Bajaj Auto scores over Hero in valuations, margins

Though Hero MotoCorp has posted strong volume gains, challenges on R&D, branding and inferior margins don’t justify its valuation premium.

While the automobile sector is experiencing growth hurdles, the stocks of India’s largest two-wheeler companies have been trading near their lifetime highs. Hero MotoCorp (HMC), on the back of robust rural sales which account for 45 per cent of its volumes, added 11 per cent to its shareholders’ wealth, while Bajaj Auto propped these by 14 per cent over the past month. The broader indices saw lower returns of six per cent during the period.

While analysts believe the interest rate rises may not impact sales, as about 70 per cent are on cash, the consistent petrol price hikes are likely to impinge on volume growth. “The 10th hike in over a year adds nearly Rs 11 to the cost of a litre of petrol and could impact volumes in the price-sensitive (two-wheeler) space,” says Nikhil Deshpande of Pinc Research.

While volume growth outlook for the two companies is healthy, analysts prefer Bajaj over HMC due to various reasons. Analysts have a sell rating on HMC due to the jump in stock valuations. The stock is trading at 16.7 times its 2012-13 earnings estimates, much higher than the average of 14.3 times for the past five years. Bajaj Auto trades at 14.8 times its 2012-13 earnings estimates and analysts believe the discount vis-à-vis HMC is not justified, given the uncertainties for the latter in terms of technology, branding, export sales and higher competition in the rural markets. Besides, Bajaj’s margin profile is also better. A majority of analysts have a ‘buy’ on the Pune-based company, Bajaj Auto.

HMC HOLDS TURF
HMC has stood out, with sales recording a jump of 21 per cent to 2.52 million units in the first five months of 2011-12 (till August), compared to the period in 2010-11. The company is on target to reach the six-mn mark by the end of 2011-12. Bajaj Auto has recorded sales growth of 16.7 per cent to 1.6 mn during the period. After losing market share to its smaller rival in FY10 and FY11, robust volume growth from the rural segment helped HMC gain 200 basis points in market share to 56.5 per cent in calendar year 2011 (till July), as compared to 150-bps drop for Bajaj Auto to 25.4 per cent during the period. HMC has a relatively higher exposure than Bajaj to rural markets, where demand has been good due to higher incomes and rising aspirations.

Despite the break-up in the joint venture with Honda Motors in December 2010, HMC has been able to improve its position in the market place. Though the recently launched Boxer 150 (of Bajaj) at a competitive price (Rs 43,000) and the Honda bike (100cc) to be launched towards the beginning of next fiscal year could pose problems, HMC’s strengths in the medium term, be it strong brands such as Passion and Splendor, and the unparalleled distribution reach will be difficult to dislodge, says an analyst.

BAJAJ LEAD TO STAY
After trailing HMC in 2008-09, Bajaj’s changed sales mix (higher share of executive and premium bikes) helped it to surpass HMC’s volume advantage and post superior margins in 2010-11. The margin gap (540 bps in FY11), mainly due to higher royalty and advertising costs (for HMC), is likely to continue in the medium term, believes Deutsche Bank’s auto analyst, Srinivas Rao. While the technology transfer agreement runs out in 2013-14, HMC will have to increase its research and development spend to maintain the edge over competition, say analysts.

R&D expenses at about Rs 32 crore for 2010-11 are much lower as compared to Rs 100-130 crore for Bajaj Auto. The expenditure is 0.2 per cent of sales for FY11 and could be ramped up by HMC to 1-1.5 per cent of sales in 2011-12, believe analysts.

EXPORTS, TAXES

For Bajaj Auto, the reduction in export benefits from nine per cent to 5.5 per cent could impact net profits by about Rs 150 crore. However, analysts believe the price hikes from October 1, as well as the currency weakness (seven to eight per cent depreciation of the rupee since August) offer the company leeway to gradually increase prices and will support margins.

HMC and Bajaj Auto are likely to lose tax concessions for their Hardwar and Pantnagar plants in 2012-13 and 2011-12, respectively. While the impact on Bajaj would be minimal, as about five to eight per cent of profits are contributed from the plant, tax rates after 2012-13 for HMC are likely to go up to 22 per cent from the current 17-18 per cent.