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Bajaj Auto: FY07 analysis & demerger

May 17, 2007

Performance summary
Bajaj Auto, India’s second largest manufacturer of two-wheelers has announced its 4QFY07 and FY07 results. Owing to production constraints and cost pressures, the company has suffered a decline of 11% in net profits during the quarter on a YoY basis. There has also been a 550 basis points (5.5%) drop in operating margins. For the full year, however, the performance has been slightly better, as while the topline has grown by 24% YoY, bottomline has grown at a lower rate of 10% YoY. Here again, it is the 280 basis points (2.8%) contraction in operating margins that is responsible for the sedate bottomline show.

(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Units sold 619,196 625,357 1.0% 2,281,096 2,718,795 19.2%
Net sales 21,659 23,136 6.8% 76,679 95,204 24.2%
Expenditure 17,409 19,873 14.2% 63,116 81,034 28.4%
Operating profit (EBDITA) 4,250 3,263 -23.2% 13,563 14,170 4.5%
EBDITA margin (%) 19.6% 14.1%   17.7% 14.9%  
Other income 1,031 1,577 53.0% 4,385 5,556 26.7%
Interest (net) 1 24 3883.3% 3 53 1470.6%
Depreciation 468 458 -2.1% 1,910 1,903 -0.4%
Extraordinary income/(expense) 133 (124)   (10) (498)  
Profit before tax 4,813 4,358 -9.4% 16,034 17,770 10.8%
Tax 1,476 1,151 -22.0% 4,791 4,901 2.3%
Profit after tax/(loss) 3,470 3,083 -11.1% 11,233 12,371 10.1%
Net profit margin (%) 16.0% 13.3%   14.6% 13.0%  
No. of shares (m) 101.2 101.2   101.2 101.2  
Diluted earnings per share (Rs)* 137.2 121.9   111.0 122.3  
Price to earnings ratio (x)**         18.7  
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
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 4QFY07?
Motorcycles led growth: Volumes for the full year have grown by 19% YoY. Although impressive, the number is much lower than the 26% YoY growth the company managed during the first nine months of FY07. The culprit has been the fourth quarter (4QFY07), where growth stood at just 1% YoY and in the process, brought down the full year volume growth for the company. The company faced production constraints in motorcycles during the fourth quarter as a result of which, it was not able to meet the increased demand. However, higher capacities planned in this segment will considerably improve the supply position going forward.

As far as market share in motorcycles is concerned, it improved to 34% on an overall basis (including exports) in FY07, as compared to 31% in FY06. This was the consequence of 24% growth in volumes as against the industry’s 14% and was driven by a strong pull for its lead brand, ‘Pulsar’. Other segments like the ‘Discover’ and the entry level ‘Platina’ also brought in good numbers.

On the three-wheeler front, while domestic volumes fell 15% YoY during the fourth quarter, the company still managed to grow its overall volumes by an impressive 28% YoY for FY07. This was primarily driven by exports, which grew by an impressive 87% YoY during the fiscal. Domestic volume numbers were however poor and managed a modest growth of 2.5% YoY for the year. In this segment, to arrest the decline, the company is pinning its hopes on its new launch based on the latest technology and it has already received a good response during test marketing.

With 76% YoY jump in export volumes, Bajaj Auto continued to be India's top exporter of two wheelers and three wheelers. The year witnessed several landmarks like highest ever 2 wheeler exports of over 298,000 units, highest ever 3 wheeler exports of over 140,000 units and record export turnover of over Rs 1,690 crores clocked during FY07. In Srilanka, Bangladesh and Colombia, Bajaj bikes garnered leadership positions. FY07 also saw business launch in Indonesia and Nigeria.

Sales break-up...
Domestic 4QFY06 4QFY07 % change FY06 FY07 % change
Motorcycles 480,509 458,319 -4.6% 1,747,806 2,078,860 18.9%
Scooter/scooterette 12,148 7,888 -35.1% 106,377 19,370 -81.8%
3 Wheelers 53,136 45,447 -14.5% 176,745 181,133 2.5%
Total 545,793 511,654 -6.3% 2,030,928 2,279,363 12.2%
Motorcycles 52,509 74,545 42.0% 165,288 297,659 80.1%
Scooter/scooterette 1,392 7 n.a. 9,619 1,110 -88.5%
3 Wheelers 19,502 39,151 100.8% 75,261 140,663 86.9%
Total 73,403 113,703 54.9% 250,168 439,432 75.7%
Grand total 619,196 625,357 1.0% 2,281,096 2,718,795 19.2%
Source: SIAM

Higher input costs dent margins: Production constraint was not the only problem Bajaj Auto had to grapple with during 4QFY07. The company also faced enormous margin pressure. With all the commodities that go into making 2 & 3 wheelers getting dearer and company forced to absorb a majority of the same, operating margins during the quarter declined by as much as 590 basis points over corresponding previous quarter. Further, other expenditure as a percentage of sales have also tended to be on the higher side. Significant impact of this has also been felt on the full year results as here, operating margins have taken a hit of 280 basis points.

Cost break-up...
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Raw materials 14,862 16,919 13.8% 53,246 69,010 29.6%
% sales 68.6% 73.1%   69.4% 72.5%  
Staff cost 682 688 1.0% 2,741 3,015 10.0%
% sales 3.1% 3.0%   3.6% 3.2%  
Other expenditure 1,866 2,266 21.4% 7,129 9,009 26.4%
% sales 8.6% 9.8%   9.3% 9.5%  

While operating profits have grown by 5% YoY for the full year, net profit has come in at a higher rate of 10%, thanks mainly to the 27% jump in other income and a benign depreciation charge. Tax outgo has also grown at a lower rate of 2% YoY. All these factors combined have helped to convert the 5% growth in operating profits to slightly higher 10% growth in bottomline for the full year.

Over the last few quarters
As seen from the table below, operating margins, especially during the latter half of FY07 have shown a downward trend and given the fact that commodity prices are showing no signs of cooling off, we expect the pressure to continue. Net profit margins have however been saved from falling drastically owing to healthy growth in other income.

History in quarters...
  4QFY07 3QFY07 2QFY07 1QFY07 4QFY06 3QFY06
Net sales growth (% YoY) 6.8% 28.4% 30.5% 34.8% 31.5% 24.6%
OPM (%) 14.1% 14.2% 15.0% 16.4% 19.6% 17.9%
NPM (%) 13.3% 13.4% 13.0% 12.1% 15.4% 13.9%

What to expect?
At the current price of Rs 2,289, the stock is trading at a price to earnings multiple of 19 times its FY07 earnings. The company’s board has finally approved the long awaited de-merger of the company and following are the details of the same:

The existing Bajaj Auto limited will now be called as Bajaj Holdings and Investment Limited (BHIL) and the auto business will be transferred into a new company called as Bajaj Auto Limited, while the business comprising the generation of wind-energy using wind-farms, the insurance business conducted through its joint ventures Bajaj Allianz Life Insurance Company Ltd and Bajaj Allianz General Insurance Company Ltd, financial products distribution business conducted through Bajaj Allianz Financial Distributors Ltd and interests in retail / consumer finance business conducted by Bajaj Auto Finance Ltd will be transferred into another company called Bajaj Finserv Ltd (BFL). Further, BHIL will continue to hold 30% each in Bajaj Auto and Bajaj Finserv and the existing shareholders shall get 1 share each in the original Bajaj Auto (now BHIL) and the new Bajaj Auto (the auto business) and Bajaj Finserve.

We believe that while there is no change in the ownership, the way the demerger is structured does not leave much scope for value creation as historically holding companies have traded at a significant discount to their fair values. Thus, the 30% stake in Bajaj Auto and Bajaj Finserve, may not get the value they command. Secondly, the options that have been granted to Allianz, its partner in the insurance business also pose the threat of diluting Bajaj’s shareholding in the insurance businesses at a price lower than the fair value. In view of these concerns, we maintain our negative view on the stock.

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