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Bajaj Auto: Margins throw a spanner! - Views on News from Equitymaster

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Bajaj Auto: Margins throw a spanner!
Oct 18, 2006

Performance summary
Bajaj Auto, India’s second largest manufacturer of two-wheelers has reported its second quarter and half-year ended September 2006 results today. The company has witnessed considerable pressure at operating level, thus nullifying the strong volume growth it had witnessed during the quarter. On a robust topline growth of 31% YoY, the net profit of the company has grown by just 10% YoY, thanks largely to a 190 basis points contraction in operating margins. Higher interest outgo and extraordinary expenses have further added to the decline. The performance during the first half was decent, with the bottomline growing at a considerably slower pace of 17% YoY on the back of a strong 33% YoY jump in the topline.

Financial performance: Standalone snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 18,670 24,360 30.5% 35,011 46,386 32.5%
Expenditure 15,513 20,708 33.5% 29,279 39,128 33.6%
Operating profit (EBDITA) 3,156 3,652 15.7% 5,732 7,259 26.6%
EBDITA margin (%) 16.9% 15.0%   16.4% 15.6%  
Other income 1,362 1,424 4.6% 2,290 2,370 3.5%
Interest (net) 1 20 3900.0% 1 27 1850.0%
Depreciation 490 492 0.4% 952 973 2.2%
Profit before tax 4,028 4,565 13.3% 7,068 8,629 22.1%
Extraordinary income/(expense) (15) (139)   (25) (243)  
Tax 1,120 1,250 11.6% 2,070 2,550 23.2%
Profit after tax/(loss) 2,894 3,176 9.8% 4,973 5,836 17.4%
Net profit margin (%) 15.5% 13.0%   14.2% 12.6%  
No. of shares (m) 101.2 101.2   101.2 101.2  
Diluted earnings per share (Rs)* 114.4 125.6   98.3 115.3  
Price to earnings ratio (x)**         24.2  
(* 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 2QFY07?

Sales break-up…
Domestic 2QFY06 2QFY07 % change
Motorcycles 407,322 544,860 33.8%
Scooter/scooterette 39,291 3,683 -90.6%
3 Wheelers 47,026 47,735 1.5%
Total 493,639 596,278 20.8%
Exports      
Motorcycles 38,235 78,202 104.5%
Scooter/scooterette 2,219 697 -68.6%
3 Wheelers 21,459 32,948 53.5%
Total 61,913 111,847 80.7%
Grand total 555,552 708,125 27.5%
Source: SIAM

Motorcycle sales - No surprises here: The 31% YoY growth in topline was powered by a 28% YoY growth in total volumes, where domestic sales constituted 84% of total units sold and managed to grow by 21% YoY. Exports once again recorded a stellar performance, growing at a strong 81% YoY and forming 16% of total sales as against 11% during the same quarter last year.

Motorcycle sales, which accounted for 91% of domestic sales and 70% of exports, continued with their dream run by notching up growth of 34% YoY and 105% YoY in the domestic and exports segments respectively. This is significantly higher than the industry growth rate of 15% YoY and 59% YoY in both the markets under consideration. The highlight of the company’s performance during the quarter was the inroads the company was able to make into the value segment of motorcycles. Its market share in this segment, which accounted for a little over half of all the motorcycles sold in the country in FY06, improved to 21% in 1HFY07 as opposed to 16% a year ago. The company’s ‘Discover’ range of motorcycles in this segment, more popularly known as the ‘Discover Twins’, was instrumental in the company gaining market share. As far as the other segments are concerned, Bajaj continued to dominate both the price (entry level) and the premium segments, with a market share of 43% and 63% respectively. In order to protect its turf in the premium segment, the company has planned upgraded launches of its immensely successful ‘Pulsar’ in the coming quarter.

On the three-wheeler front, Bajaj Auto continued to dominate the segment with a market share of 77%. The cargo segment continued to impress with a growth of 50% YoY during 2QFY07 as against the industry growth rate of 30% YoY.

Motorcycles market share

Input pressures affect margins: Raw material costs as a percentage of sales have increased by 310 basis points (3.1%), and this is the primary reason why the company’s operating margins have contracted by 190 basis points. Had it not been for the savings on the wages and other expenses front, the fall in operating margins would have been even higher. The fall in margins could also be attributed to a shift in its product mix towards price and value segment bikes, where realisations are on the lower side as compared to the premium segment bikes. The intensifying competition also makes it difficult for the company to pass on hikes in raw material costs to the end user.

Cost break-up…
(Rs m) 2QFY06 2QFY07 Change
Raw materials 12,981 17,692 36.3%
% sales 69.5% 72.6%  
Staff cost 652 726 11.3%
% sales 3.5% 3.0%  
Other expenditure 1,879 2,290 21.9%
% sales 10.1% 9.4%  

Higher interest outgo and higher extraordinary expenses have further put pressure on the bottomline and as a consequence, the growth was restricted to a modest 10% YoY with a 250 basis points contraction in net profit margins. If we exclude the extraordinary expenses incurred this quarter, then the net profit growth improves slightly to 14% YoY.

What to expect?
At the current price of Rs 2,895, the stock is trading at a price-to-earnings multiple of 23 times our estimated FY08 EPS. Despite the strong growth potential of the two-wheeler industry in general and motorcycles in particular, we believe the current valuations fully reflect Bajaj Auto’s earnings potential from a medium term perspective. As such, we would advise investors to exercise caution at the current juncture.

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