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Bajaj Auto: On a strong footing - Views on News from Equitymaster

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Bajaj Auto: On a strong footing

May 22, 2006

Performance summary
FY06 has been another eventful year for Bajaj Auto. While net profit has grown by more than 44% YoY during the year, what is important is the fact that the company has outperformed the motorcycle industry sales by almost twice the industry growth rate. The extent of the improvement in operating margin has also come as a surprise.

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 16,470 21,659 31.5% 59,271 76,679 29.4%
Expenditure 13,987 17,409 24.5% 50,137 63,116 25.9%
Operating profit (EBDITA) 2,483 4,250 71.2% 9,134 13,563 48.5%
EBDITA margin (%) 15.1% 19.6%   15.4% 17.7%  
Other income 1,266 1,031 -18.5% 4,081 4,385 7.4%
Interest 3 1 -80.0% 7 3 -49.3%
Depreciation 460 468 1.6% 1,854 1,910 3.0%
Profit before tax 3,285 4,813 46.5% 11,355 16,034 41.2%
Extraordinary income/(expense) - - - - (10) -
Tax 1,084 1,476 36.1% 3,554 4,791 34.8%
Profit after tax/(loss) 2,201 3,337 51.6% 7,800 11,233 44.0%
Net profit margin (%) 13.4% 15.4%   13.2% 14.6%  
No. of shares (m)       101.2 101.2  
Diluted earnings per share (Rs)       77.1 111.0  
Price to earnings ratio (x)         25.3  

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 FY05. It has also entered into an agreement with Kawasaki for export of motorcycles to emerging markets.

What has driven performance in FY06?
Market share gains: Motorcycle sales, for the industry as a whole, grew by 19% YoY during FY06. This was led by increased number of launches in the 'executive' segment. Bajaj Auto strengthened its standing in the 'executive' and the 'premium' segments during the year and it is reflected in the 32% YoY growth in motorcycle volumes. Consequently, the company has further increased its market share from 28% in FY05 to 31% in FY06. Though Hero Honda still dominates the sector with around 50% market share, we expect the gap between the market leaders to narrow in the next two to three years.

Volume break-upů
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Motorcycles 396,107 533,018 34.6% 1,449,667 1,912,224 31.9%
Scooters-Geared 20,418 7,531 -63.1% 102,762 62,860 -38.8%
Scooters-Ungeared 4,818 6,009 24.7% 30,931 52,612 70.1%
Step thrust 4,391 - -100.0% 19,195 870 -95.5%
Three wheelers 53,725 72,638 35.2% 221,987 252,006 13.5%
Total 479,459 619,196 29.1% 1,824,542 2,280,572 25.0%

While geared-scooter sales continued to suffer, ungeared scooter sales increased on account of the re-launch of the existing models. However, further growth in volumes will be influenced by new launches, which is expected towards the second half of the current fiscal. In our view, motorcycle sales are expected to grow by 15% YoY in FY07 and we expect Bajaj Auto to outperform the industry growth rate. Three-wheeler volumes were higher was 14% YoY in FY06, though significantly lower than the growth rate witnessed in FY05. This was on account of the launch of a lower ton LCV (light commercial vehicle) targeted at the goods carrier three-wheeler segment by Tata Motors in May 2006. Incidentally, Tata Motors sold around 30,000 units of 'Ace' (the lower ton LCV) in FY06, which we expect to double in the next year. To that extent, Bajaj Auto's three-wheeler volume sales will be impacted. Also, TVS is expected to launch its three-wheelers this year. Given this background, we expect Bajaj's dominating market share of 80% in the passenger three-wheeler segment to also come under pressure.

Better mix - Better margins: Given the fact that the share of the 'executive' and 'premium' motorcycles is increasing as a percentage of total volumes sold, operating margins expanded in FY06. The fact that exports increased by 27% and the company was able to maintain costs under a tight leash has also helped matters. This is despite raw material as a percentage of sales going up in FY06. We have a positive bias as far as operating margins are concerned in light of the softening of commodity prices in the global markets. For FY06, the company's performance at the operating level was in line with our estimates.

Cost break-upů
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Raw materials 11,105 15,291 37.7% 40,786 53,736 31.8%
% sales 67.4% 70.6%   68.8% 70.1%  
Staff cost 599 682 13.9% 2,491 2,741 10.1%
% sales 3.6% 3.1%   4.2% 3.6%  
Other expenses 2,079 1,930 -7.2% 6,824 7,377 8.1%
% sales 12.6% 8.9%   11.5% 9.6%  
Change in stock 144.3 -429.5   111 -490.1  
% sales 0.9% -2.0%   0.2% -0.6%  

Over the last few quarters: While the topline growth has been impressive in FY06, what is important to understand is the improvement in operating margins. Even as input costs have increased, combined with higher advertisement expenses towards new models, operating margins have been steadily increasing. This, as we mentioned earlier, is a function of better capacity utilization as well as improved product mix.

What to expect?
At Rs 2,808, the stock is trading at a price to earnings multiple of 28 times its FY06 earnings. It is pertinent to note that the market value of the company's investment portfolio (equities and debt) as of March 2006 stood at Rs 75.7 bn or Rs 750 per share. Though there have been talks regarding the spin-off of this investment arm to a separate company, nothing has been concretised as yet. In our view, while we expect the company to improve its market share, there are value unlocking possibilities with respect to its insurance presence in the future. To that extent, we are positive.

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