Outperformance put to test

Amid slowing growth and rising competition, they have the tough task of sustaining high growth rates.

Stocks of Bajaj Auto and Hero Honda outperformed the Sensex by 26 per cent and 18 per cent, respectively, last year. However, led by slowdown concerns, these underperformed the broader Sensex by 18 per cent and 9.5 per cent, respectively, last month. Though these companies reported a good set of numbers for the December quarter, largely in line with expectations, there are questions over their stocks’ outperformance going ahead.

For instance, in a January 13 report, CLSA’s analysts cut the motorcycle industry growth forecast for FY13 from 14 to eight per cent, while downgrading Hero to ‘sell’ and retaining an ‘underperformer’ rating on Bajaj.

Though some analysts are optimistic of a 12-15 per cent growth, the top two players have a challenging take to sustain high growth amid increasing competition, especially from Honda. On Thursday, Bajaj Auto was flat, while Hero was up two per cent. At current levels of Rs 1,471 and Rs 1,884, up 1.13 per cent and 1.25 per cent, respectively (in line with the market), they trade at 12.4 times and 14 times FY13 consensus EPS estimates.
 

STRONG GROWTH SO FAR
In Rs  crore	FY11	FY12E	FY13E
Hero MotoCorp
Sales	19,245	23,407	26,061
Y-o-Y change (%)	22.1	21.6	11.3
EPS (Rs )	96.5	122.4	132.3
Y-o-Y change (%)	-13.6	26.8	8.0
Bajaj Auto
Sales	16,586	19,726	22,031
Y-o-Y change (%)	39.0	18.7	11.6
EPS (Rs )	90.4	105.1	113.3
Y-o-Y change (%)	53.6	16.2	7.9
E: Estimates                                                                        Source: CLSA

December quarter
The softer demand environment seen in December 2011 two-wheeler volumes was displayed in Bajaj Auto’s volumes for the quarter as well. Down nearly eight per cent sequentially (over the September quarter), the management also acknowledged that growth for 2011-12 would be about 16 per cent, against the 20 per cent earlier looked for. Hero MotoCorp bucked the environment by posting three per cent sequential growth for the quarter.

However, analysts attributed this partly to a higher dealer-level inventory push, which could possibly impact volumes for January 2012.

The other differentiator between the companies’ performances came up in margins, with Hero MotoCorp posting a surprising margin decline (14 bps) at the Ebitda level, mainly because of higher raw material costs as a percentage to gross sales. This surprised the Street, as softer input costs globally had led to expectations of improved (expanded) operating margins.

Bajaj Auto did see lower raw material costs, down over 2.5 per cent, compared to the previous quarter. Its margins expanded by about 70 bps compared to the previous quarter, to 20.9 per cent. The margin improvement for Bajaj came through because of the strong growth in export, of 28 per cent year-on-year.

The company saw realisations improve as well, as it carried through a price increase equivalent to the lowered Duty Entitlement Passbook (DEPB) incentives effective end –September. Analysts noted this rise was probably slightly greater than the effective DEPB impact, due to a few other export incentives. Consequently, export revenue was up 50 per cent year-on-year.

Export focus
With over a third of its volumes derived from exports to Africa and Latin America, beside Sri Lanka and Bangladesh, its senior vice-president, business development, S Ravi, is very confident of robust growth. This gives Bajaj Auto firepower to differentiate performance in the face of a domestic slowdown. A depreciating rupee is an added advantage. Standard Chartered Research noted that with most of its 2012-13 exposure hedged at an attractive range, there is good visibility for margins to stay robust.

Hero MotoCorp is also expected to ramp up exports to milk the obvious opportunity but Standard Chartered believes this could impact its profitability, as the company increases its marketing and advertising spend.

However, Jinesh Gandhi of Motilal Oswal Research believes that in the near term, Hero Honda’s export thrust isn’t likely to impact its bottom line in a meaningful way. He expects margins to improve over the next couple of years to about 13 per cent (it was 10.7 per cent in 2010-11), as vendor consolidation and operating leverages kick in.

Road ahead
The domestic market, where it is a clear leader, is where Hero MotoCorp’s advantages lie. The Street is divided on how quickly demand would revive. Rajiv Bajaj, CEO, Bajaj Auto, maintain that volumes in the next few months are critical and sentiment takes time to change. Gandhi of Motilal Oswal believes the turnaround should come as soon as the first quarter of 2012-13.

He expects volume growth to be 12-15 per cent for the industry as a whole and sees both companies showing strong volume and, consequently, earnings growth. However, Standard Chartered Research evinces concern about incre-asing levels of domestic competitive intensity.

Honda Motors will enter the key 100cc market segment with its Yuva launch this April.

This places it in the Passion and Splendor category, point out analysts. It is also expected to launch a 125cc bike this year, close to Hero’s secondary segment.

Bajaj is relying on its new launches, four expected in CY2012, to boost growth. Its Boxer launched late in CY2011, didn’t have much of an impact and the company hopes it will do better going ahead.

Analyst opinion is divided into two camps. One sees a clear advantage in Bajaj Auto’s strong export segment, with benefits flowing on both volumes and profitability in a tough environment for the industry at large.

The other sees domestic demand rallying and flowing through to both companies, with Hero MotoCorp benefiting as operating leverages flow through. The key question is how domestic demand and competitive intensity pan out, which will determine how the stocks perform.