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Two-wheeler industry: A perspective - Views on News from Equitymaster
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Two-wheeler industry: A perspective
Oct 3, 2005

The month of September 2005 was another good month for major Indian two-wheeler companies, which saw them record another period of scorching volume growth. While Bajaj Auto registered a 33% YoY growth, Hero Honda and TVS Motor registered growth of 22% YoY and 16% YoY respectively. The two-wheeler industry has continued to register a sustained growth during the current fiscal, when the other automobile segments (CVs, passenger cars, tractors) have recorded muted performance. In this article, we take a look at key dynamics of the two-wheeler industry and see how these affect performance of companies. It should be noted that as the two-wheeler companies under Quantum universe (Hero Honda, Bajaj Auto and TVS Motor) account for almost 90% of the industry volumes and 105% of the industry profits, we have considered the financial details of these companies for this article.

Seasonal demand: The performance of the Indian two-wheeler industry is seasonal in nature. To give a perspective, the demand for automobiles significantly increases during the festive season (October to March), which account for around 60% to 65% of the total volume sales during the year. This seasonality is reflected in the quarterly performance of the companies, who generally report higher profits during the said period.

Price elasticity: Another important factor that affects the demand of the two wheelers is the price elasticity. Though it is true that there have been fundamental changes in the Indian economy like increasing youth population, rising disposable incomes and changing demand patterns, the YoY increase in demand witnessed over the last few years has also been aided by almost static prices of two wheelers.

Taxes: It should be noted that Indian automobile industry is amongst the highly taxed industry. If one was to consider the plethora of taxes, the final tax component can be as high as 50% of the cost price. Hence, any change in the tax rates directly affects the performance of the automobile manufacturers.

Capacity utilisation: The automobile industry, being capital intensive, operating margins improve with a increase in capacity utilisation, other things being equal. This is because of an inverse relationship between rising volumes and the fixed cost per unit. FY05 was an aberration due to significant increase in the steel prices during the year.

Steel prices: Raw material cost accounts for around 70% of net sales of the companies. Further, steel accounts for around 60% to 65% of the raw material costs. Hence, any significant changes in the steel prices directly affect the performance of the two-wheeler manufacturers. To give a perspective, during FY05, steel prices increased by around 30% YoY, which directly affected the earnings of these companies, despite improvement on the productivity and efficiency fronts.

Advertisement and publicity cost: Performance of a two-wheeler company depends upon the ability to introduce new model/variants of existing models consistently. Every new introduction requires higher amount of the publicity and promotional costs. It should be noted that the two-wheeler companies are amongst the highest money-spinners for the advertisement industry.

What to expect?
With intensifying domestic competition and supply exceeding demand situation, we expect the Indian two-wheeler companies to continue to face pressure on the pricing front going forward. Also, the capacity expansion plans that the companies have lined up for the future, might put additional pressure on margins. Having said that, softening steel prices can provide cushion to the margins. To give a perspective, a 10% fall in steel prices can result in 0.5% improvement in the operating margins of two-wheeler companies. As far as advertisement costs are concerned, we expect them to continue to increase in absolute terms with the shortening of the product life cycle.

All in all, we expect the Indian two-wheeler industry to grow at a compounded rate of 13% per annum. While growth will be volume-driven, margins will be under pressure on account of the factors mentioned above.

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