with a slew of new launches has resulted in increasing 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 for emerging markets.

What has driven the performance in FY05?
Motorcycles leading the way: As can be seen from the table below, in FY05, the motorcycle segment grew at 42% as against the industry growth of 19%. This was mainly due to the launch of 'CT-100' (in May 2004) and 'Discover' (in August 2004). 'Pulsar' continues to register impressive growth. Just to put things in perspective, in 2HFY05, the company registered a 37% growth in volumes over 1HFY05. The overall growth was dampened by 42% fall in its scooter segment YoY. It should be noted that while BAL's has failed to restrict the decline in scooter volumes, competitors like TVS and Honda have increased market share (especially ungeared scooters). Its three-wheeler segment, which can be regarded as a cash cow, also showed a decline of 3% in the current year. The primary reason of the same is the restriction imposed in Bangladesh by the government for issuing new permits for three-wheelers and also the Tsunami that affected South East Asian countries including Sri Lanka.

Volume breakup
4QFY04 4QFY05 Change FY04 FY05 Change
Motorcycles 262,992 396,107 50.6% 1,023,633 1,449,677 41.6%
Scooters-Geared 49,523 20,418 -58.8% 178,666 102,762 -42.5%
Scooters-Ungeared 12,039 4,818 -60.0% 54,709 30,931 -43.5%
Step thrus 8,487 4,391 -48.3% 32,502 19,195 -40.9%
Three wheelers 60,409 53,725 -11.1% 229,154 221,987 -3.1%
Total 393,450 479,459 21.9% 1,518,664 1,824,552 20.1%

Rising input costs: There has been an evident pressure on the margins, as the operating costs have risen at a faster clip than increase in the sales. While the rise in the cost of inputs like steel, rubber and plastics directly affected the profitability, the inability of the company to pass on the rise resulted in margin decline. But lower other expenses and staff cost as a percentage of sales has cushioned margins. For 4QFY05, the 43% increase in other expenses is primarily due to a provision for warranty amounting to Rs 140 m made during the year and also a write back of provision of Rs 110 m made in the 4QFY04 (i.e. the other expenses in 4QFY04 are deflated to that extent).

The tax effect: The tax outgo for the year as well as the last quarter has increased primarily because of the charge (infact a reversal of Deferred tax asset) of Rs 358 m in respect of certain investments, consequent to the changes made by the Budget 2004-05 with respect to taxation of long-term gains post the introduction of Security Transaction Tax. The extraordinary item mainly includes VRS expenditure incurred, as a part of its employee rationalization policy.

Cost Breakup
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Raw materials 8,532 11,229 31.6% 31,992 40,910 27.9%
% of sales 66.5% 68.2%   65.1% 69.0%  
Staff cost 549 599 9.0% 2405 2490.6 3.6%
% of sales 4.3% 3.6%   4.9% 4.2%  
Other expenses 1455 2,079 42.9% 6,242 6,824 9.3%
% of sales 11.3% 12.6%   12.7% 11.5%  

Has the margins bottomed out? Over the last few quarters, the company's operating margins have shown a steady decline from as high as 19% to 15% in FY05. However, if one considers last 4 quarters, margins seem to be stabilizing at the current levels (See chart below). With the steel prices showing signs of cooling off coupled with rationalization of employees, we feel that the pressure on the margins will not be that severe as it had been in the past few quarters. Further, if one compares the margins of the company with the leader in the two-wheeler industry, the same are more or less comparable (See Chart below).

What to expect?
At Rs 1,120, the stock is trading at a price to earnings multiple of 11.7 times our estimated FY06 earnings. Excluding the extraordinary items, the company's performance at the topline and at the bottomline level is in line with our estimates. With the better than industry performance in FY05, we expect the momentum to continue in FY06. Further, the company's thrust on geographical diversification (led by exports) provides an additional cushion against any slowdown in the domestic demand. The company exported more than 100,000 units in the current year accounting for 10% of total volume sales. The company intends to increase this contribution to 20% in the coming years. The company's agreement with Kawasaki, which already has a developed network in overseas market, whereby the former will market the company's product in the foreign markets provides an added impetus. Further, the company has also clarified its intention to launch new scooters in the next year to capture the scooter market. Overall, given the strong cash balance, it is better placed to withstand competition in the domestic and in the international markets. Hence, the stock is our preferred player in the two-wheeler segment with a two to three year perspective.

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