TVS Motor: Higher costs limit margin expansion

Street will keep an eye on its ability to balance higher volumes, market share gains with margin growth

Despite strong volume and revenue growth exhibited in the June quarter, TVS Motor disappointed on the profitability front. Volumes were up 22 per cent on the back of robust sales of scooters and three-wheelers, helping revenues grow 31 per cent year-on-year (y-o-y) to Rs 2,305 crore, in line with estimates. However, operating profit margins at 5.69 per cent (up seven basis points against 50 basis points estimated) were lower than analyst expectations, and the lowest in four quarters. There was disappointment at the bottom line, too, with net profit growing 39 per cent y-o-y to Rs 72 crore, much below Bloomberg consensus estimates of Rs 90 crore. This led to the stock falling 6.34 per cent to Rs 158.70 on Thursday.

  Almost all the cost heads saw an increase with raw material costs (cost of goods sold) being the key contributor to margin disappointment. It rose 33 per cent y-o-y and as a percentage of sale by 161 basis points from 71.1 per cent in the year-ago quarter to 72.7 per cent in the June quarter. The firm attributed this to the price increases given to vendors, rupee depreciation and product mix. While TVS took a 0.5 per cent increase in vehicle prices, it was not enough to cover the rise in costs.

TVS also indicated it invested in the launch of two key brands (TVS Star City+ and Jupiter) leading to higher promotional costs. A part of other expenses, this cost head was up 20 per cent y-o-y to Rs 357 crore. Going ahead, the firm indicated advertising expenses to sales, which are pegged at 4-4.2 per cent of annual sales, are likely to drop as the brands become known and revenues grow at a faster clip. Employee costs also swelled 24 per cent to Rs 140 crore. However, the rise in these two cost heads was lower than sales growth, and helped partly offset the pressure on account of raw material costs.

Positively, TVS expects margin performance to improve. Over the next two years, it expects operating profit margin to move into double-digits aided by higher volumes, operating leverage and richer product mix. If it is able to achieve the margin targets, expect the Street to reward the stock handsomely. Currently, analysts are building in just about seven per cent Ebitda margins for FY16, based on which the PE ratio works out to 14.

On the volumes front, TVS is planning to grow at 20 per cent against the 10-12 per cent industry growth estimated for FY15. This looks achievable given TVS' year-to-date growth of 22 per cent, and its plans to launch two new motorcycles and a scooter called Zest this year. However, balancing between volumes and margin will be crucial.