Bajaj Auto: A RISKY RIDE, MAY BE

After demonetisation, the BS IV norms have been adversely impacting Indian automobile industry. The sales of the auto sector got affected due to demonetisation move by the government to curb the black money menace. The cash transactions from sale of two-wheelers also slowed down in H2FY17. We feel valuations of the auto sector would remain under pressure till some signs of demand normalisation are visible. Here we are analysing Bajaj Auto (BAL) to decode the implications of these factors for the company and the course of action investors should take for their equity holdings in the company. 

ABOUT INDUSTRY 

The Indian auto industry is one of the largest in the world. The industry accounts for 7.1 per cent of the country's gross domestic product (GDP). The two-wheeler segment with 81 per cent market share is the leader of the Indian automobile market owing to a growing middle class and a young population. Moreover, the growing interest of the companies in exploring the rural markets further aided the growth of the sector. The overall passenger vehicle (PV) segment has 13 per cent market share.

India is also a prominent auto exporter and has strong export growth expectations for the near future. Several initiatives by the Government of India and major automobile players in the Indian market are expected to make India a leader in the 2W and Four- Wheeler (4W) market in the world by 2020.

The sales of PVs, CVs and 2Ws grew 9.17 per cent, 3.03 per cent and 8.29 per cent, respectively, in H1FY17 in the period April-January 2017.
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ABOUT BAJAJ AUTO 

BAL has three plants, two at Waluj and Chakan in Maharashtra and one plant at Pant Nagar in Uttaranchal. It has a distribution network in 50 countries with a dominant presence in Sri Lanka, Colombia, Bangladesh, Mexico, Central America, Peru and Egypt.

The company is engaged in the manufacture of motorcycles, scooters and three-wheelers. In India, Bajaj Auto has a distribution network of 485 dealers and over 1600 authorised services centres. It has 171 exclusive dealers for the three-wheeler segment. It has a total of 3750 outlets in rural areas.

BAL's business segments include automotive, investments and others. The company's vehicles include two-wheelers and commercial vehicles. Its tw o-wheelers include Bajaj V, Bajaj V Avenger, Avenger Cruise 220, Pulsar RS 200, Pulsar FOS, Pulsar 200 NS, Pulsar 220, Pulsar 180, Pulsar 150, Pulsar 135 LS Discover, New Discover 125, New Discover 150S, New Discover 150F, Platina 100, Platina 100 ES, CT 100, CT 100 Ninja, Ninja 650R and Ninja 300. Its products also include CT 100B, Boxer BM150X, Avenger 220 Cruise, Avenger 220 Street, Avenger 150 Street, Pulsar AS 150 and Maxima- Cargo. The company also offers troubleshooting services.

LATEST TRENDS 

Post demonetisation, the company expects the domestic motorcycle industry to end FY17 on a flat to marginally negative growth. Hence, the company's management expects Q4FY17 to be sluggish for the domestic motorcycle industry. It also feels that its export business is not expected to recover in the next three to six months, given the geopolitical uncertainty and devalued currency in major exporting markets.

BAL has hiked prices of motorcycles by Rs.600 to Rs.1200 to reflect higher input cost (steel) and migration to BS IV. The company also expect an average hike of Rs.300 to Rs.400 by other industry players to reflect higher raw material prices.

DEMONETISATION EFFECT

BAL's strategy to squeeze competitors premium segment, expanding the economy segment and scaling its presence in the executive segment had worked for the company in FY17.

Post demonetisation, in Q3FY17, BAL's domestic volumes declined 4 per cent, as against the industry decline of 7 per cent.

Although BAL has performed well this fiscal in terms of volume growth, going ahead, growth momentum in the domestic motorcycle industry has been disrupted. It will take a quarter or two for growth to recover. The industry will migrate to BS IV norms. At the same time, price competition will increase for BAL as all models have already migrated to BSIV from FY18.

BS-IV NORMS: INVENTORY PILE-UP

In a major setback to the Indian automotive industry, the Supreme Court (SC) has banned the sale of Bharat Stage III (BS-III) vehicles after March 31, 2017. The automobile industry has an unsold BS-III vehicles stock of 8.24 lakh units.

The SC stated that public health is more important than inventories and the sale and registration of BS-III vehicles will not be permitted from April 1, 2017.

On the verge of nationwide implementation of BS-IV emission norms, BAL has an inventory of about 80,000 BS-III vehicles, valued at Rs.500 crore.

As per the company's management, it will export unsold inventory of BS-III vehicles to countries where these norms are accepted. But this will take some time and slightly impact on the company's financials in future.

PAIN IN EXPORTS 

BAL's export volumes continue to be under pressure mainly due to lower availability of dollar, a local depreciating currency in its largest exporting countries and latest geopolitical events affecting its exporting destination countries. Meanwhile, new geographies will be unable to offset the export decline to Nigeria.

INTEREST RATE CYCLE The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has kept the interest rates steady over the last three monetary policy reviews. The central bank is examining the impact of demonetisation on the country's economy and has kept repo rate on status quo stance. However, it has increased reverse repo rate by 25 basis points to 6 per cent. The steady rate may reduce demand for automobile sector in future.

FINANCIALS

BAL's topline has grown 2.97 per cent CAGR over the last five-year period (FY12-FY16). The company's operating profit also rose 5.2 per cent CAGR in the last five fiscals ending with FY16. Its bottomline also increased 4.42 per cent during FY12-FY16.

BAL's revenue increased 4.97 per cent to Rs.22,688 crore in FY16 on a yearly basis. The company's operating profit increased 15.23 per cent to Rs.4,731 crore in FY16, as compared to the previous financial year. The company's net profit too rose 25.06 per cent to Rs.3,784 crore in FY16 on a yearly basis.

On the financial front, BAL's revenue declined 2.08 per cent to Rs.13,355 crore in 9MFY17 as compared to the same period in the previous financial year. The company's EBIDTA too reduced 3.13 per cent to Rs.3515 crore in 9MFY17 on a yearly basis. Its EBITDA margin contracted by 23 basis points to 20.83 per cent in 9MFY17, as compared to the same period in the previous financial year. However, BAL's net profit increased 4.96 per cent to Rs.3,217 crore in 9MFY17 on a yearly basis.

On the segmental revenue front, BAL has earned 97.68 per cent from automotive segment and remaining 2.32 per cent from investments in FY16. On the geographical front, BAL has earned 58.4 per cent from India and remaining 41.6 per cent from rest of the world in FY16.

FORECAST FOR Q4FY17 

BAL's domestic volumes continued to be impacted by demonetisation after-effects and witnessed decline of 8 per cent YoY, with domestic 2W and 3W segments declining 5 per cent and 24 per cent YoY, respectively.

We at DSIJ, expect margins to decline due to weak product mix and increasing commodity costs. Another drag on margins would be the costs on end-ofthe- quarter clearance of BS-III inventory. However, we expect topline and bottomline also witness almost 3 per cent decline each.

VALUATIONS

On the valuation front, the share price of BAL is trading at trailing twelve months (TTM) PE of 19.38x as against its peers such as Eicher Motors (45.12x), Hero Motocorp (20.81x) and TVS Motor Company (60.31x). At the same time, the industry PE is trading at 26.77x. The company has given ROE and ROCE of 29.51 per cent and 43.38 per cent in FY16. The competitor Hero Motocorp's ROE and ROCE is better than BAL as it has given 42.1 per cent and 58.34 per cent in FY16, respectively.

CONCLUSION 

We had recommended BAL in issue no. 19 dated August 25-September 4, 2016 under ‘Analysis' section when the scrip was trading at Rs.2876. Our recommendation was based on the robust financial performance of the company, the salary hike recommendation by the Seventh Pay Commission and the passage of GST Bill in the Raj Sabha as also expectations of higher sales from rural areas as there was normal monsoon in 2016.

Going forward, BAL may face a difficult road ahead from demand perspective in FY18. The company's financial may get impacted due to update on costs related to BS-III liquidation and unsold inventory levels. Further, commodity price impact will be a worry for the company.

After giving a buy recommendation on BAL and spending more than six months, the share price of the company has not increased. Rather, it has declined 2.22 per cent during the same period. In view of the current conditions, we recommend our reader-investors to EXIT from the stock.