2Ws: A case for multiples to contract
We cut our motorcycle industry growth forecast for FY13 from 14% to
8%. After three years of above trend growth, 2W growth is moderating.
Our analysis of 2W growth over the last 20 years suggests that it is
unlikely that growth will enter negative territory but mid-single
digit
growth for a couple of years cannot be ruled out. This is worrisome as
the
slowdown comes at the time of rising competition from HMSI, though we
expect competition to rise more in FY14 than in FY13. Shrinking
earnings
visibility given slowing growth and rising competition makes a case
for
multiples to contract. Stocks have started to underperform but we
believe
that it is still early days in the down-cycle and recommend investors
to
avoid 2W space. We downgrade Hero to SELL and maintain U-PF on Bajaj.
2W growth has started moderating
2W demand has started moderating in India as evidenced by the Dec-11
2W
volumes, management commentary and our channel checks with dealers.
Rural
demand seems to be finally weakening after displaying strong
resilience in CY11.
q Our analysis of 2W and GDP growth trends since 1990 makes us believe
that
negative or low-single digit growth in 2Ws happens when GDP growth
drop by
~400bps, which is not our base case for the Indian economy for FY13.
q However we do not rule out 2W growth slipping to mid-single digits.
Even if 2W
growth is just 5% in FY13 and FY14, the volume Cagr from FY07 (year
before
financing pull-out) to FY14 will be 9.6%, close to the 9.1% Cagr over
FY90-06.
q We view the ongoing growth moderation as being cyclical and not
structural. 2W
penetration is still reasonable at 35% of total households, though we
believe that it
will not be so reasonable after 5-7 years once it reaches 70% of
households
(implying 90%+ of affording households), which is when we expect
growth to
structurally moderate to mid-single digits.
Competition rising and margin outlook weakening
q FY13-14 will see HMSI turning aggressive in the executive bike
segment. HMSI's
2W capacity is set to rise to 4mn units by end-FY13 from 1.6mn units
in end-FY11.
q In the recent Auto Expo in Delhi, HMSI showcased the 110cc Dream
Yuga, which
we believe will be the first of many launches by the company in this
segment.
q However, we note that the Dream Yuga did not come across as a 'wow'
product to
us at the Expo and we are also concerned about the bike's
unconventional name.
q In FY13, HMSI will have 0.6m units capacity for new bikes, which
will rise to 1.8m
units in FY14 after commissioning of its third plant by end-FY13. We
expect more
executive segment launches from HMSI by end-FY13 and believe that
competitive
intensity in the 2W industry will rise more in FY14 than in FY13. If
this happens, 2W
incumbents might be able to defend margins in FY13.
q A drop in industry profitability though looks highly likely in FY14.
The experience of
Maruti over FY10-11 shows that incumbents choose to defend share at
the cost of
margins. While HMSI has not displayed any 'irrational pricing' thus
far (Dream Yuga
is priced at Rs46K – in line with Splendor and Passion), we expect
that Hero and
Bajaj will aggressively defend their turf, which will impact margins.
We downgrade Hero to SELL and retain U-PF on Bajaj
q We cut our motorcycle industry growth forecast for FY13 from 14% to
8%. This
drives a 4% cut for Hero's FY13 EPS. Our FY13 EPS for Bajaj gets cut
by a lower
2% as we now factor in higher export margins thanks to a weaker rupee.
q We see a strong case for 2W multiples to contract given weak
earnings visibility on
account of slowing growth and rising competition. We cut our target
multiple to
12.5x from 14x earlier. We downgrade Hero to SELL and retain U-PF on
Bajaj.
q On a relative basis we prefer Bajaj as – 1) rising competition from
HMSI should
hurt Hero more in FY13 since HMSI will focus on 100cc bikes, 2) Bajaj
has better
new product tailwinds with a new Pulsar due for launch in early-FY13,
3) Exports
are still growing well for Bajaj with higher margins as well thanks to
a weaker INR.
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