Bajaj Auto - Macquaire

Skidding on margins
Initiate with an Underperform
We initiate coverage on Bajaj Auto with a non-consensus Underperform rating and
a target price of Rs460, implying downside potential of 19% from the current level.
Our Underperform also reflects our negative stance on the two-wheeler space.
Automobile sector reeling under pressure
The automobile sector in general and the two-wheeler space in particular are
reeling under the impact of strong commodity prices on the one hand and a
strong credit crunch on the other. With large banks such as ICICI effectively
pulling out of the two-wheeler lending space (nearly 70% of vehicles are bought
on loans), volume growth remains a challenge even on a lower base. We expect
both these trends to continue in the near to medium term. Our view is reflected in
the lacklustre earnings and valuations of Bajaj Auto.
Bajaj – the perpetual challenger
Bajaj Auto’s plans to improve profitability and sales with a major thrust in the
most profitable executive segment by challenging Hero Honda seems to have
been thwarted with the below par performance of its new product launches over
the past two years – Discover, Platina and XCD. This has resulted in Bajaj Auto
losing market share to market leader Hero Honda (HH IN, Rs784, UP, TP:
Rs590) over the past two years. We remain sceptical on Bajaj’s ability to regain
lost ground through planned product launches (four in FY09).
Profitable three-wheeler space to slowdown
The three-wheeler segment – a highly profitable segment for Bajaj Auto (35% of
operating profit) – is reeling under pressure from a general economic slowdown.
While the domestic market seems to be on a steadily declining trend; export
markets have cooled down after a surge in the past two years.
Lacklustre outlook; below consensus earnings
Our EPS estimates (6% below consensus for FY09 and FY10) imply a CAGR of
5% between FY08−11E. We would expect volume growth to recover over the
medium term as and when the credit squeeze eases. However, with strong
competition and a negative product profile (lower proportion of profitable threewheelers),
we do not expect profitability to return to the peak levels of FY07.
Valuations could get cheaper
Bajaj’s valuations at 10x FY09E earnings are below its historical band but
broadly in line with its peers. However, valuations could come down further given
the poor growth scenario in the near-to-medium term. We value Bajaj Auto at
Rs460/share based on DCF, or an implied PER of 8x FY09E earnings.
Key risks
Key risks we see for Bajaj Auto include reduced competitive intensity amongst
the top two player leading to an improvement in overall profitability, macro
economic variables – including interest rates and GDP growth which could lead
to stronger than anticipated revenue growth, as well as delay in capacity
expansion or new product launches, particularly by new players.