Automobiles: Changing the pecking order after the recent run-up in share prices ::Kotak Sec,

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Automobiles
India
Changing the pecking order after the recent run-up in share prices. We change
our pecking order in the sector after the sharp run-up in share prices. We downgrade
Hero Honda, Bajaj Auto and M&M due to expensive valuations and upgrade Tata
Motors to ADD (from REDUCE) as we expect new Evoque to aid volume growth for JLR.
We change our pecking order to – (1) Maruti Suzuki, (2) Tata Motors and (3) Mahindra
and Mahindra. Hero Honda remains our top SELL idea in the sector.


Downgrade two-wheelers to SELL due to expensive valuations
We downgrade Hero Honda and Bajaj Auto to SELL (from REDUCE and ADD earlier) as both stocks
trade at expensive valuations. Bajaj Auto trades at 14X PE multiple while Hero Honda trades at
15.5X PE multiple on our FY2013E EPS estimate, which adequately factors in the strong volume
growth of 13-15% over the next two years. We see limited scope for two-wheeler companies to
report higher than 13-15% growth in volumes over the next two years and believe operating
margins could be at risk due to a shift towards lower margin bikes and rising competitive intensity
in the sector as players shift towards volume segment to gain market share.
We believe Honda Motorcycles and Yamaha will aggressively target both premium and executive
motorcycle segments as their capacities increase. We believe Bajaj Auto and Hero Honda are likely
to lose market share in the premium motorcycle segment over the next two years while we expect
Bajaj Auto to gain 50 bps market share in the domestic executive motorcycle in FY2012E after the
launch of new Boxer in 2QFY12E. Bajaj Auto has lost 140 bps market share in the domestic
motorcycle industry between April and July 2011, but we expect it to regain its lost market share
with the launch on new Boxer in 2QFY12E and new Pulsar in 4QFY12E.
We have increased our earnings estimates by 3-4% for Bajaj Auto over FY2012-13E factoring in
revival in market share in 2HFY12E driven by new launches (Boxer 150cc and new Pulsar).
Downgrade M&M to ADD (from BUY) and upgrade Tata Motors to ADD (from REDUCE)
We downgrade M&M to ADD (from BUY) after a sharp rally while we upgrade Tata Motors to ADD
(from REDUCE) as we believe new Evoque will aid volume growth in JLR in 2HFY12E. We have kept
our earnings estimates unchanged for M&M but added the value of Ssangyong Motors at
Rs34/share (based on the investment of US$463 mn made by M&M in the firm).
We have reduced consolidated earnings estimates of Tata Motors by 3-5% over FY2012-13E as we
cut our EBITDA margin estimates of JLR by 40 bps over the next two years as we factor in higherthan-
expected increase in incentives and further deterioration of product mix towards lower priced
models (small Jaguar XF and Land Rover Evoque).
We believe Tata Motors is attractively valued at 4.9X EV/EBITDA on our FY2013E estimates (after
factoring in R&D capitalization of GBP450 mn in our reported EBITDA) and we expect excessive
pessimism on volume growth at JLR is not warranted as JLR realigns its product portfolio to lower
end higher volume models. While we expect EBITDA margins to decline by 130 bps from 1QFY12
levels, we think the key trigger to the stock price would be recovery in volume growth in JLR.