Hero MotoCorp to TVS, two-wheeler stocks skid as margin pressure weighs

Situation similar to FY2004-07, when volume growth was strong but profitability slid

Share prices of two-wheeler makers were among the biggest losers in trade on Monday, shedding up to six per cent on worries that aggressive pricing at a time of commodity inflation would squeeze margins.

Hero MotoCorp fell 6.2 per cent, Bajaj Auto by 5.3 per cent and TVS Motor by 4.2 per cent. Including Monday, the three shares are down by six to 14 per cent over the past week.

In the case of Bajaj Auto, the trigger for the sharp price correction has been a sudden change in strategy. It is now focusing on gaining of market share in the home motorcycle market, at the cost of margins. Its share was 24.4 per cent in FY13 and had slipped to 15.7 per cent in FY18; it formed the current strategy to boost dealer network and viability. The aim is to improve its overall share to 20 per cent.

A key part of the strategy is to be aggressive at the entry level or economy segment (less than 110cc), nearly a fourth of sector volumes. The company's aggressive discounting (price cuts up to nine per cent for the CT100) seems to be working, with market share up 850 basis points in the entry space over the past year, to 34 per cent in the June quarter. Buoyed, it has now set a target of 50 per cent market share here over the next two years.

The impact of this, however, has been that Bajaj Auto's margins, at 17.3 per cent in the June quarter, were their lowest since 2008-09. This fall was the result of aggressive discounting and higher share of entry-level motorcycles.

Analysts such as Bharat Gianani of Sharekhan expect the company to report flattish earnings growth and margins to fall further to 16.9 per cent.

As Bajaj Auto makes losses at the operating profit level in the entry segment, how the competition responds to the company's aggressive moves will be important. The pressure on profit comes when motorcycle growth is expected to hit a respectable nine to 10 per cent, on a strong base -the sector grew 14 per cent in FY18. Deutsche Bank's Amyn Pirani believes a revival in growth leads to a clamour for market share which drives down profitability. For example, in FY2004-07, while demand exhibited a strong 14 per cent annual growth, margins declined and stocks underperformed. 

A similar situation is likely to play out in the current fiscal as Bajaj Auto turns aggressive and the moves are likely to be matched by rivals. While analysts have cut earnings estimates for Bajaj Auto, they are awaiting results and management commentary from sector leader Hero MotoCorp on Wednesday to get a better perspective on pricing, market share and commodity inflation issues. Anupama Arora, Sector Head, Corporate Ratings ICRA believes that while there could be specific promotional schemes like free insurance and zero down payment among others to counter the deep price cuts taken by select two wheeler makers in the entry level segment, in the long term it is unlikely that companies will continue such a strategy.

Further, what could offset some of the margin pressures due to pricing and commodity costs are higher growth from the premium segment and upgrading of customers from the executive segment (51 per cent of overall volumes). Hetal Gandhi, director at CRISIL Research, expects sector margins to be stable at 15-16 per cent in FY19. Growth in FY19, according to her, will be on the back of a normal monsoon, improved affordability and positive rural sentiment. As the rural segment accounts for half of overall volume, an improvement in rural infrastructure (the rural roads scheme, affordable housing) is also expected to aid demand, she adds.