Volume growth, weak mix likely to impact Eicher Motors' margins

Muted domestic demand and margin pressure may weigh on the stock

Muted domestic demand, falling exports, and product cannibalisation worries are weighing on Eicher Motors’ stock, which is down 11 per cent over the past month. Margin pressure and high competitive intensity may also impact the market leader in the premium (350cc-plus) two-wheeler category.

The domestic demand trend shows signs of moderation for the sector with sales for October down 24 per cent month-on-month. On a higher base, volumes for Eicher’s two-wheeler arm, Royal Enfield, contracted 14 per cent over the previous month to 71,000 units. This was 7-8 per cent lower than what the brokerages were working with.

While sales in the above-350cc segment were down by 35 per cent month-on-month, ICICI Securities pointed out that motorcycle sales in the 350cc segment narrowed by 12 per cent month-on-month to 66,000 units, despite the launch of the new Hunter-350 model.

Sales were weak on the export front, as well. The company posted its lowest monthly export wholesales for year to date FY23 at 5,000 units. This was down 27 per cent YoY and was way below the first half FY23 average of about 9,000 units.

Kotak Institutional Equities has a ‘Sell’ rating on the stock as the sales performance of the core portfolio of Royal Enfield was weak. It attributed the same to a 40 per cent uptick in the upfront cost over the past five years due to multiple headwinds, as well as cannibalisation due to the launch of Hunter 350.

According to Rishi Vora of the brokerage, “The core portfolio’s (excluding Hunter 350) performance in the current festive period remains below FY18 levels on affordability issues and cannibalisation from Hunter 350, and demand trends in key states of Delhi and Kerala remain under pressure despite the new launch, indicating market saturation in the above-250cc segment. The weaker performance of its core portfolio will weigh on the company’s profitability.”

While the introduction of Hunter 350 led to a rise in sales and order book remains strong, the Street is worried about the aggressively priced product eating into volumes of Classic and Bullet models that have remained sub-par. Though the company indicated after its September quarter results that the impact of cannibalisation was small with only 6 per cent of Hunter buyers being the existing customers, the impact in rural areas, which is going through a slowdown, would be high as customers downtrade to more affordable options.

The other impact of Hunter 350 is on profitability. As was the case in the Q2FY23 results, Royal Enfield saw a 7 per cent fall in average selling prices, even as volume grew 11 per cent leading to overall revenue growth of 5 per cent in the quarter.

The company’s operations in the September quarter were impacted due to the non-availability of semiconductor chips and a sharp rise in input costs. In addition to a weaker mix, higher commodity costs led to a 160-basis point contraction in gross margin sequentially but operating leverage benefits helped it to limit the hit to the operating margin at 120 basis points.

Some brokerages believe with both these headwinds (input costs and supply issues) easing a bit, coupled with expectations of an improvement in operating leverage, the margin may perk up going ahead. What may offset this in addition to the Hunter 350 proportion is the performance of higher-margin exports. This segment has been hit due to weak demand in Europe, which remains a key market.

On the commercial vehicle front (Volvo Eicher Commercial Vehicle), while the company underperformed its peers in November wholesales volumes, most brokerages expect the sector and VECV to benefit from improving fleet operator’s profitability, led by gradual freight hikes, rising bus orders, and a decline in fuel costs.

Elara Securities has a ‘Sell’ rating on the stock, citing the Hunter 350 mix, which it highlights will be detrimental to operating profit per vehicle trajectory, as witnessed in Q2FY23. In a post-results report last month, analysts at the firm led by Jay Kale believe that the scope of sustainable market share gain is limited for Royal Enfield. Thus, premium valuation at 25-80 per cent to peers seems unjustified, they add.