>AUTOMOBILES SECTOR (GOLDMAN SACHS)

Initiate on Indian 2-wheelers; Sell Bajaj Auto, Neutral Hero Honda

■ Initiate coverage: Defensive exposure, but well priced in
We initiate coverage on the Indian 2-wheeler automobile industry with a Neutral sector stance and 2 stocks representing 30% of Indian auto industry’s market cap. We like the structurally under-penetrated nature of Indian market and the strong brand franchise of companies under coverage. However, given that valuations have already moved higher (stocks are up 100% on average ytd), risk/reward appears fairly balanced, in our view. The sector is currently trading at an average of 16X FY10E P/E, and offers 20% CAGR earnings growth over FY09E-FY11E. Our positive outlook on the sector is offset by financial market weakness and competitive headwinds, particularly in the premium segment of the market.

■ Exploring global and Indian industry themes
Themes explored in this report are: (1) oligopolistic nature of the 2-wheeler industry globally – implications for India; (2) structural reasons behind superior earnings growth and returns of Indian 2-wheeler companies; (3) sustainability of Hero Honda’s dominant franchise; and (4) the position of stocks on P/B, CROCI, and DCF-based valuation metrics.

■ Bajaj Auto – Growth interrupted, rich valuations, Sell
We initiate coverage on Bajaj Auto (BAJA.BO) with a Sell rating and a 12- month FY11E P/E-based target price of Rs705 implying 25% potential downside. We believe that currently the market is overestimating the impact of new model launches on Bajaj Auto’s market share and profitability over FY09E-FY11E. Intensifying competition and macroeconomic demand headwinds in the premium segment of the market are the catalysts likely to drive stock-price underperformance in, our view.

■ Hero Honda – Structural leader, fairly valued, Neutral
We initiate coverage on Hero Honda (HROH.BO) with a Neutral rating and a 12-month FY11E P/E-based target price of Rs1,399 implying 10% potential upside. We believe that Hero Honda’s market leading growth and returns are already priced in at current levels; as a consequence, we would wait for a more attractive opportunity to gain exposure to this stock.

■ Risks
Key risks include: (1) Competitive pressure from operators such as Honda and Yamaha and (2) macroeconomic headwinds to demand growth.

To see full report: AUTOMOBILES SECTOR