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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). DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 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 inScootersshare 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. 300,000 Even with constant capacity increases in aIncrease phased to 4manner Mn Honda has been operating at near 250,000-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 200,000-up with each of these capacity increases. It has again increased capacity to 4 mn unitsIncrease by ope to 2.2ning Mn a new plantIncrease in Karnataka to 2.8 Mn and has set an aggressive target of 3.9 mn units 150,000 sales in FY14, implying operation at full utilisation should sustain. Figure 13Capacity: Honda’s 1.6 Mnmarket share in 2Ws has increased Figure 14: Each capacity expansion of Honda has led to 100,000 ~600 bpApr-11 in theJul-11 pastOct-11 18 mJan-12onthsApr-12 Jul-12 Oct-12 Jan-13 Apr-13 an increase in run-rate Honda Domestic 2W sales 100% 7% 7% 8% 7% 15% 14% 13% 12% 80% 13% 15% 19% 21% 60% 45% 45% 40% 43% 43% 20% 20% 19% 18% 17% 0% FY11 FY12 FY13 1QFY14 Mkt share 2W's Bajaj Hero Honda TVS Others 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).

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