Bajaj Auto: Initiating Coverage

Morningstar Analyst Manish Vaswani believes increasing exports and premium product sales should boost Bajaj's returns. Shares are currently trading in the three-star territory.
By Manish Vaswani |  10-08-12 | 
 
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About the Author
Manish Vaswani is an equity research analyst on Morningstar's India team, based in Mumbai.

The article below is part of the Morningstar Analyst Manish Vaswani's Stock Analyst Report for Bajaj Auto.

Registered Morningstar users can read the complete PDF (which includes our take on the firm's valuation, growth and profitability) here.

Thesis

Bajaj is the largest three-wheeler, the largest premium motorcycle, and the second largest two-wheeler maker in the Indian passenger vehicle market. Its market position, along with a strong distribution and retail network lends Bajaj a narrow economic moat, in our view. However, increasing competition in the domestic market is likely to erode Bajaj's margins over time. The company's rising export and premium motorcycle business should enhance revenue growth, but won't fully alleviate domestic competitive pressure on market share and margin.

Bajaj, an erstwhile Indian scooter company, has successfully diversified into the motorcycle space. The company's association with Kawasaki, and its aggressive spending on capacity and its brand, have helped Bajaj emerge as a strong player in the Indian motorcycle market. In the domestic market, the company commands a 45% market share with its Pulsar brand in the fast-growing high-margin premium motorcycle segment, which accounts for 17% of the overall motorcycle market.

Additionally, in the domestic three-wheeler industry, Bajaj is the dominant player, with the most respected three-wheeler brand. Although, the company's share in the combined passenger carrier and goods carrier market has declined from about 45% in 2007 to about 40% in 2012, Bajaj has been able to hold its market share in the high-margin higher volume passenger carrier business, at 48% levels over the same period. This is way ahead of Piaggio, the closest competitor, which holds 32% market share. In 2012, however, both the premium motorcycle and the passenger carrier three-wheeler segments contracted a bit, and may decline marginally this year owing to a decrease in demand due to high inflation and interest rates. Nevertheless, we expect these segments to rebound by 2014 as interest rates ease.

We also believe increased rural market penetration, customers' increased purchasing power, and expected strong replacement demand will contribute to a rebound for the premium motorcycle segment. Additionally, strong launches this year should further promote Bajaj's continued dominance in this segment. We also expect the premium segment to grow faster than the overall market, and for Bajaj to reap a commensurate share. As premium products become a larger part of the company's total revenue, Bajaj's product mix should become richer, enabling profit margin expansion.

We think Bajaj is well-positioned in the faster growing, higher volume passenger carrier three-wheeler market. The company is the only two-wheeler maker with a presence in the three-wheeler product segment, which generates relatively higher margins. Bajaj recently exhibited the four-wheel RE 60, its latest passenger carrier. It is intended to replace the passenger carrier three-wheelers on Indian roads as a safer and sturdier alternative. As a result, we expect the RE-60 to partially cannibalize Bajaj's three wheeler sales in the short term. However, we think the combination of both three-wheeler and four-wheeler passenger carrier vehicles will enhance Bajaj's revenue, market share and margins beginning in 2014.

Bajaj's vast distribution and domestic retail network also provides it with a key competitive advantage compared to smaller players and new entrants.

The company has 600 primary dealerships, which places it midway between Hero MotoCorp, (India's largest two-wheeler manufacturer) and Honda Motorcycles and Scooters India’s, HMSI (the country’s third largest two wheeler manufacturer). However, both Hero MotoCorp and HMSI compete primarily in the domestic executive motorcycle and scooter segments. This leaves Bajaj, with its dealership/retail network spanning urban, semi-urban and rural markets, as the dominant player in the premium motorcycle and three-wheeler segments. This advantage certainly aides in creating an economic moat for Bajaj. However, foreign competitors such as Honda HMC, Suzuki, and Yamaha are aggressively expanding their dealer network targeting the premium segment. As a result, we expect Bajaj's dealer advantage to gradually erode.

The company is India's biggest exporter of motorcycles and three-wheelers. Its increased focus on exports has effectively changed its domestic/exports revenue mix from 88%/12% in 2006 to 65%/35% in 2012. This has diversified the company's revenue streams, and enabled it a strong presence in Africa, Southeast Asia, and Latin America. Bajajs Boxer is one of the largest selling brands in Africa, while Pulsar is a well-recognized brand in Latin America.

We expect the company to grow its export business such that it contributes nearly 50% of Bajaj's revenue by 2020. Due to the exports' profitability, we believe it will partially offset the downward pressure we expect from increasing competition in the domestic motorcycle and three-wheeler markets. Consequently, over the long run, we expect gradual erosion in the company's excess returns on invested capital over its cost of capital.

Risk

Bajaj Auto's operations are exposed to highly cyclical industry demand, and are capital intense, which impacts profitability due to high operating leverage. The company's operations are also subject to fluctuations in exchange rates with respect to the countries in which it sells. In addition to cyclical demand, production volume and product mix can sometimes be difficult to plan due to intensifying competition, changing customer preferences, and supply chain disruptions. Furthermore, increases in capital expenditures and research and development expenses to meet stringent government regulations could result in lower margins. An increase in input prices such as commodities, land, manpower, technology and energy would also have an adverse impact on the company's profitability.

Company Profile

Founded in 1945 as an automotive sales company, Bajaj is today the third largest manufacturer of motorcycles and the largest manufacturer of three wheelers in the world. Based out of Pune, Maharashtra, India, the company offers a range of motorcycles and three wheelers across different segments not only in India but in 50 countries worldwide. During the fiscal year ended March 31, 2012 (fiscal 2012), Bajaj sold about 4.35 million vehicles, including about 1.58 million units of exports with INR 199 billion in consolidated revenues.

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