Market leader to feel the heat in FY11

Bajaj Auto’s splendid performance in the just-concluded quarter did not go unnoticed. The market sent the scrip to its one-year high on Thursday. The company, which had two forgettable years prior to 2009-10, bounced back with a twin-brand strategy and new product launches. Its, rival Hero Honda, too, has been hovering near its 52-week high since its results were announced last month.

Both benefited from a surge in volumes as demand recovered strongly. The operating leverage — along with lower raw material costs, better product mix and tax breaks — helped them achieve record margins.

Volumes show the way
Hero Honda led the way, recording a 24 per cent year-on-year growth in sales volume to a record four million units for the financial year. Bajaj Auto, too, was not far behind with 2.8 million units, notching a 30 per cent volume gain on the back of robust demand and Discover launches spanning the entire 100-135cc segment. For 2010-11, while Hero Honda is looking at a sales target of about 5.2 million units (15 per cent growth), Bajaj Auto has set an ambitious target of four million units — 43 per cent higher than in 2009-10.
 

RACING AHEAD
FY10	Bajaj Auto *	Hero Honda
Volumes (lakh)	28.52	46.00
Growth (%) y-o-y	30.00	23.60
Realisation (Rs)	40,473	34,256
Net sales	11,543	15,758
Growth (%) y-o-y	36.40	28.00
RM as % of sales	66.80	68.10
Ebitda	2,505	2,742
Ebitda Margin (%)	21.70	17.40
Net profit	1,703	2,231
Growth (%) y-o-y	159.80	74.10
P/E (x) (FY11E)	17.80	15.90
* Standalone performance                                  E: Estimates

Margins surge 
Volumes, tax breaks and lower raw material costs worked wonders for the two companies. Hero Honda’s raw material costs, as a percentage of sales, came down 500 basis points over the last one year, improving earning before interest, taxes, depreciation and amortisation margins by a similar metric.

While Hero Honda’s margins were the highest in the September quarter (nearly 18 per cent), Bajaj Auto improved its margins in every passing quarter, finishing the March 2010 quarter with an unheard of figure of nearly 23 per cent.

The dream run, however, might not last. Analysts have indicated the margins are unsustainable owing to high raw material costs. While Bajaj Auto believes it can maintain about 20 per cent margins for 2010-11 through a combination of product and sales initiatives, Hero Honda feels volume-driven discounts from vendors could do the trick for it.

Investment rationale
While Hero Honda continues to lead the two-wheeler segment (59 per cent market share), it has been ceding market share to Bajaj Auto (about 24 per cent). The battle between the two companies will be decided in the executive segment (Rs 40,000-55,000 price band), which accounts for about two-thirds of industry sales and about 80 per cent of Hero Honda’s sales.

Analysts expect Hero Honda’s market share to drop to about 55 per cent in 2010-11 and Bajaj to be the main beneficiary of this. Both stocks (more so Bajaj Auto) have run up substantially over the last one year and are fully priced at the current level.

Investors can look at them on dips.