Bajaj Auto sales had a strong run, outperforming the market leader, Hero Motocorp, by 42% and the Sensex by 23% over the past six months. The stock is currently trading at 15.5x our FY14f EPS of R134.7, which is above its the past three-year average of around 15x.
We note that historically, valuation multiples for most auto original equipment manufacturers (OEMs) have been quite sticky and trade in a narrow brand of 14-16x. Even in years when earnings growth is more than 50%, multiples have not expanded significantly.
We continue to value Bajaj Auto based on 15x one-year forward EPS to arrive at our revised target price (from R2,051 earlier), as we roll forward to December 2013 from September 2013 and increase our FY14-15f earrings estimates by 2-4%.
The company has been developing aspirational products and now has a stronger product portfolio than Hero Motocorp, in our view. This, we believe, has helped the company gain share in the domestic market and take price increases in export markets to offset lower export incentives.
We still believe that its volume growth should continue to beat Hero Motocorp over the next few months. However, at 15.5x FY14f EPS, we believe this is largely priced-in. Thus, we downgrade the stock to neutral.
In our view, lower-than expected export growth and a sharper slowdown in domestic industry volumes pose downside risks to our estimates. We expect domestic volume growth to remain weak over the next two years.
In addition, increased competition from Honda could lead to downward pressure on margins. Honda is expanding its two-wheeler capacity in India from 2.8 million units to around 4 million units in FY14f.
We believe higher competition could lead to margin pressures, especially for low-end bikes. Even though we expect Bajaj Auto would be less affected by competition given its more diversified portfolio, there could be downside risks to our estimates in such a scenario. A 100 basis points-margin decline would shave ~5% off our earnings estimates.