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Bajaj Auto Limited
Attractive valuation, positive guidance; upgrading to Buy
Upgrading to Buy with a target price of Rs1,650
Our upgrade is based on Bajaj's good 3QFY11 results, positive margin guidance
and attractive valuation after its recent underperformance (9% vs. Sensex in 3m).
It trades at 7.5% FY12E FCF yield and a 20% discount to Hero Honda. We believe
Bajaj’s rejuvenated brand franchise should help sustain its market share at current
level of 27% which is close to its trend level. Its stable margin performance over
the last three quarters despite rising input costs is impressive Management has
guided for a stable margin and c. 20% volume growth in FY12E.
Exports should partially offset slower growth in domestic market
We forecast Bajaj’s 2W volumes at 4m/4.7m and 3W volumes at 485K/543K in
FY12E/13E. We forecast 2W exports to grow 21% vs. 12% for domestic sales in
FY12. Honda’s sale of its 26% stake in Hero Honda will increase competitive
intensity in domestic and export markets. However, we believe it also enhances
Bajaj’s relative competitive position over the next 2-3 years.
3QFY11: In-line results, stable margins and encouraging guidance for FY12E
Revenue: Rs42bn (27% YoY, in line), EBITDA: Rs8.5bn (17% YoY, 3% above our
est.), EBITDA margin (20.3%), profit: Rs6.7bn (28% YoY, 6% above our est.).
Management forecast FY12 volumes of around 4.7m and EBITDA margin of
around 20%. Among inputs, management noted concern on plastic and rubber
prices but thought steel, aluminum and copper were manageable.
Two-year EPS CAGR (FY11-13E) of 12%, FY12E FCF yield of 7.5%
Our Rs1,650/share DCF-based target price (RFR 6.4%, ERP 7.2%, CoE 12.6% and
terminal growth rate 4%) implies 16.5x FY12E EPS. Downside risks are loss of
market share and significant appreciation of the rupee. Increased competition from
M&M’s recently launched 110cc bike in the 2W segment is also a risk.
Management commentary suggests continued focus on profitability
Management indicated that it is unlikely to initiate a price war to gain market share. The
company has constantly indicated its desire to preserve EBITDA margins around 20%
We expect Bajaj’s market share to remain stable at current level of c. 27% and forecast its
domestic two-wheeler sales to rise in line with the industry growth of 12%. We expect
exports to grow at 22% p.a. over FY11-13E. Overall, our estimates imply a two-year CAGR
(FY11-13E) of 14.6% for motorcycles and 12% for three wheelers.
Capacity constraints to ease with capacity additions
Bajaj expects to increase its motorcycle capacity from 3.9m at the end of FY10 to 4.5m by
end-FY11E. The expansion will take place at its Pantnagar plant where the production
capacity is being increased from 1.2m motorcycles to 1.8m per year. The capacity at its two
other plants at Chakan and Waluj would remain at 1.2m and 1.5m, respectively. Bajaj’s threewheeler capacity would increase from 420,000 currently to 500,000 by year end. This
compares with our forecasts of 4.8m two-wheeler sales and 556,000 three-wheeler sales in
FY13E.
Our forecasts do not take car project into account
Bajaj is collaborating with Nissan to manufacture a low-cost car along the lines of Tata
Motor’s Nano. Management has indicated that the project is progressing on expected
schedule – product development is complete and testing has commenced. They expect to
launch in CY2012
Financial analysis
Two-year revenue CAGR (FY11-13E) of 15%
We expect overall volumes to grow at a CAGR (FY11-13E) of 14%, comprising 15% p.a.
growth in motorcycles and 12% p.a. in three-wheelers. We forecast 2W exports to grow
22% vs. domestic sales growth at 12%.
EBITDA margins forecast to trend downwards but management guides for stable
outcome
We expect Bajaj’s EBITDA margins to fall to 18.2% in FY13E from 19.2% in FY11E largely on
account of inflation and input prices. However, we note that management has guided for a
stable margin outcome in FY12E. Among inputs, management indicated a potential adverse
impact only from plastics and rubber which we estimate account for c. 15% of material
costs. Overall, we forecast an EBITDA and EPS CAGR (FY11-13E) of 11% and 12.4%,
respectively.
Capex and cash flows
We forecast Bajaj to generate operating cash flows of Rs101bn over FY11-13E as against
capex of Rs4.5bn. In addition, we expect the company to invest c. Rs5.9bn in its Indonesian
subsidiary and to increase its stake in KTM. In April 2010, Bajaj invested Euro20m to increase
its stake in KTM from 31.92% to 35.67%. In November 2010, Bajaj further increased its stake
to 38.09% for an undisclosed sum. Overall, we forecast Bajaj to generate free cash flows
(after and investments) of Rs90.5bn in FY11-13E.
Valuation and risks
DCF – Assumptions and valuation
Our DCF-based target price is Rs1,650/share. We have used a 15-year time frame for our
DCF forecasts, with revenue growth trending down over our forecast period from 15% in
FY13E to 5% by 2026. We expect capex/sales to stabilise around 1% and EBIT margin to
trend down to 16.3% from 17.6% in FY13E. Our assumptions are: a risk-free rate of 6.4%, an
equity risk premium of 7.2%, beta of 0.86 and a terminal growth rate of 4%. Our terminal
growth rate is in line with the expected long-term growth rate of households in India. Our
resultant WACC is 12.6%.
Bajaj has underperformed by c.9% over the past three months. It currently trades at 13x
FY12E EPS and at a FCF yield of 7.5%. It is at a 20% discount to Hero Honda, its closest peer
on FY12E P/E basis. On our target price, Bajaj would trade at 16x FY12E EPS – a 6% premium
to our implied valuation for Hero Honda. Since its re-listing in May 2008, Bajaj’s valuation
discount has ranged from 10% to 50%, varying with the success or failure of its new model
launches.
Risks
Downside risks
Increase in competition in the 100cc motorcycle segment
M&M recently launched a 110cc bike, Stallio, in the executive segment. HMSI’s Twister also
directly competes with Bajaj’s Discover100. These launches by competitors could wean
market share away from Bajaj. The Discover100 is one of Bajaj’s more profitable products
and a loss of volume of this product could affect our revenue and EBITDA estimates.
Increasing competition in three-wheeler segment
TVS, a late entrant in the three-wheeler segment, has been gaining market share at the cost
of Piaggio and other smaller manufacturers. Piaggio is expected to launch a small passenger
three-wheeler in 2011. If the increase in competition leads to a price war, it could have a
negative impact on Bajaj’s margins as three wheelers contribute c. 17% of its revenues and
24% of EBITDA.
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