Bajaj Auto: Rickshaw drag

Lower three-wheeler sales caused an unexpectedly high drop in Bajaj's profitability

Bajaj Auto's results were even worse than Hero Honda's. Despite an impressive 33 per cent volume growth, profit growth (before exceptionals) was just 4 per cent on a year-on-year basis. On a sequential basis, profit growth was flat at 1.4 per cent despite a 19 per cent volume growth.

Operating margin fell 420 basis points year-on-year and 150 basis points quarter-on-quarter. The main reason for the drop in margins was a sharp drop in the proportion of three-wheeler sales (the company's most profitable business), from 16 per cent in Q3FY04 to just 9.4 per cent last quarter.

Besides, prices of raw materials such as steel and aluminium were higher on a year-on-year basis. Finally, export benefits (under DEPB) had been halved last year, which also impacted profitability.

The sequential drop in margins was almost entirely because of the drop in three wheeler sales. Operating profit per vehicle sold fell 15 per cent sequentially, as a result.

What's surprising is that the company made major savings of over 200 basis points (as a percentage of sales) on "other expenses" on a sequential basis. Hero Honda had reported a jump in other expenses, reflecting the plethora of freebies and discounts on offer during the festive season.

The three-wheeler segment could well continue to underperform, given that several large cities have put a freeze on permits. Also, the company is facing increased competition in the goods segment.

This is bad news since three-wheelers accounted for an estimated 53 per cent of the company's operating EBIT in FY04. The fast-paced growth in the motorcycles segment could make up, helped by the price increase of Rs 400-800 taken in December 2004.

For now, however, analysts would be busy downgrading their earnings estimates after two successive quarters of margin decline. It's no wonder the stock corrected by almost six per cent after the results were announced.

Industrial growth

The growth in the Index of Industrial Production has slipped to 7.9 per cent in November 2004, from 9.8 per cent in October. It's the first time since June that industrial growth has dipped below 8 per cent.

Manufacturing growth fell to 8.8 per cent, the first time since July that growth has been below 9 per cent. Could it be that the impact of the poor monsoons is slowing manufacturing growth?

That seems unlikely, because the slowdown has occurred most in capital goods. While the capital goods index rose 14.6 per cent in November 2003, it went up by 10.3 per cent in November 2004. The index for machinery and equipment other than transport equipment grew by 15 per cent in November 2004, compared to 21 per cent in October.

However, other data, like that of non-oil imports, shows that growth is still very strong. Non-oil imports, which are viewed as a proxy for economic growth, rose by 44 per cent to $7814 million in December 2004, well above November's y-o-y growth.

Nevertheless, industrial production spurted in December 2003, and the base effect will ensure that IIP growth for December 2004 too will remain muted.

As a matter of fact, the month of November 2003 kicked off a period of strong growth in production, and it's going to be increasingly difficult, because of the base effect, to keep up the industrial growth rates seen so far. But much will depend on the strength of capital expenditure.

Remember that the IIP rose 13.1 per cent in 1995-96, after rising by 9.1 per cent in the previous year.

Asian Paints: Sober shades

Asian Paints managed a 21 per cent increase in net profit (post-extraordinaries), despite pressure on its margins owing to higher raw material costs. Net sales rose 32.12 per cent to Rs 595.9 crore y-o-y.

But one must keep in mind that Q3FY04 represented a low base what with the festive season coming in earlier in FY04. If one compares sales for both Q2 and Q3 for the two years, the growth is lower at 19.7 per cent.

Raw material costs rose by over 350 basis points as a percentage of sales to 60.9 per cent - the company's inputs include derivatives of crude, prices of which had jumped last quarter.

As a result, EBITDA margins fell to 15.1 per cent, compared with 16.3 per in Q3FY04. On a sequential basis, margins were stable.

Asian Paints strategy of taking a price cut in August 2004 for its emulsion range seems to have paid off, what with sales growth picking up in the emulsion segment, which enjoys higher margins.

But now, with costs having increased significantly, the company has taken a price increase in November of 4.5 per cent across the board. The benefit from this should accrue next quarter onwards.

Besides, since the price differential between the emulsion range and distempers still remains pretty much the same, analysts expect erstwhile distemper customers to continue migrating to the emulsion range.

Benefits from this going forward seem to be priced in the stock, which trades at around 15 times estimated FY06 earnings.

With contributions from Mobis Philipose and Shobhana Subramanian