RESULT UPDATE BAJAJ AUTO Strong show in a tough environment India Equity Research| Automobiles COMPANYNAME Bajaj Auto’s (BJAUT) Q2FY20 EBITDA of INR12.7bn (down 6.6% YoY) EDELWEISS 4D RATINGS surpassed our estimate 15% driven by significant improvement in Absolute Rating HOLD realisation. Post a bleak Q2FY20, near-term demand outlook has Rating Relative to Sector Underperform improved, triggered by the festive season as well as clarity on GST rate Risk Rating Relative to Sector Low cut. With current inventory at 60 plus days and the BS VI transition Sector Relative to Market Overweight around the corner, sustained bounce-back in demand remains key. Near- term export growth is likely to find some support from new product launches (Pulsar NS) as well as resumption of 3W exports to a few key MARKET DATA (R: BAJA.BO, B: BJAUT IN) markets (Egypt). However, we expect margin to remain range bound as CMP : INR 3,163 Target Price : INR 3,177 sustained improvement in mix is likely to be offset by rising share of 52-week range (INR) : 3,237 / 2,400 exports and BS VI transition costs. Maintain ‘HOLD’ with revised TP of Share in issue (mn) : 289.4 INR3,163 (earlier INR2,988) as we roll over to 12x March 2021E EPS. M cap (INR bn/USD mn) : 915 / 12,905 Avg. Daily Vol.BSE/NSE(‘000) : 533.6 Q2FY20: Strong show Net revenue at INR77bn (down 4% YoY) was 5% ahead of estimate due to sharp 5% SHARE HOLDING PATTERN (%) QoQ improvement in ASP. Strong ASP growth was driven by higher share of 110/125cc Current Q1FY20 Q4FY19 motorcycles and domestic 3W sales. EBITDA margin at 16.1% surpassed our estimate Promoters * 53.5 53.5 51.2 of 15.1% driven by revenue beat as well as lower-than-expected staff costs. PAT beat MF's, FI's & BK’s 8.6 8.6 7.4 of ~19% was due to higher than expected benefits of the corporate tax cuts from the FII's 14.6 14.6 15.6 previous quarter. Others 23.3 23.3 25.8 * Promoters pledged shares : 0.9 (% of share in issue) Margin to remain range bound We expect improvement in product mix (higher share of 110/125cc motorcycles) to PRICE PERFORMANCE (%) drive BJAUT’s market share gains going forward. However, the volatile demand Stock Nifty EW Auto Index environment could limit the company’s ability to pass on BS VI costs, mitigating margin 1 month 5.2 4.2 4.9 improvement due to a better mix. 3 months 10.7 (1.7) (1.4) 12 months 15.8 8.3 (15.9) Outlook and valuation: BS VI transition key; maintain ‘HOLD’ We estimate FY19–21 volume CAGR of only 5.0% factoring volatile demand environment and uncertainty due to upcoming BS VI transition. We maintain ‘HOLD/SO’ with TP of INR3,163, valuing the stock at 16x March 2021E core EPS, cash/ share of INR802 and KTM at INR100. The stock is trading at 20.6x/17.9x FY20/21E EPS. Financials (INR mn) Chirag Shah Year to March Q2FY20 Q2FY19 % Chg Q1FY20 % Chg FY19 FY20E FY21E +91 22 6623 3367 Total operating Income 77,073 80,118 (3.8) 77,558 (0.6) 302,501 323,255 360,697 [email protected] EBITDA 12,781 13,680 (6.6) 11,982 6.7 49,821 53,000 58,908 Adjusted Profit 14,024 11,525 21.7 11,257 24.6 44,367 51,035 57,043 Jay Mehta +91 22 4088 6072 Adjusted Diluted EPS 48.5 39.8 21.7 38.9 24.6 153.3 176.4 197.1 [email protected] Diluted P/E (x) 20.6 17.9 16.0 EV/EBITDA (x) 14.6 13.3 11.6 ROAE (%) 21.7 22.5 22.9 October 23, 2019 Edelweiss Research is also available on www.edelresearch.com, Edelweiss Securities Limited Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Automobiles Key highlights from the Q2FY20 conference call and management’s TV interview Key highlights Management expects the 2W industry’s growth to be flat to marginally negative in FY20, caveats being: 1) sustained pick up in festive season; and 2) no BSVI pre-buying. Demand: Some green shots from second half of September. Clarity on GST rate cut has helped. Festive season has also been a trigger for demand improvement. Expects volume growth in the current festive season to be in line with previous festive season (by the time Diwali is done). Retail sales trend: Retail sales are now flattish to marginally negative (double-digit decline a few months ago). Retail sales have picked up in October. Incentives: Range from INR1,500-5,000 depending upon the model. These are not entirely given in the form of cash discounts. Not increased incentives meaningfully in the festive season. Outlook on profitability: Commodity costs and exchange rates are stable, but overall demand situation still remains relatively volatile (for instance, there could be pre or postponement of demand due to BS VI). So difficult to give exact guidance, but margin trajectory should move upwards. Inventory 1. Current inventory is at 60 plus days (normal 35-40). 2. Inventory level right now is exactly the same as it was in October 2018. 3. Has been relatively constant between June and September. 4. However, the company is not worried about these levels given the ongoing festive season. 5. Target is to bring it to normal level over the next couple of months. 6. Aim is to have primarily BS VI inventory from Q1FY20. 7. Inventory at factory is very low. Tax rate for the full year should be 24-25%. Exports revenue: INR3,108mn in Q2FY20 versus INR3,123mn in Q2FY19. Spare revenue: INR7,930mn in Q2FY20 versus INR8,110mn in Q2FY19. 2W exports: Bajaj continues to outperform in markets where it competes. Has garnered 2.5% points market share in overall 2W exports. Margin Gross margin improvement: 1. QoQ, 50-60% improvement from product mix, while balance was contributed by raw material prices. 2. Expects commodity costs to remain benign in Q3FY20. May get some benefit from these. Steel price may be beneficial, but ferrous prices could be a headwind. At this juncture, management expects commodity costs to be a net benefit in Q3FY20. 2 Edelweiss Securities Limited Bajaj Auto Segmental margin unlikely to decline QoQ in Q3FY20. Blended margin will still be decided on the basis of the final mix over the next three months. Realisation Currency benefit was ~0.5%; balance is due to mix improvement (higher share of 110/12cc motorcycles) and price increase. Took calibrated price hikes in Q2FY20. Took one in July and another in September (hike of about 1.0-1.5% in the sports segment in September). In the domestic market, mix between 2W and 3W has tilted in favour of 3W, which has helped realisation. BS VI update Phasing out of BS IV inventory has started from the current month. The company will not artificially advance sales to liquidate BS IV inventory (assuming competition does not either). There will be no major change in overheads (negative operating leverage) due to any change in motorcycle production in Q3FY20. Financing Seen uptick in financing for Bajaj Auto. Currently finance penetration is at 70% (more than 50% is from Bajaj Finance) versus 65% in Q1FY20. 3W Domestic 3W sales have received a boost from the festive season. Egypt: Retail sales have now settled from the high of 8k to ~3k per month. The company has not exported to Egypt in the past six months as it was destocking inventory; exports have now resumed. Cargo segment: BS VI should be a tailwind for Bajaj as some of the traditionally used 4W will become too expensive post BS VI. Market share Market share has stabilised in recent months, but this should be seen in context of a sharp slowdown in the industry. The company has, however, managed to reshape its portfolio. Once industry revives (or settles down), management expects to make market share gains. Product launches Has a strong product pipeline for the next 18 months, but there may be a slight lull in the launch activity until BS VI. 3 Edelweiss Securities Limited Automobiles The company has yet to take a call on the launch sequence and will take it only post BS VI. Pulsar The ABS mandate has been a tailwind for the 125cc motorcycle segment. So Bajaj has decided to introduce the 125cc Pulsar. Export growth: Pulsar 160 NS and 200 MS are key drivers of export growth. EV Forecasting demand is difficult in this space given multiple variables. The strategy is to secure a first-mover advantage, atleast among established OEMs. Pricing will be announced closer to January. Promotion accounting Spends on promotion this year have been less compared to last year. Netting off on the topline (as per accounting guidelines) has reduced this year, while other expenses have jumped. Husqvarna Will start production by FY20-end (in Q4FY20) and target export markets. Expects domestic launch in Q1FY21. Triumph Talks are on and both the companies are close to signing a partnership agreement. Profitability of product launches All new launches (Platina 110 for example) are more profitable than their existing peers within the same group. 4 Edelweiss Securities Limited Bajaj Auto Table 1: Volume assumptions Particulars FY18 FY19 FY20E FY21E Domestic 23,44,214 29,40,903 28,69,353 31,24,381 Two-wheeler 19,74,577 25,41,450 24,89,872 27,25,926 Three-wheeler 3,69,637 3,99,453 3,79,480 3,98,454 Exports 16,62,577 20,78,730 21,70,021 24,07,893 Two-wheeler 13,94,757 16,95,553 18,48,153 20,69,931 Three-wheeler 2,67,820 3,83,177 3,21,869 3,37,962 Total 40,06,791 50,19,633 50,39,374 55,32,274 % YoY Domestic 4.0 25.5 (2.4) 8.9 Two-wheeler (1.3) 28.7 (2.0) 9.5 Three-wheeler 46.0 8.1 (5.0) 5.0 Exports 17.8 25.0 4.4 11.0 Two-wheeler 14.5 21.6 9.0 12.0 Three-wheeler 38.9 43.1 (16.0) 5.0 Total 9.3 25.3 0.4 9.8 Product-mix (% total sales) Domestic 58.5 58.6 56.9 56.5 Two-wheeler 49.3 50.6 49.4 49.3 Three-wheeler 9.2 8.0 7.5 7.2 Exports 41.5 41.4 43.1 43.5