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India: Automobiles
Equity Research
Deconstructing the 2-wheeler value creation engine; Buy Bajaj Auto
40%+ cash returns for 10 years: hidden risks or opportunities?
Indian 2-wheeler market leaders Hero Moto and Bajaj Auto have generated
on average over 40% cash returns on capital invested for over 10 years,
placing them among the most profitable companies globally. We believe
this naturally raises questions about the sustainability of such high returns.
Deconstructing high returns reveals three main drivers
Our analysis reveals three main drivers of their returns on capital: 1) Less
global competition – only two significant Japanese competitors in the
mass-market motorcycle segment globally (vs. 12 in cars). We estimate this
alone drives 10-20 pt of incremental cash returns. 2) Fragmented vendor
and distributor base – leading to a favorable negative working capital
position, driving another 10-18 pt of higher returns. 3) Lower R&D
investments – at 0.5%-2% of revenue vs 3%-7% spent on average by global
automakers, driving up to 5 pt of higher returns on capital.
Stocks look undervalued under a stressed normalization scenario
We stress test our valuations for Bajaj Auto and Hero Moto by assuming
some drivers normalize and converge with global auto peers in FY2013E:
1) Reversal in working capital, if vendor/distributors consolidate over time.
2) Higher R&D costs if consumers demand higher technology motorcycles.
Even in a stressed scenario, these stocks generate top quartile +25%
CROCI, and imply 13-45% upside on Director’s Cut vs GS India coverage.
Market structure drives top quartile returns; Buy Bajaj (CL), Hero
1) Less competitive market, with changing consumer aspirations. Twowheeler
market size is relatively unattractive for most global automakers,
in our view. As consumers shift to higher technology motorcycles in the
long run, we believe market participants who can offer relevant technology
and brand will emerge as winners, namely Honda, Bajaj and Yamaha.
2) Sustainable demand growth. Low penetration in Asian, N-11 markets,
where we find Honda, Bajaj, Hero and Yamaha have first-mover advantage.
We reiterate Buy on Bajaj Auto and have added it to our Conviction List,
and also upgrade Hero Moto to Buy (see Buy, Buy, Sell: Bottom-up choices
amid rally; Buy Bajaj, Sell Maruti, dated February 15, 2012).
Key risks: rapid emergence of electric bike technology; change in tax
structure; increasing success of Japanese competitors.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India: Automobiles
Equity Research
Deconstructing the 2-wheeler value creation engine; Buy Bajaj Auto
40%+ cash returns for 10 years: hidden risks or opportunities?
Indian 2-wheeler market leaders Hero Moto and Bajaj Auto have generated
on average over 40% cash returns on capital invested for over 10 years,
placing them among the most profitable companies globally. We believe
this naturally raises questions about the sustainability of such high returns.
Deconstructing high returns reveals three main drivers
Our analysis reveals three main drivers of their returns on capital: 1) Less
global competition – only two significant Japanese competitors in the
mass-market motorcycle segment globally (vs. 12 in cars). We estimate this
alone drives 10-20 pt of incremental cash returns. 2) Fragmented vendor
and distributor base – leading to a favorable negative working capital
position, driving another 10-18 pt of higher returns. 3) Lower R&D
investments – at 0.5%-2% of revenue vs 3%-7% spent on average by global
automakers, driving up to 5 pt of higher returns on capital.
Stocks look undervalued under a stressed normalization scenario
We stress test our valuations for Bajaj Auto and Hero Moto by assuming
some drivers normalize and converge with global auto peers in FY2013E:
1) Reversal in working capital, if vendor/distributors consolidate over time.
2) Higher R&D costs if consumers demand higher technology motorcycles.
Even in a stressed scenario, these stocks generate top quartile +25%
CROCI, and imply 13-45% upside on Director’s Cut vs GS India coverage.
Market structure drives top quartile returns; Buy Bajaj (CL), Hero
1) Less competitive market, with changing consumer aspirations. Twowheeler
market size is relatively unattractive for most global automakers,
in our view. As consumers shift to higher technology motorcycles in the
long run, we believe market participants who can offer relevant technology
and brand will emerge as winners, namely Honda, Bajaj and Yamaha.
2) Sustainable demand growth. Low penetration in Asian, N-11 markets,
where we find Honda, Bajaj, Hero and Yamaha have first-mover advantage.
We reiterate Buy on Bajaj Auto and have added it to our Conviction List,
and also upgrade Hero Moto to Buy (see Buy, Buy, Sell: Bottom-up choices
amid rally; Buy Bajaj, Sell Maruti, dated February 15, 2012).
Key risks: rapid emergence of electric bike technology; change in tax
structure; increasing success of Japanese competitors.
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