Royal Enfield making market inroads on broadening appeal
We take a look at two-wheeler (2W) stocks through a new six-filter framework. We prefer 2W makers with: (i) niche premium positioning; (ii) lower exposure to the scooter market, which dilutes margins; (iii) strong exports; (iv) higher quality of earnings growth; and (v) strong cash flow. Valuation is our sixth filter. Eicher comes out ahead of Bajaj; they are followed by TVS and Hero MotoCorp (HMCL).
Niche premium preferred over mass market: We foresee limited growth in market leader HMCL, as the mass motorcycle market (60% of 2W industry) is unlikely to grow by more than a mid- to high-single digit annually in coming years. On top of this, competition from TVS and Honda may intensify, resulting in a lose-lose situation for those competing in the low growth mass segment.
By contrast, we expect Eicher’s Royal Enfield brand to continue performing robustly in the premium segment, led by a growing addressable market, improving product quality and widening distribution reach.
Higher exposure to scooters is margin dilutive: With low barriers to entry, the scooter market in India has been largely commoditised and has already reached a high level of urban penetration. As a result, growth at HMCL, whose new models are scooters, is likely to be margin dilutive due to its lack of scale in this product area versus motorcycles.
Higher exports exposure enhances earnings resilience: Bajaj scores high here. Not only has near-term visibility of exports improved for Bajaj, but INR depreciation provides a significant margin tailwind of 150 basis point in FY16e.
TVS has credible export potential as well. We prefer stocks for which earnings are driven by volume growth rather than margin expansion; Eicher and Bajaj score high on this parameter as well. We initiate coverage on Eicher with a
Buy and take it our preferred 2W play, followed by Bajaj. But is a Hold on valuation grounds.
We initiate coverage on TVS with a Hold and reiterate our Hold rating on HMCL. Our FY16e EPS estimates are between 5% below and 4% above consensus.
Investment summary: We are initiating coverage on two companies—Eicher Motors and TVS Motor—which operate in two different parts of the 2W market. Eicher makes the Royal Enfield, originally manufactured in England in 1901 and considered the oldest motorcycle brand in continuous production. Royal Enfield has 18% market share in the premium segment in India; this rises to 95% in the luxury cruiser segment (above 250cc). Both the motorcycle and the stock are strong performers: sales are up 70% y-o-y and the stock has risen 150% in the last 12 months.
TVS makes a much broader range of products, including mopeds, scooters and motorcycles. Last year it launched a scooter, the Jupiter, which has been a great success, selling 30,000 a month. It hopes that its new Victor model – aimed at the mass motorcycle market and set to hit the road later this year – will be a similar success.
Flagship brand Royal Enfield already sell more than 35,000 units a month. This makes it the eighth highest selling motorcycle in India and its target market is growing all the time as its appeal broadens. Forbes says Royal Enfield was the world’s best-selling motorcycle in the cruiser segment in 2014 with sales of just over 300,000 units, ahead of
Harley-Davidson’s 267,999 units. Eicher plans to increase capacity from 30,000 units a month to 40,000 units by the end of 2015 and 50,000 units in 2016.
The company sells nearly 60% of its motorcycles in the top 20 cities in India. Royal Enfield has 400 dealerships and is adding 6-8 every month. We expect the company to have nearly 500 dealerships by the end of 2015. Its sales per dealer have nearly doubled in the past four years.
Ebitda margins for Royal Enfield have improved from 12% in FY11 to 26% in Q1FY16. This is extraordinary, considering prices have increased only 3-4% annually in the last three years. Most of the margin expansion has been driven by operating leverage and lower variable costs, resulting from improved negotiating power with suppliers.
However, we believe Eicher is much more than a one-bike story. It is also a heavy vehicle and bus maker through a joint venture with Volvo Group. Volvo Eicher Commercial Vehicles (VECV) designs, manufactures and markets commercial vehicles. VECV has an 11% share of the medium and heavy commercial vehicle market segment. Its new Pro Series of trucks launched in December 2014 and the company plans a pan-India rollout by the end of 2015.
Eicher’s third key business is the medium-duty engine platform (MDEP), which manufactures Euro-5 and Euro-6 compliant engines for Volvo’s global use. Commercial production of these new engines started in July 2013. The annual capacity is 25,000 units, which should rise to 30,000 units by end-FY16e.
Valuation: The stock is trading at 33x FY17e consolidated earnings, significantly higher than its peers. The company has reported a 35% EPS CAGR (compound annual growth rate in earnings per share) in the past four years and we think this will increase to 50% over the next three years. We arrive at a DCF(discounted cash flow)-based fair value target price of R23,500, which implies 14% upside from the current share price.
The company’s product portfolio covers mopeds, scooters and motorcycles. 2Ws account for 95% volumes and 90% revenues, and TVS has a market share of 13% in the domestic 2W industry. TVS moved into the 3W market in FY08.
In FY14, 3W annual sales volumes were 108,000 units (4% of total volumes and 10% of revenues). The company has four plants, in Hosur, Mysore and Nalagarh and one in Indonesia (Karawang). It has annual 2W capacity of 3m units and 3W capacity of 120,000 units; it has a network of 870 dealers. TVS and BMW Motorrad signed an agreement in 2013 to produce high-end motorcycles and the first new motorcycle is expected to be launched in this financial year.
TVS Jupiter is selling 30,000 untis a month, with its popularity having a knock-on effect; sales of the Apache picked up after the Jupiter launch. However, we are cautious and initiate coverage with a Hold rating on the stock.
The market has been positive on TVS for two reasons: (i) its new Victor model, which is aimed at the mass motorcycle market; and (ii) stronger margins—consensus expects the nearly 50% EPS CAGR to come from margin expansion over the next three years. We think the mass market is unlikely to grow strongly, and it is difficult to see TVS gaining market share here.
We forecast volume growth of 13.5% in FY16e and 14.1% in FY17e. We expect margins to rise to 7% and 8.5% in FY16e and FY17e. The stock is trading at 17xFY17e EPS. If we factor in losses in subsidiaries (e.g., in Indonesia) then the PE is 19x FY17e EPS, which is expensive compared to Bajaj and HMCL.
Valuation: We value the stock on a DCF-based methodology with a fair value target price of R260, which implies upside from the current share price of 1%.