>TWO WHEELERS (ICICI SECURITIES)

Circumventing potholes

The two-wheeler segment, after a sharp recovery in the recent months, is heading towards rough weather – Deficient monsoons impacting rural income is likely to affect segmental growth post H2FY10. Although profitability of players is expected to be robust, we prefer companies with higher revenue diversification, which would de-risk the domestic growth slowdown. We initiate coverage on two-wheeler sector with Bajaj Auto (BAL) as BUY, Hero Honda Motors (HHML) as HOLD and TVS Motors (TVSM) as SELL.

■ Two-wheeler growth to moderate. We expect the domestic two-wheeler segment to grow at a moderate 10.3% over FY09-11E after a sharp 15.8% recovery in 4MFY10. The rural segment is a key long-term growth driver for the industry on account of lower penetration level and rising rural income. Due to 24% lower monsoons during June-August ’09, agricultural income would be affected, taking a toll on rural segment growth. Higher liquidity and decline in interest rate would be incrementally positive for retail sales. However, exports will likely grow at 8.2% over FY10E-11E, de-risking companies against further decline in domestic growth.

■ Profitability to be robust. Two-wheeler players would post improved profitability due to sharp decline in raw material costs, which hurt margins in FY09. HHML and BAL would continue to benefit from fiscal incentives from their Uttaranchal plants, thereby improving profitability. We expect the industry’s EBITDA margin to expand 440bps YoY over FY09-11E, as indicated by the sharp margin expansion in Q1FY10 results.

■ HHML – Initiate with HOLD and Rs1,650 target price. HHML is trading at FY10E & FY11E P/E of 17.7x and 14.2x respectively. Our one-year target price is Rs1,650, based on FY11E P/E of 15x. HHML will maintain its leadership in two-wheelers, which is factored in higher valuations. Key risk is the impact of dismal monsoons on rural segment growth. HHML’s FY09 dividend yield is 1.3% and cash per share Rs180.

■ BAL – Initiate with BUY and Rs1,400 target price. Higher-than-expected growth in exports, passenger three-wheeler segment and decline in raw material costs would drive BAL’s profitability. BAL enjoys the most diversified product portfolio with threewheelers and spares together accounting for 31.6% of net sales. We expect recurring net profit CAGR to be 44.1% over FY09-11E. Our one-year target price is Rs1,400 based on FY11E P/E of 14x (in line with current valuations, discount to HHML). BAL’s FY09 dividend yield is 1.8% and cash per share Rs82.

■ TVSM – Initiate with SELL and Rs34 target price. TVSM has been losing market share in motorcycles and scooters, while strengthening its position only in mopeds. We expect market share losses to continue. Recent margin uptick would not be sustainable due to high cost structure and losses from the Indonesian subsidiary. Our one-year target price is Rs34 based on FY11E EV/E of 12x (premium to peers).

To see full report: AUTOMOBILE SECTOR