09 July 2013 Asia Pacific/India Equity Research Auto Parts & Equipment

India Two Wheeler Sector Research Analysts CHANNEL CHECK

Jatin Chawla 91 22 6777 3719 [email protected] Bumpy road to continue – Bajaj better placed Akshay Saxena 91 22 6777 3825 [email protected] Figure 1: Honda could gain another 5% share in next 18 months 20% 17% 1.8% 0.5%

16% 2.3%

1.2% 12.5% 1.8% 12% 2% 7.5% (1) India Two Wheeler Sector: Riding the world 8%

(2) India Two Wheeler Sector: 2012- Share gains in a slow market 4% Honda FY12 New Network Clearing 1QFY14 Dream Neo New bike in Network FY15E market share Segment Expansion Waiting market share (Lower economy Expansion market share motorcycles (Dream Period Executive) Yuga) Source: Company data, Credit Suisse estimates ■ Honda to gain further market share, Hero to lose the most. Our price- point-wise analysis suggests that Honda is still not present in almost 50% of the motorcycle market, a situation which we expect to be corrected in the next 12-18 months. Even if Honda were to gain ~10% market share in these segments, its motorcycle market share will increase ~5%. Moreover, Hero’s share in this untapped Honda segment is ~70%; it will be the most impacted. ■ Honda protecting its scooters turf aggressively. A feature-by-feature comparison of the Activa and the recently introduced Activa-i suggests that the only difference between the two is a weight reduction of 7 kg and despite this negligible difference, Honda has cut prices by Rs3k, setting off a sort of a price war, signalling its aggression in order to protect its turf. In our exhaustive nation-wide channel checks Honda dealers indicated strong demand for the new Activa variant. ■ Continue to prefer Bajaj over Hero. We believe 2W stocks will continue to languish until market growth returns to double-digits or market share loss to Honda stabilises; we expect neither to happen in FY14. We cut our domestic volume growth for Hero/Bajaj to ~0% for FY14, resulting in our earnings and target price being reduced by 1-3% for both the companies. Our target price for Hero reduces to Rs1,710 from Rs1,742; for Bajaj, our TP goes down to Rs2,090 from Rs2,132. Key risk to our call is a sudden turnaround in domestic 2W market on positive sentiment from monsoons. We continue to prefer Bajaj over Hero, largely due to its export potential (click here for report), prospects of margin improvement over and above the FX benefits currently factored in street estimates and limited exposure to Honda’s new launches (only 10% of EBITDA vs 45% for Hero).

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09 July 2013

Focus charts and tables

Figure 2: Honda’s each capacity expansion has led to Figure 3: Honda not present in the lowest two of the five increase in run-rate; so questions on what happens with segments by price; launch in each of these segments will the recent expansion to 4mn units help it gain incremental share (Hero dominates currently) 300,000 Others Increase to 4 Mn 11% 250,000 Bajaj 22%

200,000

Increase to 2.2 Mn Increase to 2.8 Mn Hero 150,000 67% Capacity 1.6 Mn 100,000 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Market Share in Honda's untapped segments Honda Domestic 2W sales

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 4: Even after Dream Yuga launch ~50% of market below price point of Rs45k where HMSI is not present Segment Hero Honda Price Point Proportion of market Honda's segment share Economy Dawn Deluxe To come by FY15 end Below 42 19% 0% Lower Executive Splendor Dream Neo 42-45 30% 0% Mid Executive Passion Dream Yuga, Twister 45-50 20% 15% Upper Executive Glamour Stunner, Shine 50-60 15% 40% Premium Xtreme, Karizma Unicorn 60 and above 16% 15% Source: Company data, Credit Suisse estimates. Price range is Ex-Showroom price for base model in Delhi

Figure 5: Hero’s market share loss and volume growth Figure 6: 45% of Hero’s EBITDA vs 10% for Bajaj exposed impact in domestic 2W market will be greater than Bajaj’s to Honda’s entry into new segments

9% 30% 50%

6% 40%

20% 5% 3% 30%

20% 0% -1% 10% -4% 10% -3% 0%

-6% 0% Hero Motocorp Bajaj Hero Moto Bajaj Honda Proportion of EBITDA at risk from Honda's aggressiveness FY13-15 mkt share change motorcycles 2 Yr CAGR volumes (RHS)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 7: Activa-i cheaper with near similar features Figure 8: Scooter penetration increases with literacy Activa-i vs Activa Feature difference 35% Engine Same 28%

Electricals Same W's 2

Suspension Same 21% Ignition Same Brake Same 14%

Tyres Same Scooters share inshareScooters 7% Platform Same Weight 7kg lighter 0% Price Rs3,000 cheaper 70 75 80 85 90 Maharashtra District Literacy (%) Source: Company data, Credit Suisse estimates Source: Maharashtra Govt., Credit Suisse estimates

India Two Wheeler Sector 2 09 July 2013 Hero and Bajaj – what next? While 2Ws have enjoyed a secular growth story in India with volume growth rarely turning negative in the past 20 years, the past couple of years have bucked the trend. After flattish growth in FY13 the domestic motorcycle industry (constituting ~75% of total 2W sales) has remained subdued even in 1QFY14. Both the major Indian players, i.e., Hero Motocorp and Bajaj Auto have suffered more growing slower than the industry with market share loss to Honda.

Figure 9: Not only has domestic motorcycle growth Figure 10: ..but both Hero and Bajaj have been growing steadily come off in the past 18 months... slower than the industry on account of market share loss to Honda

30% 10.0%

5.0% 20%

0.0% 10%

-5.0% 0% -10.0%

-10% -15.0%

-20% -20.0% 04 05 06 07 08 09 10 11 12 13 1Q14 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14

Domestic Motorcycle industry growth Domestic Motorcycle growth for Bajaj Hero Motocorp Industry

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Not surprisingly, 2W stocks have de-rated on these concerns and have underperformed both broader market and other auto stocks. Given the underperformance and cheap valuations (Hero trading at ~12x FY14E earnings ex-royalty), most investors are looking at a good point to enter these stocks. The key things to monitor in this regard will be both market share movement and market growth.

Figure 11: This has led to a de-rating in 2W stocks... Figure 12: …and underperformance relative to both market and other Indian auto stocks

80% 18

60%

16 40%

20%

14 0%

-20% 12 BSE Tata Motors Mahindra Maruti Hero Bajaj Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Motocorp

Hero Motocorp Price to 12M fwd EPS Stock returns since 1-Jan-12

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

India Two Wheeler Sector 3 09 July 2013

See further market share loss to Honda Since its split with Hero in FY11 Honda has signalled its intent of becoming the No.1 2W player in India. The company has been aggressive on all fronts – be it launching new products, adding new features, capacity addition or network expansion. Since 1HFY12 its market share in 2Ws has increased ~600 bp with gains in both scooters & motorcycles. Even with constant capacity increases in a phased manner Honda has been operating at near-full capacity. From 1.6 mn units annually, capacity was first increased to 2.2 mn units in Sep-11 and then to 2.8 mn units in Mar-12. Honda’s monthly production run-rate saw a bump-up with each of these capacity increases. It has again increased capacity to 4 mn units by opening a new plant in Karnataka and has set an aggressive target of 3.9 mn units sales in FY14, implying operation at full utilisation should sustain.

Figure 13: Honda’s market share in 2Ws has increased Figure 14: Each capacity expansion of Honda has led to ~600 bp in the past 18 months an increase in run-rate 100% 300,000 7% 7% 8% 7%

15% 14% 13% 12% Increase to 4 Mn 80% 250,000 13% 15% 19% 21% 60% 200,000 45% 45% 40% 43% 43% Increase to 2.2 Mn Increase to 2.8 Mn

150,000 20%

20% 19% 18% 17% Capacity 1.6 Mn 0% 100,000 FY11 FY12 FY13 1QFY14 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13

Mkt share 2W's Bajaj Hero Honda TVS Others Honda Domestic 2W sales

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Hence, while Honda’s sales have stabilised at ~240k units per month for the past few months, the most recent capacity increase could give that number an upward boost. In order to understand the possible impact of this capacity expansion we look at factors responsible for Honda’s share gains in motorcycles (given it was already strong in scooters and is leading the Indian players in motorcycles). Product in new segment In the motorcycle market Honda was earlier focused on the premium range. If the market is segmented according to price points, Honda was just present in the upper executive and premium segments while having limited presence in mid-executive segment through Twister and no presence in the lower segments. Given that bulk of the market (~70%) was mid-executive or lower, Honda was targeting a very small set. These lower segments have been the forte of Hero Motocorp which has a dominant share in all these segments. Last year, Honda launched “Dream Yuga” to take Hero’s key offerings head on for the first time. Figure 15: ~50% of market below price point of Rs45k (base model ex-showroom) where HMSI is not present Segment Hero Honda Price Point Proportion of market Honda's share in segment Economy Dawn Deluxe To come by FY15 end Below 42 19% 0% Lower Executive Splendor Dream Neo 42-45 30% 0% Mid Executive Passion Dream Yuga, Twister 45-50 20% 15% Upper Executive Glamour Stunner, Shine 50-60 15% 40% Premium Xtreme, Karizma Unicorn 60 and above 16% 15% Source: Company data, Credit Suisse estimates. Price range is Ex-Showroom price for base model in Delhi

India Two Wheeler Sector 4 09 July 2013

While Honda earlier had a paltry ~5% share in the mid-executive segment; with the Dream Yuga launch it got an incremental ~10% share. Given that this segment constitutes 20% of the overall market, Dream Yuga helped Honda gain ~200 bp share in overall market. The vehicle was largely targeted to take on Hero’s Passion in terms of pricing. Honda is now launching another bike, Dream Neo, which is ~Rs3k cheaper than Dream Yuga and would be in direct competition with Hero’s best-selling product Splendor. It is also expected to enter the lowest price point segment, economy within the next 18 months. The Dream Yuga experience suggests that both Dream Neo and any economy segment bike can help Honda gain ~10% share in the respective segments. However, with Dream Neo we assume some bit of cannibalisation from Dream Yuga, and Honda to get 2.3% share from Dream Neo (8% share in the segment which is ~30% of the market) and 1.8% share from economy segment launch (10% share in the segment which is ~19% of the market).

Figure 16: The lower segments where Honda has just Figure 17: Honda got an incremental ~10% share in mid- started focusing on are large part of market with both executive through Dream Yuga; it can gain similar share Hero/ Bajaj getting significant share from these in both lower executive and economy segments

100% 3% 36% 5% 11% 20% 27% 80% 26% 2% 24% 14% 60% 53% 16% 1% 12% 40% 39% 23%

20% 27% 0% 0% 19% 20% Dream Yuga (Mid Dream Neo (Lower Economy 0% Executive) Exectuive) Hero Bajaj Honda Honda's incremental share in motorcycles from launch Economy Lower Executive Mid Executive Upper Executive Premium Segment proportion of market (RHS)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Clearing waiting periods on existing models with increased capacity The second lever for Honda’s market share gain was clearing the waiting period on existing models (Activa, Shine and Unicorn). Before the Rajasthan plant was operational in Sep-11, there was a 5-6 month waiting period for Activa and a 3-4 month waiting period on Shine and Unicorn models. So just in motorcycles there was a backlog of 150k units (three months on Shine + Unicorn which had a run-rate of 50,000 per month). Currently, the company has a total backlog of 100,000 units (70,000 in scooters and 30,000 in motorcycles). So backlog on motorcycles has reduced from 150,000 units to 30,000 units. Combining some bits of lost sales due to model shortage, we estimate Honda to have gained ~120 bp of share in motorcycles on account of clearing the waiting periods on its models. Now with most of the models available off the shelf (only Shine has some backlog), this lever will not exist anymore for any potential market share gain in future. Network expansion impact should recede Indian incumbents, particularly Hero Motocorp, have a clear advantage of reach with well- established distribution and servicing network, even in far-flung towns and villages. Whilst Hero and Bajaj have ~5,000 and ~4,000 touch-points, respectively, Honda has only ~2000 touch-points. Honda has been reducing this gap by planning to add 500 touch-points every year. We estimate Honda to have gained ~180 bp share from network expansion, from 1,500 to 2,000 touch-points in FY13, but with the incremental touch-points either coming in smaller centres or cannibalising existing touch-points in larger centres this effect should gradually recede hereon.

India Two Wheeler Sector 5 09 July 2013

Even though rural constitutes ~45% of sales for Hero Motocorp, our interaction with dealers suggests that even if there is a sub-dealership in their village, people in the rural areas still prefer to shop at a nearby town because of more product options in terms of colours, features, etc. It is just that having a servicing network of a particular company in a village tilts people to go in for that brand because of ease of maintenance. Hence, while Honda will go on adding more dealerships, incremental benefit from this factor will recede as Honda gets fully entrenched in tier 1 and tier 2 cities, and will then have to add on in the smaller places only, from where delta in volumes is very less. Attracting the dealers in smaller places will also be a much bigger challenge for Honda because servicing income is a critical part of revenues for a village dealer and it will only be feasible for him to open a dealership in a village if there is a big population of existing vehicles of the company in that village. In this regard, Hero’s network advantage will help with its best-selling products such as Splendour and Passion already having a large base, the bikes being sold for over 15 years. Figure 18: Even with the aggressive addition, Honda’s network lags Hero significantly— any future market share gains from this factor would be slow though Touch-points Hero Motocorp 5,000 Bajaj 4,000 HMSI 2,000 TVS 2,800 Yamaha 1,100 Suzuki 335 Source: Company data, Credit Suisse estimates Do models get successful with time? Most of Honda’s dealers we interacted with were of the view that the way Shine has seen gradual acceptance and a steady rise in sales since its launch in FY09, other models such as the Dream Yuga should grow similarly. If this is true, we believe it is a big negative for the Indian players—if Dream Yuga continues garnering greater market share in the mid- executive segment combined with Honda’s entry into the lower segments, it would seriously hamper growth of the Indian players. We look at the evolution of other models to validate this. Unfortunately, the only other big successful launch in the past ten years has been of Bajaj’s Discover. Looking at Discover’s sales, it saw a bump-up from the first year itself. Hence, it seems Shine was more of a one-off where, due to capacity constraints, sales grew gradually. In our assumptions, we assume that Dream Yuga’s share in the mid- executive segment has largely stabilised and there will be no major incremental gains. Figure 19: While Honda’s Shine has found gradual Figure 20: …other successful models such as Discover acceptance and increase in sales since its launch… have seen bump-up from the first year itself 700,000 800,000

600,000 700,000

600,000 500,000 500,000 400,000 400,000 300,000 300,000 200,000 200,000

100,000 100,000

0 0 FY09 FY10 FY11 FY12 FY13 FY05 FY06 FY07

Honda Shine annual sales Bajaj Discover annual sales

Source: Company data, SIAM Source: Company data, SIAM

India Two Wheeler Sector 6 09 July 2013

To summarise, Honda’s market share gain in motorcycles until now has been a function of its entry into the new segment (Dream Yuga), clearing waiting periods of existing models with increased capacity and network expansion. Going forward, the only lever is entry into untapped segments, but this factor will be more significant given that Honda will now be targeting the remaining ~50% of the market. Even if Honda were to gain ~10% additional market share in these new segments, combined with some bit of network expansion in the rural areas, its total motorcycle market share will increase ~5% by the end of FY15.

Figure 21: Honda’s ~500 bp share gain since FY12 from Figure 22: Bulk of gain in the future will be from entry into combination of three factors the economy and lower-executive segments

14.0% 18.0% 0.5% 1.2% 12.5% 1.8% 17% 12.0% 1.8% 16.0% 2.3% 10.0% 2%

14.0% 8.0% 7.5% 12.5% 6.0% 12.0%

4.0% 10.0% 2.0%

0.0% 8.0% FY12 market New Segment Network Clearing 1QFY14 1QFY14 Dream Neo New bike in Network FY15 market share (Dream Yuga) Waiting Period market share market share (Lower economy share motorcycles motorcycles Executive)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Impact more on Hero than Bajaj The lower segments where Honda is yet to enter are unevenly split between Hero and Bajaj. These segments together form ~60% for Hero’s domestic volumes vs ~40% of domestic volumes for Bajaj. Hero also has a much larger market share in these segments (~67%) vs ~22% for Bajaj. Hence we believe, with Honda’s entry, Hero’s market share will be impacted more than Bajaj's. Moreover, since Bajaj is more diversified with only ~50% of revenues and ~40% of profits from domestic 2Ws, the net impact will be even less.

Figure 23: Hero has 67% share and larger volume share in Figure 24: Hence Hero’s market share loss and volume Honda’s untapped segments compared with Bajaj growth will be impacted more than Bajaj's

9% 30% Others 11% 6% Bajaj 22% 20% 5% 3%

0% -1% 10% -4% Hero -3% 67%

-6% 0% Hero Moto Bajaj Honda Market Share in Honda's untapped segments FY13-15 mkt share change motorcycles 2 Yr CAGR volumes (RHS)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

India Two Wheeler Sector 7 09 July 2013

Hero has overcome the quality hump for now, but can it sustain? As per our interactions with Hero Motocorp’s dealers, the recent five-year warranty scheme introduced by the company has been a success since it has helped allay concerns on quality post the split with Honda. This initiative has no doubt been a major confidence booster for the customers at negligible additional cost (only Rs60/bike, as per the company). While it seems that Hero has temporarily overcome the quality fears which everyone had post the split, it remains to be seen whether it can be sustained. The key would be whether Hero can build and scale up its R&D capability. The company plans to launch a completely new product using indigenous technology by FY14 end and the success of this technology would be critical. The key challenge on the technology front will come in 2015, when India moves to a tighter set of emission norms. It has to be seen whether Hero can scale up its R&D capability by then. Scooters—Honda should gain here too Activa demand continues to outpace supply; further share increase post expansion As we noted earlier, Honda will gain share in motorcycles on account of its entry into untapped segments. Though Honda is dominant in scooters with ~50% share, we expect it to gain more share here too with the new Karnataka plant coming on stream. As per our dealer interactions, the new Honda Eco Technology (HET engine) on Activa has been received very well with a clear ~10% increase in fuel economy with the same. Nearly all of Honda’s dealers were confident on prospects for scooters and seemed to indicate that they could sell as many scooters as is the supply from the company. Activa remains the brand which customers aspire to in scooters. They also said that presently, consumers are less willing to wait, hence, in the absence of Activa’s availability, there was some amount of sales lost to other companies. This implies that with increased Activa production from the new plant, growth of other players in scooters, like that of Hero's, can get impacted. Hero saw its scooters sales grow ~30% in FY13, significantly outpacing Honda’s scooters growth (~15%). While part of this is explained by the new launch “Maestro”, we reckon it was helped by the capacity constraints on Activa. Honda’s scooters monthly run-rate has stabilised at ~120k units over the course of last year with the company largely operating at full capacity. This coincided with significant growth in Hero’s scooters. Like motorcycles, we expect Honda to gain ~500 bp share from FY13-15 in scooters too.

Figure 25: Hero’s monthly run-rate has grown ~50% while Figure 26: The recent capacity expansion will help Honda Honda’s has remained steady on capacity constraints gain further share in scooters 60,000 160,000 -2.7% TVS

Suzuki -2.7% 50,000 140,000

Piaggio 1.3%

40,000 120,000 Mahindra -1.7%

Yamaha 2.0% 30,000 100,000 5.5% Honda

Hero Motocorp -1.6% 20,000 80,000 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%

Hero scooter sales (3 month moving average) Honda (RHS) Difference in FY13 and FY15 market share in scooters

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

India Two Wheeler Sector 8 09 July 2013

Price war of a different kind? Unlike the passenger car segment which has seen heavy discounting with the weakening of industry demand and increase in competition, the 2W segment has not witnessed any discounts since 2008 (when both Hero and Bajaj engaged in a severe price war). Even during last year’s slowdown, all players managed to take regular price hikes and there was no discounting. Most players realise that price cuts would only destroy the brand with consumers not getting swayed in their purchase decisions on account of small price differences. Hence, rather than destroying the brand, companies have resorted to lower priced variants to make it affordable for consumers struggling with low income growth and high inflation; these variants usually have fewer features. But the launch of the Activa-i variant last month shows Honda’s aggressiveness on pricing, which is a tad worrisome. A feature-by-feature comparison of the Activa and the recently introduced Activa-i suggests that the only difference between the two is a weight reduction of 7kg, and Honda has cut prices by Rs3,000; this seems to suggest that the new variant will have lower margins and hence in a way is a price cut.

Figure 27: The newly launched Activa-i is nearly identical to Activa other than it being a little lighter and ~Rs3,000 cheaper Activa Activa-i Displacement 109cc 109 cc Max Power 8 bhp@ 7500 rpm 8 bhp@ 7500 rpm Max Torque 8.74 Nm@5500 rpm 8.74 Nm@5500 rpm Transmission V-Matic V-Matic Ignition Self & Kick Self & Kick Battery 12V 3 Ah 12V 3 Ah Headlamp 12V 35/35 W 12V 35/35 W Suspension Spring loaded hydraulic Spring loaded hydraulic Frame Rigid under bone type Rigid under bone type Dimension 1761mm x 710mm x 1147mm 1795mm x 705mm x 1115mm Wheelbase 1238mm 1238mm Seat Height 765mm 765mm Ground Clearance 153mm 165mm Kerb Weight 111 kg 103 kg Tyre Tubeless Tubeless Tyre Size 90/100-10 53J 90/100-10 53J Brake Drum, 130mm dia Drum, 130mm dia Price (Ex Showroom Delhi) 47,204 44,200 Source: Company data, Credit Suisse estimates Return of market growth critical for 2W stocks We believe 2W stocks will continue to languish until market growth returns to double digits or the market share loss to Honda stabilises; we expect neither to happen in FY14. With Honda continuing to gain share, the domestic industry needs to grow at double digits for Hero and Bajaj to demonstrate domestic volume growth. The industry has been sluggish for nearly 18 months now as an adverse macro economy (high inflation, high rates, high fuel prices and low consumer sentiment in a weak economy) has affected demand. We expect this trend to continue in FY14, growing at ~5% before returning to long-term trend growth of 10-12% in later years. Whilst the trend of rising share of scooters should continue to gain momentum (helped by new launches), the trend towards premium bikes would require economic recovery and hence is likely to resume only in FY15.

India Two Wheeler Sector 9 09 July 2013

Trend towards premium bikes coming back important for Bajaj Between FY06 and FY11, the share of premium bikes increased from 9% to 18% on account of an aspiration to own more powerful and higher cc bikes. However, in the past two years, we have seen a trend reversal with the premium segment being the worst impacted due to the slowdown. Nonetheless, we believe the trend of the premium segment growing faster should return as the economy slowly recovers. This will benefit Bajaj the most since it has the highest share (~40%) in the premium segment and also the largest volume contribution (~27% vs 5% for Hero and 20% for Honda).

Figure 28: After a temporary blip in the past two years, the Figure 29: High growth in premium segment should return share of premium bikes in India will gradually move up in FY15E

Share of Premium motorcycles 30%

20%

20%

16%

10%

12%

0%

8%

-10% FY11 FY12 FY13 FY14E FY15E FY16E 4% FY06 FY08 FY10 FY12 FY14E FY16E Economy growth Executive Premium

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Scooters’ share will rise with economic development While 75% of two-wheelers sold in India are motorcycles, gearless scooters have been slowly gaining popularity, especially among women. The growing participation of women in the labour force has seen scooter growth well outpacing motorcycle growth, with the share of scooters increasing from 12% in FY07 to 22% at present.

Figure 30: Scooters' proportion as a percentage of total Figure 31: Scooters' share in Indonesia has grown from 2W population has direct correlation with district literacy ~25% in 2008 to 60% in 2012

35% 100% 11% 10% 9% 11% 14%

80% 28% 26% 39% 46% 52% 60% 21% 60%

40% 14% 63% 52% 45% 20% 38%

7% 26% Share of scooters in total 2W's total in scooters of Share 0% 0% 2008 2009 2010 2011 2012 70 75 80 85 90 Share of cubs in Indonesia Scooters Sports Maharshtra Districts Literacy (%) Source: : Maharashtra Govt, Credit Suisse estimates Source: Company data, Credit Suisse estimates Based on anecdotal evidence, in places where female literacy is high—states such as Kerala and big cities such as Mumbai and Delhi—the share of scooters is already 50%.

India Two Wheeler Sector 10 09 July 2013

On the other hand, in states where female literacy is low, such as Bihar and UP, the share of scooters is much lower. As female literacy improves, women are increasingly riding to school/college/work, which is driving growth for scooters. Maharashtra (the third largest state in terms of two-wheeler sales) is the only big state which publishes district-wise split in 2Ws between motorcycles and scooters. There is a strong correlation between the share of scooters in a district and some development indicators (literacy, per capita income, etc.). Hence, scooters will grow faster as the country develops. Experience from other countries shows that the share of scooters rises as markets mature. In Indonesia, for instance, the share of scooters as a percentage of the total 2W sales has risen from ~25% in 2008 to ~60% in 2012. This has been driven by increased congestion in road traffic, in which scenario, scooters being gearless, have greater ease of driving.

Figure 32: Scooter sales should continue growing faster Figure 33: Share of gearless scooters in India has been than motorcycles over the next few years consistently increasing 20% 30% 16% 15% 25% 15% 14% 14%

20% 10% 10% 9% 15% 5% 5% 10%

0% 5% FY13 FY14E FY15E FY16E 0% 0% -5% FY02 FY04 FY06 FY08 FY10 FY12 FY14E FY16E

Growth in motorcycles Scooters Share of gearless scooters

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Industry growth to remain subdued for second straight year With ~5% growth in motorcycles and 14% growth in scooters, we expect India’s 2W industry to grow ~6% YoY in FY14E and return to long-term trend growth of 10-12% from FY15. Hero Motocorp should see a 4% market share loss to Honda, while both Bajaj and TVS would see small market share losses from FY13-15E.

Figure 34: Volumes and market share forecast of different players in Indian 2W industry Volumes (mn units) YoY growth(%) Market share (%) FY12 FY13 FY14E FY15E FY13 FY14E FY15E FY12 FY13 FY14E FY15E Bajaj 2.6 2.5 2.5 2.7 -4% 2% 8% 19% 18% 17% 17% Hero Motocorp 6.1 5.9 6.0 6.4 -3% 1% 6% 45% 43% 41% 39% Honda 2.0 2.6 3.3 4.1 31% 27% 23% 15% 19% 23% 25% Yamaha 0.4 0.4 0.4 0.5 2% 14% 21% 3% 3% 3% 3% Suzuki 0.3 0.4 0.4 0.4 22% -6% 10% 3% 3% 3% 3% TVS 1.9 1.8 1.7 1.8 -7% -4% 4% 14% 13% 12% 11% Others 0.2 0.3 0.3 0.4 25% 18% 30% 2% 2% 2% 3% Total 13.4 13.8 14.6 16.3 3% 6% 11% Source: Company data, Credit Suisse estimates While near-term weakness exists, monsoon can be a surprise We believe 2W stocks will continue to languish until market growth returns to double digits or the market share loss to Honda stabilises; we expect neither to happen in FY14. However, if industry demand picks up on improving sentiment from good monsoons and then the festival season, there can be a positive surprise on volumes.

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Another factor to monitor will be where Honda’s monthly sales stabilise after two-three months, now that the Karnataka plant has been opened. Given that Honda’ competitive threat has been a big overhang on the 2W stocks, if Honda is unable to grow its motorcycle sales and Dream Neo largely cannibalises Dream Yuga, it can be a big positive surprise for the 2W stocks. We continue to prefer Bajaj over Hero, largely for its export potential and limited exposure to the Honda threat. For Bajaj, only ~50% of its revenues and ~40% of profits come from the domestic 2W market vs ~95% for Hero Motocorp. Moreover, Hero has a larger ~70% share in segments that Honda has not tapped yet but would be targeting soon, hence Hero is impacted much more than Bajaj. Changes to estimates We cut our earnings estimates and target price for Bajaj and Hero Motocorp by 1-3% as we lower our domestic volume growth assumptions for FY14 to ~0% for the two companies.

Figure 35: Changed summary for Hero Motocorp FY14 FY15 Old New Change Old New Change Volumes 6,364,852 6,214,904 -2.4% 6,806,221 6,686,581 -1.8% Sales 254,619 248,618 -2.4% 279,464 274,327 -1.8% EBITDA 35,501 34,589 -2.6% 39,306 38,567 -1.9% EBITDA margin 13.9% 13.9% 14.1% 14.1% PAT 22,110 21,512 -2.7% 28,990 28,506 -1.7% Source: Company data, Credit Suisse estimates Currency benefit for Bajaj could be more than what the street is estimating currently All of Bajaj’s USD hedges for FY14 are range forwards from 54 to 58 and with the currency currently at 61, Bajaj’s export realisation could be 58 instead of 54 that is currently built in our numbers. Moreover, the company has passed on just ~30% of the benefit to its overseas distributors vs its guidance of passing on 50%.

Figure 36: Changes summary for Bajaj Auto FY14 FY15 Old New Change Old New Change Volumes 4,543,401 4,464,049 -1.7% 5,120,494 4,987,357 -2.6% Sales 227,934 224,784 -1.4% 264,219 258,776 -2.1% EBITDA 43,371 43,070 -0.7% 51,242 50,553 -1.3% EBITDA margin 19.0% 19.2% 19.4% 19.5% PAT 35,419 34,949 -1.3% 41,080 40,331 -1.8% Source: Company data, Credit Suisse estimates Key takeaways from our dealer interaction We interacted with a number of 2W dealers of the top three players (Honda, Hero, Bajaj) across the country to gauge the demand mood and competitive dynamics in the industry. Below are the key takeaways:

■ Industry demand has seen no major pickup: The months of April and May were good for the 2W industry as the marriage season in the north Indian states such as Rajasthan and UP pushed up demand. Dealers in these states saw high-double-digit growth during the period (Hero being stronger in these states had particularly good growth). However, since nearly half of the sales during the season were marriage related, there has again been a moderation in sales from June post the end of the marriage season. Most dealers feel that from hereon good monsoons are a key to any demand revival.

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■ Honda dealers very optimistic; Hero and Bajaj dealers mixed: Most Honda dealers have had continuous 20-30% growth while Bajaj and Hero have been barely flat for the whole of last year (other than in April-May when Hero had 10% growth). It was not surprising that Honda dealers were very optimistic believing that the company can easily become the No.1 2W player in the country. Honda is already the No.1 2W player in a number of large cities given the higher share of scooters in these markets. Honda dealers continue to believe that they can sell a lot more Activas if they were to get a higher supply. Hero’s and Bajaj’s dealers while acknowledging Honda’s strength in scooters (and that Honda would continue to dominate that space) believe motorcycles would be much more difficult for it. Bajaj dealers want the company to venture into scooters and have been urging the company for some time, but the company is committed to further increasing its higher share in motorcycles before entering scooters.

■ Inventory under control, no major discounting: After increasing to record ~5 weeks in January, Hero’s inventory had come down to ~2 weeks by May and is now slightly less than the normal 3 weeks after a slow June. Honda dealers also largely have low inventories across models as they still have supply issues. While waiting periods on Honda’s models have gone, there are still instances of stock-out problems in Activa and Shine. Bajaj’s inventory is close to the normal 4 weeks. While there have been instances of aggressive financing there has been an absence of any direct discounting as the companies feel that cutting prices by small amounts doesn’t give incremental volumes and dilutes brands. All the three took price hikes in April.

■ New engine on Activa has improved mileage: Honda’s dealers said that the new HET engine on Activa has actually improved mileage by 7-8% and will further help it in consolidating scooter share. They were of the opinion that currently consumers are less willing to wait in case of shortages, and capacity constraints on Activa have led to lost scooter sales to other companies which should go away once supply improves. There have been no complaints on the new launches such as Dream Yuga and gradually the Honda brand is strengthening in motorcycles also for its higher quality (better mileage, smoothness, etc.).

■ Hero’s five-year warranty scheme a major confidence booster: Hero’s dealers said they didn’t see consumers having any major quality fears post the split with Honda. Moreover, the recent five-year warranty scheme introduced by the company has been a major success since it has allayed any possible fears on that front.

■ Hero has network advantage, Honda sells similar to Hero in urban India: Honda dealers argued that similar to Shine taking time to get acceptance, Dream Yuga too will need time and will gradually grow. In many parts of urban India, Honda is now bigger than Hero in 2W sales (including scooters). A large part of market share gain for Honda in motorcycles until now has been from urban consumers. There has not been a big shift in rural customers where Hero still has the brand and network advantage.

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Companies Mentioned (Price as of 08-Jul-2013) Bajaj Auto Limited (BAJA.BO, Rs1856.25, OUTPERFORM, TP Rs2090.0) Hero Motocorp Ltd (HROM.BO, Rs1651.85, NEUTRAL, TP Rs1710.0) Honda Motor (7267.T, ¥3,760) Suzuki Motor (7269.T, ¥2,432) TVS Motor (TVSM.BO, Rs31.85) Yamaha Motor (7272.T, ¥1,426)

Disclosure Appendix Important Global Disclosures Jatin Chawla and Akshay Saxena, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Bajaj Auto Limited (BAJA.BO)

BAJA.BO Closing Price Target Price Date (Rs) (Rs) Rating 26-Jul-10 1263.30 1139.62 N 20-Oct-10 1485.15 1531.52 22-Aug-11 1482.10 1552.00 * 20-Oct-11 1615.95 1641.00 03-Jan-12 1496.70 1670.00 03-Apr-12 1647.70 1651.00 18-May-12 1532.95 1779.00 26-Jun-12 1559.20 1776.00 18-Jul-12 1522.35 1854.00 O 29-Aug-12 1627.25 2152.00 NEUTRAL OUTPERFORM 02-Oct-12 1812.25 2123.00 22-Oct-12 1782.50 2073.00 08-Jan-13 2198.60 2530.00 17-Jan-13 2051.90 2537.00 03-Apr-13 1691.85 2259.00 17-May-13 1833.80 2126.00 25-Jun-13 1799.90 2132.00 * Asterisk signifies initiation or assumption of coverage.

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3-Year Price and Rating History for Hero Motocorp Ltd (HROM.BO)

HROM.BO Closing Price Target Price Date (Rs) (Rs) Rating 24-Sep-10 1865.15 1773.17 N 18-Nov-10 1912.85 2364.73 O 09-Feb-11 1439.65 2293.92 05-May-11 1697.90 2347.87 * 22-Aug-11 2005.95 2492.00 * 18-Oct-11 1984.85 2522.00 03-Jan-12 1837.50 2238.00 06-Mar-12 1867.10 2278.00 03-Apr-12 2009.90 2245.00 02-May-12 2245.00 2470.00 NEUTRAL OUTPERFORM 19-Jul-12 2087.50 2401.00 29-Aug-12 1849.65 2056.00 N 02-Oct-12 1881.20 1952.00 23-Oct-12 1795.95 1911.00 08-Jan-13 1879.10 1985.00 17-Jan-13 1818.50 1860.00 03-Apr-13 1498.85 1692.00 29-Apr-13 1648.65 1742.00 * Asterisk signifies initiation or assumption of coverage.

3-Year Price and Rating History for Honda Motor (7267.T)

7267.T Closing Price Target Price Date (¥) (¥) Rating 15-Dec-10 3,175 3,900 O * 24-Feb-11 3,475 3,920 27-Apr-11 3,100 3,740 01-Jun-11 3,120 3,830 31-Aug-11 2,474 2,640 N 01-Feb-12 2,674 * 09-Feb-12 2,822 * 05-Mar-12 3,050 3,400 N * 02-Apr-12 3,210 3,500 07-May-12 2,660 3,770 O OUTPERFORM NEUTRAL 01-Jun-12 2,459 3,150 20-Jun-12 2,576 3,400 06-Aug-12 2,470 2,850 05-Oct-12 2,422 2,670 N 29-Oct-12 2,399 2,410 16-Nov-12 2,591 2,570 16-Jan-13 3,280 3,600 21-Feb-13 3,475 3,570 02-Apr-13 3,370 3,710 20-May-13 4,275 4,710 03-Jul-13 3,815 4,360 * Asterisk signifies initiation or assumption of coverage.

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3-Year Price and Rating History for Suzuki Motor (7269.T)

7269.T Closing Price Target Price Date (¥) (¥) Rating 15-Dec-10 2,031 2,510 O * 24-Feb-11 1,879 2,270 27-Apr-11 1,877 2,150 22-Aug-11 1,497 1,820 N 18-Nov-11 1,565 1,860 29-Mar-12 1,985 1,900 05-Jun-12 1,579 1,830 21-Aug-12 1,563 1,540 19-Nov-12 1,866 1,860

08-Jan-13 2,303 2,090 U OUTPERFORM 16-Jan-13 2,354 2,180 NEUTRAL UNDERPERFORM 21-Feb-13 2,253 2,170 03-Apr-13 2,090 2,290 N 20-May-13 2,802 3,060 04-Jul-13 2,428 2,560 * Asterisk signifies initiation or assumption of coverage.

3-Year Price and Rating History for Yamaha Motor (7272.T)

7272.T Closing Price Target Price Date (¥) (¥) Rating 11-May-12 916 770 U * 28-May-12 711 770 N 16-Aug-12 712 960 O 17-Dec-12 962 960 N 16-Jan-13 1,052 1,090 21-Feb-13 1,068 870 U 02-Apr-13 1,198 840 20-May-13 1,614 1,050 03-Jul-13 1,404 1,015 * Asterisk signifies initiation or assumption of coverage. UNDERPERFORM NEUTRAL OUTPERFORM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin Ame rican and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; Australia, New Zealand are, and prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return relative to the average total return of the relevant country or regional benchmark. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

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Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

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Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 42% (53% banking clients) Neutral/Hold* 40% (49% banking clients) Underperform/Sell* 15% (38% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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Price Target: (12 months) for Bajaj Auto Limited (BAJA.BO) Method: Our Rs2,090 target price for Bajaj Auto is based on a P/E (price-to-earnings) of 15x Mar-15 earnings. Our valuation P/E is a 5% premium to the company's historic multiple, as we now have greater visibility on exports, and believe the company will witness robust growth in its FY14 exports. Risk: Key risks that could impede achievement of our Rs2,090 target price for Bajaj Auto include:muted recovery in export markets and Honda gaining higher than expected share in domestic markets

Price Target: (12 months) for Hero Motocorp Ltd (HROM.BO)

Method: Our Rs1,710 target price for Hero Motocorp is based on 12x Mar-15 earnings - 10% discount to historic multiples which we beleive is justified till company shows market share stability Risk: Key risk to our target price of Rs1,710 for Hero Motocorp include if there is a disruption caused by the fact that Hero Motocorp would shift to new brand identity along with Honda's entry in the Indian motorcycle market. The key upside risk is if Honda fils to make a dent in the market.

Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names The subject company (7267.T) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (7267.T) within the past 12 months. Credit Suisse provided non-investment banking services to the subject company (7267.T) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (7267.T) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (7267.T) within the past 12 months

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Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (7269.T, 7267.T, 7272.T) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (7267.T) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (7267.T). Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (BAJA.BO, HROM.BO, 7269.T, 7267.T, 7272.T) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (India) Private Limited ...... Jatin Chawla ; Akshay Saxena

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