Trailing behind

Updated: Mar 17 2014, 09:43am hrs
WE ARE downgrading Hero (target price R1,730), Bajaj (TP R1,670) and TVS (TP R70) to Sell. Our ratings reflect the concern that Hondas sustained market share gains will impact the margins of the Indian two-wheeler companies. Honda has gained 890 bps (basis points) market share over the last 24 months, aided by an aggressive launch pipeline and stronger demand for scooters. Hero, Bajaj and TVS have been unsuccessfully trying to staunch their market share losses through more frequent product launches as well as higher brand spends. We believe such competitive activity will continue, resulting in lower margins due to loss of pricing power and higher selling costs.

Hero: Our negative stance on Hero stems from our concerns about market share losses, a deterioration in pricing power and higher marketing costs. We also highlight the market risk for Hero, as it will now be developing products on its own. We also believe that the cost reduction efforts of the management will not yield significant gains and these will be competed away in the market. Investors are positive on Hero on FY15e as the fixed royalty payable to Honda would end by then, leading to a one-time gain. However, we believe that profit growth from FY16e would taper to lower levels.

Bajaj: We downgrade Bajaj to Sell as we believe that current valuations (15.5xFY15e EPS) do not factor in the sustained market share losses in the domestic market as well as the uncertainties emanating in its exports. Bajajs margins have remained higher than peers, due to richer product mix and currency benefits on its exports. However, we expect Hondas aggression to hurt Bajajs margins going forward. While exports (40% of revenues) have provided a cushion, we highlight that near-term growth may remain below trend level. We understand that demand in Bajajs major export destinations (Africa, South Asia, Latin America) continue to be affected by changes in regulations and an increase in import barriers.

TVS: TVS is also likely to be affected by the increase in competitive intensity which would constrain its margin expansion efforts. The pressure could be offset to an extent by its recent product launches and a revival in its higher margin three-wheeler business. However, TVSs current valuations at 15.7xFY15e EPS (adjusting for Indonesian business) are at a premium to Hero and Bajaj. We believe this is unsustainable as the profitability gap with peers continues to be significantly high.

Our revised forecasts and Tps are below consensus: Our target prices for Hero and Bajaj are 20% below consensus and imply valuations at 13.5x FY15e EPS (lower than the long-term average). TVSs current valuation is at a premium to Hero and Bajaj, which is untenable. On Hero, consensus is building in margin expansion to factor in the companys cost reduction efforts. However, we do not see material headroom in Heros current cost structure and believe that a large portion of the savings will be competed away. Bajajs margins have been cushioned by the currency benefit on exports which should taper in the next few quarters. In the medium term, margins for Hero and Bajaj will reflect the impact of competition and this will act as a key catalyst for underperformance.

High competition during FY04-07 significantly impacted margins: 2W (two-wheeler) margins contracted by 250-500bps during FY04-07 as Hero and Bajaj were competing aggressively to gain leadership in motorcycles. Currently, we have seven players who continue to compete for market share. Moreover, Honda is competing with all companies in their respective niches.

We forecast 2W industry volumes to grow at a CAGR (FY14-16e) of 11%: We expect the growth to be driven by scooters (19% per annum) even as motorcycles continue to lag (8% p.a.). Hondas dominance of the scooter segment and its gains in motorcycles should result in market share increasing from 23.7% in FY14e to 26.8% in FY16e. Hero and Bajaj would lose share by 100-170 bps.

Honda driving market share through models and distribution: Over the last two years, Honda has introduced motorcycle models in segments in which it wasnt present. It has nearly doubled its distribution from 1,500 outlets in FY12 to a projected 2,500 by end-FY14. This has been supported by an increase in capacity from 2.2m (FY12) to 4.6m currently, and this will further expand to 5.8m by FY16. As a result, Hondas volume growth of 32% p.a. over FY12-14e has significantly surpassed industry growth of 5% p.a. Hero/Bajaj/TVS have grown at 0%/-10%/-4% during the same period.