TVS Motor: Impressive volumes, margin gains disappoint

The company has a target of improving margins from 6.1% to 10% over three years

For yet another quarter, TVS Motor's margins disappointed the Street despite a sharp jump in volumes.

After the results on Friday, the stock shed seven per cent over two trading sessions. The earnings before interest, taxes, depreciation, and amortisation (Ebitda) margins have largely been stuck at the six per cent mark recently though the volume show has been impressive with the July-September quarter registering a 35 per cent increase year-on-year.

In addition to attractive valuations, among the reasons investors have been buying the stock (up from Rs 50 to Rs 250 over the last year) has been on expectations higher volumes and increased market share would lead to operating leverage, helping the company improve its profitability. While the company has been able to improve its volumes (up 34.7 per cent year-on-year to 676,000 units), as well as the market share, higher margin gains have been elusive.

Analysts at Sharekhan said the stunning growth in volume had failed to make any meaningful impact on the profitability. Despite the 30 per cent-plus volume growth, margins continued to hover near six per cent, significantly lower than peers Hero MotoCorp (13.5 per cent) and Bajaj Auto (20 per cent).

While the Ebitda margins did go up by 20 basis points to 6.1 per cent year-on-year, higher raw-material costs, which were up 190 basis points due to adverse product mix and other expenses (marketing spend) on the launches of Star City and Scooty Zest, pegged back profitability gains. On a sequential basis, margins were higher by 40 basis points.

Kaushal Maroo of Emkay Global Financial Services said that tepid margins could be due to aggressive pricing of launches and continued spending on the brand-building of these products.

While the company is expected to invest in growing its brands and improving its share, analysts expect marketing spends as a percentage of overall sales to come down as the company is done with its launches. Further, while the company has taken a small price rise to take care of higher costs, given benign commodity prices, expect raw-material costs to come down.

While there is little doubt the volumes have risen sharply from 476,000 units at the start of FY14, this is yet to translate into superior margins. Volume growth is expected to be strong, given coming launches of New Victor and Apache in 2015. Led by motorcycles, exports too have been growing at a fast clip, with the September quarter growth pegged at 28 per cent. Most analysts believe that volume growth will continue to be in strong double digits. Volume growth, coupled with better product mix, is expected to improve its margins. The company is targeting an Ebitda margin of 10 per cent over three years. Despite the strong outlook on the volumes and market share fronts, about 70 per cent of analysts have a sell or a hold rating on the stock. Given the sharp run of the stock, it is discounting its FY16 earnings by 20 times compared to bigger peers Bajaj Auto, Hero MotoCorp; both trade at 16-18 times FY16 earnings. While analysts believe the company's earnings will grow at an annual rate of 40 per cent in FY14-17, most say the gains are priced in and the company trades at rich valuations. Continued momentum of its current models, as well as positive response to launches, coupled with improvement in operating performance, specially margins, will be the key trigger to watch.