The stocks of Hero Honda and Bajaj Auto have tanked 18-21 per cent since the start of the year on concerns over profit margins and the ability to maintain higher sales growth. The December quarter results of the companies which control over 80 per cent of the motorcycle market also confirm pressure on the margin front. The Street is worried that higher interest rates, availability of finance, the rising cost of fuel and firm raw material prices may take a turn for the worse and hit the two companies’ profitability. While these issues are likely to see these stocks underperform in the near term, analysts prefer Bajaj Auto over Hero Honda on account of higher margins and more attractive valuations.
Margin pressures Both companies have been facing margin pressures over the last few quarters, with Hero Honda faring worse than its closest competitor as it had to contend with supply constraints as well. To counter input cost pressures, Hero Honda has effected price increases of 2-3 per cent across models in December and Bajaj has raised prices 2 per cent in January. Pawan Munjal, managing director and CEO, Hero Honda, believes demand will remain bullish but he expects margins to remain under pressure in the near term. On the other hand, Bajaj Auto's management says it can maintain margins at 20 per cent on the back of higher operating leverage.
No problems on demand front Though there are operational and macro headwinds, demand has been robust. While Hero Honda's volumes grew 16 per cent for the ten months ended January to 44 lakh units, Bajaj Auto posted an increase of 38 per cent to 32 lakh units for the same period. In 2011-12, analysts expect Hero Honda's volumes to grow 14 per cent to six million units while Bajaj is expected to register a growth of 25 per cent to 4.3 million. They believe capacity expansion is critical for the growth of Hero Honda (the company is scouting for its fourth plant to expand its current capacity of 5.5 million units) if it is to top six million units. Exports, which have been a strong point for Bajaj Auto (a third of sales), could become a window of opportunity for Hero Honda (3 per cent of sales) post its split with Honda.
| BAJAJ SCORES ON HIGHER MARGINS | ||
| FY12 estimates in Rs cr | Hero Honda | Bajaj Auto |
| Sales | 20,184 | 19,281 |
| Ebitda | 2,817 | 3,862 |
| Ebitda margin (%) | 14.0 | 20.0 |
| Net profit | 2,296 | 2,885 |
| P/E (x) | 13.7 | 12.1 |
| Source: Analyst reports | ||
Market share, new launches After losing share over the last six quarters, market leader Hero Honda gained share in the domestic motorcycle segment in the third quarter, helped by six new launches (including the new Hunk in the premium segment, and Splendor Pro and Super Splendor in the high-volume executive segment).
The company will be banking on variants as well as three new models from the Honda stable before its agreement runs out in 2014. Bajaj Auto, which has been losing market share in the December quarter (partly due to a maintenance shutdown in December 2010), could regain some of the share on the back of the launch of a new Discover bike in April this year and a Pulsar variant by the end of this calendar year.
Q3: Divergent trend Bajaj Auto's December quarter results were better than expected with volumes growing 17 per cent and realisations increasing 8.3 per cent; it managed to hang on to an Ebitda margin of 20.3 per cent on lower than estimated fixed costs. Hero Honda disappointed. While it posted good numbers on the top line driven by a 29 per cent yearly jump in volumes and a five per cent rise in realisations (helped by the December price rise), the profitability was below Street estimates due to a rise in other expenses and higher than expected raw material costs.
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Valuations While Hero Honda has delivered record volumes on the back of strong demand, analysts believe there will be more pressure on it not just because of intensifying competition in the entry-level bike category as well as input costs but also higher brand-building expenses (it is the global partner for the forthcoming World Cup) post its split with Honda.
Analysts believe Hero Honda will likely focus on maintaining market share at the cost of margins while Bajaj will continue to focus on promoting its twin brands (Discover and Pulsar) with an eye on keeping the margins stable. Among key risks for Bajaj will be heightened competition in the premium and executive segment, which could impact its pricing power. For now, given the current valuations and margin difference, analysts prefer Bajaj Auto over Hero Honda.