TVS Motor rides on defensive theme

Steady growth outlook, no major downside risks and fair valuations allow a low-risk alpha quest from potential triggers

While rising interest rates and slowing demand have hurt economic growth in recent months, two-wheeler volumes have stayed relatively true to their defensive positioning. TVS Motor Company, the second-largest player in the scooters and mopeds segments, with presence in motorcycles and three-wheelers, is also expected to report healthy growth in volumes. More so because there is potential for the margins to expand. Along with an expected turnaround of its Indonesian subsidiary, this should help it report a faster growth in profits in the coming quarters. Analysts say, given the growth outlook for TVS, there is about 15 per cent upside potential for the stock from the current Rs 60.

HEALTHY VOLUME GROWTH

Analysts expect the volume growth witnessed by the industry to sustain on the assumption of a strong rural demand, given low penetration levels, improving incomes and relatively lower dependence on financing for purchase. TVS Motor is expected to clock a compounded annual growth rate (CAGR) of 12 per cent, in line with the industry, over the next couple of years, says Mohan Lal, auto analyst, Elara Securities.

The view is based on its strong presence in scooters and mopeds, which should see relatively stable demand and growth, as the competitive intensity is significantly lower. These segments contribute 56 per cent to TVS’ revenues. Its market share is 22 per cent in scooters, where it is the second-largest player, and volumes have grown at nearly 18 per cent CAGR in the last five years. With its newly-launched Wego and a new variant of Scooty (below 100cc), TVS should clock 16-18 per cent year-on-year volume growth in 2011-12, believe analysts, moderating slightly due to the impact of Honda’s initial capacity expansion.

In the mopeds segment, where it is the only player, TVS has grown by 17.6 per cent year-to-date and should clock volume growth of about 13 per cent in FY12, according to Elara.

However, motorcycle and three-wheeler sales are areas of concern, believes Chirag Shah, analyst, Emkay Research. Competitive pressures in the motorcycles segment, alongside a relatively weaker product profile, are expected to keep volumes subdued for TVS, with growth estimated at just over six per cent CAGR over the next two years.

Three-wheeler volumes and market share dropped sharply last quarter, but its prospects are improving. The company had seen robust three-wheeler volume growth, with market share increasing from 1.7 per cent in FY09 to 5.2 per cent in FY11.
Going ahead, volumes are expected to recover and grow by 18.3 per cent CAGR for FY11-13, believes Gopal, with an added kicker from 40,000 new licence permits to be announced in Karnataka.

EXPANSION IN MARGIN AND EARNINGS

With improved product mix from increasing scooter and three-wheeler (higher margin) sales, as well as lower product development expenses, margins could expand by about 50 basis points, says Shah. TVS had raised prices in July, which should help margins this quarter. Even with margins around current levels and only nominal growth in three-wheeler and export volumes, a steady top-line outlook should translate into earnings per share (EPS) growth of 22 per cent CAGR over the next two years.

ADDITIONAL KICKERS

TVS’ current cost structure translates to the weakest margin profile among its peers (earnings before interest, taxes, depreciation and amortisation margin of 7.2 per cent). It has high indirect costs, including advertising spends on par with its peers, despite the lower volume base, observes Lal. This, however, means a significant operational leverage from higher-than-expected volumes. The low-margin profile also lends to a disproportionately beneficial impact from softening raw material costs. The company saw input costs rise last quarter (160 basis points sequentially to 74.7 per cent of net sales) because of vendor price hikes. But the management had said further increases weren’t expected immediately and raw material prices should soften gradually.

VALUATIONS

The stock outperformed the Bombay Stock Exchange Auto index by eight per cent last month. This factors in an improving outlook for its loss-making Indonesian arm and TVS believes losses should come down from Rs 62.3 crore in FY11 to Rs 20.4 crore in FY13. The management also expects a break-even in CY13, according to a Brics Research report. However, the performance of the Indonesian subsidiary and continued losses remains a key risk.

TVS’ inability to establish a convincing motorcycle product presence beyond the Apache, especially in the executive segment, has weighed on its margins and valuation versus peers. The stock currently trades at a price-to-earnings ratio of about nine times FY13 EPS estimates, as against 13-15 for Bajaj Auto and Hero MotoCorp.

While this isn’t expected to change soon, given that there are no major downsides visible, Lal of Elara Securities believes TVS is only going to improve from these levels. Based on the earnings’ outlook, analysts see a decent upside of around 15 per cent for the stock from current levels. This outlook, however, does not factor in any expansion in valuation multiple or margin improvement (additional kickers), which is where the potential alpha lies for investors.