Volume growth may make up for Bajaj Auto’s margin loss

ET Intelligence Group: Bajaj Auto’s strategy to gain a bigger share of the local motorcycle market at the cost of fatter margins compels investors to make a tough choice: Trust the Bajaj Auto brand and stick with it, or highlight the potential RoE contraction to justify investments elsewhere.

Given the prevailing uncertainty in the broader markets, the first appears a far more attractive option.

To be sure, Bajaj Auto lost about 10 per cent market share locally between FY12 and FY18. Through aggressive intervention in the entry-level bike segment in the last two quarters, the company’s share climbed around 180 basis points in the first half of FY19.

CT 100 and Platina sales increased 37 per cent and 26 per cent, respectively, in the September quarter, compared with the motorcycle industry growth of 12 per cent. So, 75-110 cc bikes constituted 33 per cent of the total volumes, up from 26 per cent at the end of FY18.

But what worries investors are thin margins for CT100 and Platina, explaining the 210-basispoint drop in the September quarter blended operating margins at 16.8 per cent. The Street is currently pencilling in 16.5-17 per cent profitability for FY19.

For Bajaj Auto, export and domestic three-wheeler businesses make up about 70 per cent of revenues —and are high-yielding. Hence, it can leverage these businesses to strengthen its volume presence in the entry-level bike business.

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The company also leads the three-wheeler segment in India. After the government announced plans to expand CNG outlets, Bajaj Auto raised its capacity to 1 million from 0.85 million. Furthermore, the removal of permits in several states promises quick volume growth. Threewheeler operating profit margins are superior to historical blended margins of about 18-20 per cent. In the first half FY19, three-wheeler volumes grew 50 per cent to 2.06 lakh locally.

Bajaj Auto expects to export two million units in FY19, implying 22 per cent growth, as demand is strong in Nigeria, Egypt, Cambodia, Iraq and Ghana. Higher realisation from exports could act as significant tailwinds for operating margins from the next fiscal year — increasing the spread by 200 basis points.

Bajaj Auto is targeting a share of 45 per cent in entry-level bikes, compared with 33 per cent now. There are concerns of a price war. But a closer look at the volume growth in the 75-110 cc segment in the September quarter shows that while Bajaj expanded its share, the market and volumes for Hero MotoCorp and TVS Motors did not shrink.

So, expanding volumes should lower the fixed cost per unit for Bajaj Auto. And, incremental volumes could reduce the negative margins at CT100. Besides, a bigger pie for the Platina should further support blended margins. Bajaj Auto raised prices by 2 per cent in the first half of FY19. Further price revisions will take care of recent commodity cost increases.

Lower margin profile could result in a drop of around 1 per cent in RoE in FY19, although valuations look reasonable after the recent fall. The stock is trading at 16.4 times the next twelve-month earnings, a discount of 11 per cent to the five-year mean of 18.7.


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