Motilal Oswal is neutral on Bajaj Auto

Valuations factor in strong momentum
Limited probability of positive surprises; Peak margins, valuations
 Volume outlook positive, in line with estimates: Bajaj Auto's volume growth
outlook is positive with momentum in motorcycles and three wheelers continuing.
The management's FY11 volume guidance is positive, and in line with our estimate
of 3.94m units in FY11 and 4.43m units in FY12 (12.4% growth). Our FY12
estimates factor in 13.3% growth in two-wheeler volumes to 3.96m units and 6%
growth in three-wheelers to 469,800 units. Given normalization of the base, as
volumes recovered from September 2009, Bajaj's volume growth rate will slow
from 56% in 1HFY11 to 24% in 2HFY11, and is estimated at 12.4% in FY12.
 Margins peaked in 4QFY10, cost push pressurize margins: With limited levers
to improve margins, we believe margins peaked in 4QFY10 at 23% and will trend
downwards going forward. With an increase in rubber based component prices,
we believe 2QFY11 margins could be lower than our estimate of 21.2% and taper
off to 20% in 2HFY11 as metal prices have started strengthening. Besides, Bajaj
Auto expects spends on advertising and marketing will increase from 2QFY11.
 Competition stiffens with entry of M&M and Honda's probable exit from
Hero Honda: Honda's probable exit from Hero Honda will increase Honda's focus
and aggression regarding product launches and pricing. Besides, M&M's entry
into the motorcycle segment, with its brand and distribution strength, can add to
competitive pressure. This coupled with existing players sharpening focus on the
100cc segment will boost competition.
 Earnings upgrade cycle ending, limited levers to expand margins: Bajaj
Auto's stock performance over the past 12-15 months was driven by an earnings
upgrade cycle by the street. Earnings for FY12 has been upgraded multiple times
since April 2009, with the FY12 consensus EPS being upgraded from Rs34.9 to
Rs87.6 in September 2010. Our FY12 EPS estimate is Rs98.6, ~12.5% above
consensus estimates, is based on a 12.4% volume growth (scope for positive
surprise) and EBITDA margin decline of just 70bp to 19.8% (limited levers to surprise,
with potential of negative surprise).
 Peak margins, valuations: We downgraded Bajaj Auto to Neutral in our India
Strategy report, September 2010. It has been the best performing auto stock
with 64% outperformance since January 2010, driven by strong volume and margin
momentum. But with volume growth normalizing and there being limited levers to
boost margins, we believe peak margins are behind us. Consequently there is
little scope for the stock's re-rating and it should perform in line with markets. The
stock trades at 17.2x FY11E EPS of Rs90.3 and 15.7x FY12E EPS of Rs98.6.
Maintain Neutral with a target price of Rs1,480 (~15x FY12E EPS).