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Auto: Two-wheelers or four-wheelers? - Views on News from Equitymaster
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  • Sep 29, 2004

    Auto: Two-wheelers or four-wheelers?

    With per capita income in the country growing at a fair clip, growth prospects of the Indian auto industry appear to be quite encouraging. Therefore its an opportune time for an investor to stay invested in an auto company for the longer term and benefit by way of attractive returns. But what would be bewildering from his point of view would be the fact that if given a choice, where would he like to put his money: A two-wheeler stock or a four-wheeler stock?

    In this article, we have made an attempt to compare the past track record of two-wheeler companies vis-ŕ-vis their four-wheeler counterparts. We will consider aggregate numbers of three leading two-wheeler manufacturers (TVS, Bajaj Auto and Hero Honda) and three-leading four-wheeler manufacturers (Tata Motors, Maruti and M&M) over the past five years and see as to how do they compare on some of the key financial parameters.

    As far as the growth in topline is concerned, after growing by an impressive 25% during FY02, there has been a consistent de-growth in the aggregated topline of two-wheeler companies. Since a large part of the two-wheeler demand comes from rural areas, unfavorable monsoons during FY03 impacted industry sales. Moreover, with entry-level motorcycles increasingly gaining acceptance, realisations of companies have also come under pressure as the shift in product-mix has resulted into the topline growing at a lower rate in FY03 and FY04.

    On account of being more price and income elastic as compared to their two-wheeler counterparts, growth in topline of the four-wheeler companies has moved in tandem with the overall macro environment in the country. This explains the negative growth in FY01 and flattish growth in FY03, as GDP growth in these two years was rather low. However, fiscal incentives by way of excise duty cuts and an impressive performance by the economy in FY04 enabled the topline to grow by an impressive 37% YoY during the year.

    The charts above indicate profit margins of the two different segments over the last five years. As far as the operating margins are concerned, while they have flattened for two-wheeler companies in the last couple of years, four-wheeler companies have witnessed a steady rise in operating margins. This could be attributed to improved capacity utilisation as higher volumes leads to one’s fixed cost being spread over a wider base. Since four-wheeler companies are more fixed- assets intensive, the gain in margins is more pronounced in case of these companies. On the other hand, two-wheeler companies have also suffered from price erosions as increasing competition has led to fall in realisations thus affecting the margins.

    Net profit margins have also shown a trend similar to that observed in case of operating margins. Here also, high financial leverage and falling interest costs has meant that four-wheeler companies were able to reap more benefits than their two-wheeler counterparts during the past few years. On account of their being almost zero debt companies, two-wheeler companies were not able to benefit from low interest regime as reflected from their almost flattish net profit margins over the last couple of years.

    On the returns to shareholders front, while two-wheeler companies have been more consistent in rewarding their shareholders, shareholder rewards in case of four-wheeler companies have shown marked increase during the same period. We believe that with growth in operating and net profit margins having been peaked, further rise in RONW in case of four wheeler companies would be possible only through rise in topline. Further, with most of the four-wheeler companies having resorted to FCCBs, any adverse economic scnerio is likely to dilute RONW going forward.

    One thing that clearly stands out from the above comparison is the fact that four-wheeler companies are more prone to economic cycle than their two-wheeler counterparts. However, we would like to point out that certain structural changes in the economy has led to increase in the disposable income of the Indian consuming class and this might put the growth in car demand on a higher trajectory. Thus a CAGR of 10%-11% over the long-term cannot be ruled out. On the other hand, two-wheeler companies would continue to show a stable long-term growth in the region of 10%-12%, with motorcycles outgrowing the industry by a couple of percentage points. Apart from similarity in growth, another factor that binds the two together is rising competition. This is likely to exert margin pressure and affect the bottomline of companies.

    In these trying conditions, the company (be it a two-wheeler or four-wheeler), which is able to sweat its assets more and hence generate more cash from its operations would be able to weather the storm better. Higher amount of cash will ensure that the company’s balance sheet is strong enough to fund new models, a key to survival in a competitive environment. Therefore keep an eye on the cash that the company generates internally and base your investment decisions accordingly.



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