Auto Sector Intiation Sep2010

All rights reserved. Standard Chartered Bank 2010

IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX. http://research.standardchartered.com

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Amit Kasat [email protected] +91 22 6751 5816

India | Automobiles & Parts

EQUITY RESEARCH

2 September 2010

India Auto Sector

Foot off the accelerator? Not yet

All rights reserved. Standard Chartered Bank 2010

IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX. http://research.standardchartered.com


India | Automobiles & Parts

EQUITY RESEARCH

2 September 2010

India Auto Sector

Foot off the accelerator? Not yet

We are upbeat on India’s auto sector given strong macro drivers, healthy margins and still reasonable valuations relative to growth. Though all stocks could be swept up in the surge, we prefer companies with likely market share gains, good return ratios and strong cash flows. We have a contrarian view on Maruti Suzuki (where we think the worst is behind and in the price) and expect Bajaj Auto to command a premium over Hero Honda. We also initiate on Mahindra & Mahindra and Tata Motors with Outperform, Ashok Leyland with In-Line, and Hero Honda and TVS Motor with Underperform.

Strong macro drivers to boost volume growth – We expect the sector to report ~20% volume CAGR over FY10-12 given India’s strong macro drivers – fast-growing per capita income, favourable demographics, shifting consumption patterns and easier credit availability. Our analysis also shows that monetary tightening would only have a limited impact on growth.

Margins to stabilise lower, but be healthy relative to history – From the FY10 peak, we expect margins to decline by 120-130bps after factoring in a 200bps increase in raw material costs. This builds in a cushion against any commodity price fluctuation. Notwithstanding this, the sector’s FY11 EBITDA margin is likely to be a healthy 12-13%, aided by productivity improvements and operational leverage, and still be respectable vs historical performance.

Sector valuation to catch up with broader market – Given the auto sector’s superior earnings growth compared with the Sensex (43% vs 20%), we expect the sector’s current ~16% discount to Sensex multiples to narrow significantly. We, in fact, expect sector valuations to do much better than the historical average discount of 10-12%.

Top picks – Maruti Suzuki (our contrarian call; valuations depressed beyond realistic levels), Bajaj Auto (gaining market share, most profitable two-wheeler company), M&M (strong core business outlook), and Tata Motors (riding the commercial vehicle cycle, recovery at JLR).

Risks – Competition is intensifying given the entry of more global majors across all segments, which could lead to aggressive price wars to gain market share. Other risks: higher-than-expected monetary tightening/interest rates/commodity prices.

India Auto Sector Valuation Matrix Mkt cap Price FV EPS (Rs) EPS CAGR PE (x) EV/EBITDA (x)

BB code Rec (US$bn) (Rs) (Rs) FY11e FY12e FY10-12e (%) FY11e FY12e FY11e FY12e Ashok Leyland AL IN I/L 2.1 72 79 4.4 5.7 40.4 16.3 12.6 10.4 8.3 Bajaj Auto BJAUT IN O/P 8.9 2,780 3,260 175.4 203.2 27.2 15.8 13.7 11.2 9.4 Hero Honda HH IN U/P 7.9 1,785 1,901 116.4 134.3 9.6 15.3 13.3 11.2 9.1 M&M (SA) MM IN O/P 7.7 611 762 40.8 45.6 16.8 15.0 13.4 8.9 8.0 Maruti Suzuki MSIL IN O/P 7.8 1,218 1,478 90.3 113.7 14.2 13.5 10.7 6.4 4.8 Tata Motors (SA) TTMT IN O/P 12.6 991 1,452 28.9 38.7 28.9 34.3 25.6 9.8 8.2 TVS Motors TVSL IN U/P 0.8 143 146 8.0 10.9 42.3 17.8 13.1 7.9 6.2

Note:O/P=OUTPERFORM,U/P=UNDERPERFORM,IL=IN-LINE; SA: Standalone; Stock prices as at 26 Aug 2010; For Tata Motors and M&M consolidated numbers please see pg 8

Source: Company, Bloomberg, Standard Chartered Research estimates

Top picks:

Maruti Suzuki

Bajaj Auto

M&M

Tata Motors

Sector research – India Auto | 2 September 2010

2

Contents

Investment argument and valuation 3

Sector valuation 4

Company valuation 9

Top picks 12

Strong macro drivers to boost volume growth 13

Macro drivers favour the sector 13

Macro factors impacting the various segments 15

A rewind of FY10 16

Sector volume assumptions – FY11-13e 16

Segment-wise volume growth assumptions 17

Monetary tightening would push up ownership costs 19

Scenario analysis – Impact of higher interest rates 20

Margins to stabilise lower, yet remain healthy 21

Raw material costs to increase 200bps 21

Assumptions for our forecast period 21

Flexible strategies that auto OEMs can adopt 22

Industry utilisation to improve to 88.7% in FY11e 23

Fundamentals intact, competition intensifies 24

Cash generation likely to improve 24

Competition intensifies across segments 25

Company section 27

Ashok Leyland 28

Bajaj Auto 40

Hero Honda 57

Mahindra & Mahindra 69

Maruti Suzuki 84

Tata Motors 96

TVS Motor 113


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Investment argument and valuation We are upbeat on India’s auto sector given strong macro drivers, healthy margins and still reasonable valuations relative to growth. Though all stocks could be swept up in the surge, we prefer companies with likely market share gains, good return ratios and strong cash flows. We have a contrarian view on Maruti Suzuki (where we think the worst is behind and in the price) and expect Bajaj Auto to command a premium over Hero Honda. We also initiate on M&M and Tata Motors with Outperform, Ashok Leyland with In-Line, and Hero Honda and TVS Motor with Underperform.

Strong macro drivers to boost volume growth

FY10 was a landmark year for India’s auto companies (excluding Ashok Leyland). They reported all-time high unit sales, strong volume growth and record profits. The performance came on the heels of an economic downturn in FY09, making it more remarkable. Going forward, we expect the sector to report volume CAGR of 19.8% over FY10-12e, compared with 25.6% in FY10.

We believe that fundamental factors – India’s high per capita income growth, recovering urban demand, aggressive vehicle financing, among others – are intact and favour the sector, though monetary tightening could raise the cost of ownership in the short term. Furthermore, recent monsoon rainfall data suggest a normal to above-normal monsoon with good spatial distribution, that augurs well for agri-GDP growth in FY11.

Fig 1 – Industry volume growth (FY02-13e)

(‘000s) PV LCV M&HCV 2W 3W Total % Growth

FY02 722 64 95 4,306 216 5,402 FY03 779 82 121 5,060 275 6,317 16.9 FY04 1,027 108 169 5,622 336 7,262 15.0 FY05 1,229 136 211 6,573 374 8,524 17.4 FY06 1,319 171 221 7,571 436 9,718 14.0 FY07 1,578 223 295 8,492 548 11,136 14.6 FY08 1,766 253 294 8,069 506 10,888 -2.2 FY09 1,872 227 199 8,442 497 11,238 3.2 FY10 2,423 308 265 10,511 613 14,120 25.6 FY11e 3,143 362 320 13,105 706 17,637 24.9 FY12e 3,674 413 361 15,060 767 20,275 15.0 FY13e 4,183 455 398 16,789 810 22,635 11.6

Source: Society of Indian Automobile Manufacturers (SIAM), Standard Chartered Research estimates

Sector margins to stabilize at 12-13%

We expect commodity price risk to be offset by productivity improvements and operational leverage. This will enable auto companies to maintain EBITDA margins of around 12-13% over FY11 and FY12, 140bps lower yoy, but still healthy.

The auto sector’s raw material to sales ratio rose from 69.6% in 1Q FY10 to 72.5% in 1Q FY11. The main reasons: key input prices around 50% higher; rise in excise duty; and cost of implementing new emission norms. Given these, most OEMs raised prices in the past 12 months. Nevertheless, demand has continued to be strong.

We expect 19.8% CAGR in sector volume over FY10-12e

India’s strong macro-economic fundamentals driving growth

At 12-13%, sector margins 140bps lower yoy but still healthy


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Fig 2 – Trend in industry EBITDA margins (FY99-13e)

9.68.3

4.7

11.7

13.612.9 13.2

12.311.6

9.6

14.112.9 12.7 13.3

14.7

0

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8

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16

FY99

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FY02

FY03

FY04

FY05

FY06

FY07

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FY10

FY11

e

FY12

e

FY13

e

%

Source: Companies, Standard Chartered Research estimates

We believe that companies would not run the risk of increasing their channel inventories as we expect moderate demand growth over FY11-12 (compared with growth seen in FY10) and a high premium credit environment over the medium term.

Fundamentals intact, competition intensifying

We expect Indian auto companies to continue to report strong cash flows and good return ratios, even though competition is intensifying given the entry of more global majors.

We believe competition is set to rise over FY10-12, driven by the entry of Toyota and Nissan into the small/mid car segment and with the current success of GM’s Beat, VW’s Polo, Ford’s Figo, M&M’s entry into commercial vehicles (CVs), and Yamaha and HMSIL becoming more aggressive in two-wheelers following M&M’s entry through Kinetic. Yet, we believe that the incumbents have built multiple competitive advantages that will enable them to maintain their dominance.

Sector valuation

Sector to catch up with the Sensex multiple We expect earnings upgrades to continue and believe the sector valuation is still reasonable relative to growth. The sector is trading at 12.2x FY11e consolidated earnings, which is a 15.6% discount to the Sensex PE of 14.4x and at 10.4x FY12e consolidated earnings, an 18.2% discount to the Sensex PE of 12.7x.

Fig 3 – Sensex valuation

FY09 FY10 FY11e FY12e

Earnings (Rs) 840 1,027 1,260 1,468 PE (x) 21.4 17.6 14.4 12.7 EV/EBITDA (x) 12.2 9.4 8.4 EV/S (x) 2.2 1.8 1.6

Source: Bloomberg

Despite the sharp rise in stock prices in FY10, the sector is still trading at a reasonable PE relative to growth. The auto universe’s EPS CAGR of 43.2% over FY10-12e (consolidated) and 19.6% (standalone) against consensus Sensex earnings growth of 20% over the same period, strengthens the likelihood that the discount to the broad market would narrow. Within the auto sector, we expect two-wheeler companies to report earnings CAGR of 19% over the period and four-wheelers at 58%.

Competition from global majors, especially in the small-mid-size car segment

Sector trading at 18.2% discount to Sensex on FY12e earnings

Strong auto sector earnings growth to narrow discount


5

Fig 4 – Auto sector valuation – Aggregates

FY09 FY10 FY11e FY12e

Market capitalisation (Rsm) 2,150,516 2,150,516 2,150,516 2,150,516 Adj. net profit (Standalone) (Rsm) 52,988 105,200 124,778 150,512 PE (x) 40.6 20.4 17.2 14.3 Adj. net profit (Consolidated) (Rsm) 18,452 101,163 176,759 207,566 PE (x) 116.4 21.3 12.2 10.4 EV (standalone) (Rsm) 1,985,738 1,983,365 1,952,413 1,880,772 EBITDA (standalone) (Rsm) 87,283 175,353 200,936 233,849 EBITDA (consolidated) (Rsm) 93,620 219,711 304,664 345,095 EV/E (x) 22.8 11.3 9.7 8.0 EV/E (consolidated) (x) 21.2 9.0 6.4 5.5 Sales (standalone) (Rsm) 901,638 1,230,256 1,544,309 1,826,093 Sales (consolidated) (Rsm) 1,356,314 1,799,519 2,247,496 2,648,194 EV/S (x) 2.20 1.61 1.28 1.03 EV/S (consolidated) (x) 1.46 1.10 0.87 0.71


Historically, the auto sector has traded at a 10-12% discount to the Sensex, while currently it is trading at discounts of 16% and 18% for FY11e and FY12e, respectively. We expect the sector’s current discount to the Sensex multiple to narrow significantly and, in fact, expect the sector valuation to do much better than the historical average discount.

PEG supports our view For our PEG valuation, we have excluded FY10 earnings and looked at PE valuations for coverage companies on FY11e earning basis against earnings CAGR over FY11-13e. This is to remove the impact of low commodity prices in FY10, which created a temporary peak in margins that year. With commodity prices having recovered from the lows, we believe FY11 is more indicative of the sustainable margins going forward.

Valuations relative to growth is one of the key determining factors for our recommendation spread. As per the figure below, Tata Motors, Maruti and M&M are cheap relative to earnings growth. Two-wheeler stocks are relatively more expensive due to relatively less volatile earnings profile, higher return ratios and balance sheet strength. However, we prefer Bajaj Auto over Hero Honda given higher earnings growth in Bajaj at similar valuations. Ashok Leyland and TVS appear to have priced in the positives.

Fig 5 – PE to earnings growth

0

4

8

12

16

20

0 5 10 15 20 25 30 35

EPS CAGR FY11-13e (%)

PE F

Y11e

(x)

ALBA

HH

M&M (Consol)MSL

TM (Consol)

TVS

Source: Standard Chartered Research estimates


6

Fig 6 – Auto sector PE vs EPS CAGR

EPS (Rs) CAGR Price PE (x) PEG FY10 FY11e FY12e FY13e (FY11e-13e) (Rs) FY11e (x)

Ashok Leyland 2.9 4.4 5.7 6.2 19.1 72 16.3 0.9 Bajaj Auto 125.5 175.4 203.2 235.3 15.8 2,780 15.8 1.0 Hero Honda 111.8 116.4 134.3 149.7 13.4 1,785 15.3 1.1 M&M (Standalone) 33.4 40.8 45.6 48.0 8.4 611 15.0 1.8 M&M (Consolidated) 41.6 48.5 53.7 63.8 14.6 611 12.6 0.9 Maruti Suzuki 87.1 90.3 113.7 141.0 24.5 1,218 13.5 0.5 Tata Motors (Standalone) 23.3 28.9 38.7 47.6 28.4 991 34.3 1.2 Tata Motors (Consolidated) 18.9 115.2 134.3 158.5 17.3 991 8.6 0.5 TVS Motor 5.4 7.9 10.6 13.8 32.8 143 17.8 0.6


On a Price/Book basis, the sector seems to be sticking to a trend, the exception being Tata Motors, which also has the highest target price upside in our universe. M&M is also attractive on P/B basis relative to the return on equity.

Fig 7 – Price/Book vs RoE

0

2

4

6

8

10

0 10 20 30 40 50 60

RoE FY11e (%)

PBR

FY1

1e (x

)

AL

BAHH

M & M (Consol)MSLTM (Consol)

TVS


Sensitivity analysis We have undertaken a sensitivity analysis based on volume and margins, the latter partly dependent on the former, for all the stocks in our coverage universe. Ashok Leyland, TVS and Tata Motors are the most sensitive given higher operating/financial leverage. Bajaj and Hero Honda are the most stable, which also justifies their premium valuations relative to the sector.

Fig 8 – Earnings sensitivity to Key Assumptions

Ashok Leyland – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

9.6% 2.9 3.2 3.5 3.8 4.1

10.1% 3.2 3.5 3.8 4.1 4.4

11.1% 3.7 4.1 4.4 4.7 5.0

12.1% 4.3 4.6 5.0 5.3 5.7 Ope

ratin

g m

argi

n

12.6% 4.5 4.9 5.3 5.7 6.0

Bajaj Auto – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

18.0% 146.2 154.1 162.0 169.9 177.8

18.5% 150.2 158.3 166.4 174.5 182.6

19.5% 158.1 166.6 175.1 183.7 192.2

20.5% 165.9 174.9 183.9 192.9 201.8 Ope

ratin

g m

argi

n

21.0% 169.9 179.1 188.3 197.5 206.7

AL’s earnings will change by 21.8% and -20.4% if volume exceeds/declines by+/- 5% and margins by +/-100bps

Bajaj's earnings will change by 10.1% and -9.6% if volume exceeds/declines by+/- 5% and margins by +/-100bps


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Hero Honda – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

13.4% 95.5 100.5 105.5 110.5 115.6

13.9% 98.9 104.1 109.3 114.5 119.7

14.9% 105.3 110.8 116.4 122.0 127.5

15.9% 112.3 118.3 124.3 130.2 136.2 Ope

ratin

g m

argi

n

16.4% 115.7 121.9 128.0 134.1 140.3

Mahindra & Mahindra (standalone) – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

13.5% 32.7 34.6 36.6 38.5 40.5

14.0% 34.0 36.0 38.0 40.1 42.1

15.0% 36.5 38.6 40.8 43.0 45.2

16.0% 39.2 41.5 43.9 46.2 48.5 Ope

ratin

g m

argi

n

16.5% 40.5 42.9 45.3 47.7 50.1

Maruti Suzuki – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

10.1% 67.5 72.1 76.7 81.3 85.9

10.6% 71.6 76.4 81.2 86.0 90.9

11.6% 79.8 85.0 90.3 95.6 100.8

12.1% 83.9 89.4 94.8 100.3 105.8 Ope

ratin

g m

argi

n

12.6% 88.0 93.7 99.4 105.1 110.8

TVS Motor – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

6.5% 3.8 4.4 5.1 5.7 6.4

7.0% 4.7 5.4 6.1 6.8 7.5

8.0% 6.4 7.2 8.0 8.8 9.6

9.0% 8.3 9.2 10.1 11.0 11.9 Ope

ratin

g m

argi

n

9.5% 9.2 10.2 11.1 12.1 13.0

Tata Motors (standalone) – FY11 EPS sensitivity Volume

-10% -5% 0% 5% 10%

10.1% 18.0 20.8 23.5 26.3 29.0

10.6% 20.5 23.4 26.3 29.2 32.1

11.1% 22.8 25.8 28.9 31.9 34.9

12.1% 27.8 31.2 34.5 37.8 41.1

Ope

ratin

g m

argi

n

12.6% 30.3 33.7 37.2 40.6 44.1


Hero Honda's earnings will change by 11.9% and -10.6% if volume exceeds/declines by+/- 5% and margins by +/-100bps

M&M's earnings will change by 13% and -12% if volume exceeds/declines by+/- 5% and margins by +/-100bps

Maruti's earnings will change by 11% and -15% if volume exceeds/declines by+/- 5% and margins by +/-100bps

TVS' earnings will change by 37% and -33% if volume exceeds/declines by+/- 5% and margins by +/-100bps

Tata Motor's earnings will change by 31% and -19% if volume exceeds/declines by+/- 5% and margins by +/-100bps


8

Fig 9 – India auto sector valuation matrix

Mkt cap Price FV Up/ EPS (Rs) CAGR (%) BB code Rec (US$bn) (Rs) (Rs) Down FY10 FY11e FY12e FY10-12e Ashok Leyland AL IN I/L 2.1 72 79 10.8 2.9 4.4 5.7 40.4 Bajaj Auto BJAUT IN O/P 8.9 2,780 3,260 17.3 125.5 175.4 203.2 27.2 Hero Honda HH IN U/P 7.9 1,785 1,901 6.0 111.8 116.4 134.3 9.6 M&M* MM IN O/P 7.7 611 762 26.6 33.4 40.8 45.6 16.8 M&M** MM IN O/P 7.7 611 773 26.6 41.6 48.5 53.7 13.6 Maruti Suzuki MSIL IN O/P 7.8 1,218 1,478 21.3 87.1 90.3 113.7 14.2 Tata Motors* TTMT IN O/P 12.6 991 1,452 46.6 23.3 28.9 38.7 28.9 Tata Motors** TTMT IN O/P 12.6 991 1,452 46.6 18.9 115.2 134.3 166.6 TVS Motor TVSL IN U/P 0.8 143 146 2.6 5.4 8.0 10.9 42.3

PE (x) EV/EBITDA (x) EV/Sales (x)

FY10 FY11e FY12e FY10 FY11e FY12e FY10 FY11e FY12e Ashok Leyland 24.9 16.3 12.6 14.3 10.4 8.3 1.5 1.2 1.0 Bajaj Auto 22.2 15.8 13.7 14.4 11.2 9.4 3.1 2.2 1.7 Hero Honda 16.0 15.3 13.3 11.8 11.2 9.1 2.0 1.7 1.3 M&M* 18.3 15.0 13.4 10.1 8.9 8.0 1.6 1.3 1.1 M&M** 14.7 12.6 11.4 - - - - - - Maruti Suzuki 14.0 13.5 10.7 7.3 6.4 4.8 1.0 0.7 0.6 Tata Motors* 42.5 34.3 25.6 11.5 9.8 8.2 1.4 1.1 0.9 Tata Motors** 52.4 8.6 7.4 9.3 5.0 4.0 0.9 0.7 0.5 TVS Motor 26.5 17.8 13.1 10.9 7.9 6.2 0.9 0.6 0.5 ROE (%) RoCE (%) Div Yield (%)

FY10 FY11e FY12e FY10 FY11e FY12e FY10 FY11e FY12e Ashok Leyland 16.4 22.4 24.7 12.0 14.6 16.9 2.1 2.8 2.8 Bajaj Auto 62.0 52.6 41.5 60.4 56.1 46.6 1.4 1.6 1.7 Hero Honda 58.2 42.6 36.5 69.1 50.3 43.4 6.2 2.0 2.2 M&M* 25.4 25.7 24.0 25.0 24.3 23.1 1.6 2.0 2.1 M&M** - - - - - - - - - Maruti Suzuki 21.1 18.1 18.8 28.6 24.2 25.3 0.5 0.6 0.7 Tata Motors* 9.7 11.5 14.4 10.5 12.0 13.9 1.5 1.8 2.0 Tata Motors** 30.7 49.7 38.8 10.9 22.3 22.7 1.5 1.8 2.0 TVS Motor 14.7 18.6 21.0 12.8 17.3 19.5 0.8 1.1 1.4

* Standalone ** Consolidated Source: Companies, Bloomberg, Standard Chartered Research estimates


9

Company valuation

Two-wheeler companies Hero Honda – We value Hero Honda at 14x FY12e core earnings, in line with its long-term average PE of 13.7x. We believe such a valuation is justified given expected market share loss and slower earnings growth over FY10-12e. We thus expect the premium to the sector it attracted – during the years of strong profitability growth and market share gains – to decrease. Our fair value for HH is Rs1,901 (6% upside).

Fig 10 – Hero Honda: 12-month forward PE band

0

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Source: Bloomberg, Standard Chartered Research estimates

Bajaj Auto – We value Bajaj Auto at 16x FY12e core earnings, which is a15% premium to Hero Honda. We believe our PE rating for Bajaj Auto is justified considering its robust balance sheet, improvement in market share over FY10-12e and profit profile. We set a value of Rs58 on its investments in its Indonesian venture and in KTM Sports AG, the Austrian company, and give a 20% discount to cash in the balance sheet. Our fair value for Bajaj Auto is Rs3,260 (17% upside).

Fig 11 – Bajaj Auto: 12-month forward PE band

3x

5x

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TVS Motor – We value TVS at 12x FY12e core earnings, which is a 15% discount to Hero Honda. We give it a discount given its low profitability margins (compared with those of Hero Honda and Bajaj Auto) and market share in the two-wheeler space (though market share could improve over FY10-12e). We give a 20% discount to the cash on its balance sheet to arrive at our fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside).

Hero Honda – Fair value at 14.0x FY12e core earnings

Bajaj Auto – Fair value at 16x FY12e core earnings

TVS Motor – Fair value at 12x FY12e core earnings


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Fig 12 – TVS Motor: 12-month forward PE band

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Four-wheeler companies Maruti Suzuki – Our target multiple for Maruti Suzuki is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently, valuation is weighed down on account of intense competition in the passenger car (PC) segment and the negative surprise of higher royalty costs. Our earnings forecast does capture the worst-case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside).

While Maruti is in a temporary slack earnings growth phase due to the royalty issue, we expect it to return to growth in FY12 (26% over FY11e) as royalty outflow eases over a period of time and product development in India attains critical mass. The recent correction in the stock price offers an attractive entry point into the stock.

Fig 13 – Maruti Suzuki: 12-month forward PE band

6x

9x

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Mahindra & Mahindra (M&M) – At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-parts method to arrive at our fair value of Rs762 (26% upside). To arrive at fair values for M&M’s listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&M’s other investments.

We apply a PE multiple of 13x to M&M’s core business, comprising tractors and other farm equipment, utility vehicles and three-wheelers. We have not assigned any value to Satyam Computers (acquired by Tech Mahindra) due to non-availability of financials. But the cost of acquiring Satyam Computers is factored in the consolidated financials. Any positive surprise from Satyam Computers would provide upside potential to our current fair value.

Maruti Suzuki – Fair value at 13x FY12e earnings

M&M – Fair value using SOTP methodology


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Fig 14 – Mahindra & Mahindra: 12-month forward PE band

4x

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Ashok Leyland (AL) – The stock trades at a PE of 12.6x and an EV/EBITDA of 8.3x FY12e. In our view, AL’s current stock price factors in the CV cycle uptrend, market share gains and improved profitability. We assign a 14x PE multiple on FY12e, which is in line with its long-term PE multiple of 13.3x. At 14x FY12e EPS, we arrive at a fair value of Rs79 (11% upside).

Fig 15 – Ashok Leyland: 12-month forward PE band

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Tata Motors – Tata Motors currently trades at the sector average valuation, and is attractive given the CV cycle uptrend, Nano ramp-up and re-rating of Jaguar Land Rover (JLR). Our fair value for Tata Motors is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (after 20% discount), holding in Tata Sons at Rs60, and the value of investment in JLR at Rs717 (6x EBITDA). Our fair value for Tata Motors is Rs1,452 (47% upside).

Fig 16 – Tata Motors: 12-month forward PE band

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Ashok Leyland – Fair value at 14x FY12e earnings

Tata Motors – Fair value using SOTP methodology


12

Fig 17 – Target valuation multiples

Companies Fair value

(Rs) FV P/E

(x) FV EV/

EBITDA (x) View

Ashok Leyland 79 14.0 9.1 Assigned a PE of 14 against the long-term avg. of 13.3, but on our fair value EV/EBITDA will be 7% higher than the long-term average

Bajaj Auto 3,260 16.0 11.3 15% premium to Hero Honda justified on account of market share improvement and profit profile

Hero Honda 1,901 14.0 10.2 In-line with it's long-term PE average of 13.7 justified given the expected market share losses and slow earnings growth

Mahindra & Mahindra 762 17.0 10.7 SOTP basis. Core earnings at 13x; listed subsidiaries at 20% discount to current price and other investments at 50% discount to market/book values

Maruti Suzuki 1,478 13.0 6.3 13x FY12e earnings, 5% discount to its six-year forward average PE. Our target EV/EBITDA will be 12% lower than the aforesaid average.

Tata Motors 1,452 37.5 12.6 SOTP basis. Core earnings at 15x; Investment in key subsidiaries at Rs97 (20% discount); JLR at 6x EBITDA (50% discount to standalone EBITDA multiple)

TVS Motor 146 12.0 6.3 15% discount to HH target PE multiple. Discount is justified given its low profitability margins and market share in 2W space


Top picks

Bajaj Auto Bajaj Auto is our top pick in the two-wheeler segment; we initiate coverage on it with an Outperform rating and a fair value of Rs3,260. We estimate Bajaj Auto’s volume would grow at a CAGR of 28% over FY10-12, above the industry rate of 19.7%, leading to gains in market share. Based on these gains, we estimate earnings to grow at a CAGR of 27% over the same period. Hence, going forward, we expect Bajaj to trade at a premium to the two-wheeler industry leader Hero Honda.

Mahindra & Mahindra We initiate coverage on Mahindra & Mahindra (M&M) with an Outperform rating and a fair value of Rs762. With its core segments growing at a good clip, foray into international markets with the Ssangyong acquisition raising its profile/ product offerings, and new businesses having value unlocking potential, we believe M&M should be a core holding for any investor in the sector.

Maruti Suzuki We initiate coverage on Maruti Suzuki with a contrarian Outperform call and fair value of Rs1,478. We believe the negatives (rising competition, loss in market share, and increase in royalty payment) are priced in; we believe that the stock currently offers a good entry point, given its strong balance sheet, cash flows and expected 26% earnings growth in FY12.

Tata Motors We initiate coverage on Tata Motors with an Outperform rating and fair value of Rs1,452. We believe the strong revival at JLR, increasing commercial vehicle (CV) demand in India, and improving operating leverage would lead to consolidated earnings growth of 167% over FY10-12e, the highest in the sector. Tata Motors currently trades at the sector average and looks attractive for multiple reasons – uptrend in the CV cycle, Nano production ramp-up, strong product pipeline and re-rating of JLR.

Bajaj Auto Rating: Outperform Fair value: Rs3,260

M&M Rating: Outperform Fair value: Rs762

Maruti Suzuki Rating: Outperform Fair value: Rs1,478

Tata Motors Rating: Outperform Fair value: Rs1,452


13

Strong macro drivers to boost volume growth We expect the sector to report ~20% volume CAGR over FY10-12e given India’s strong macro drivers – fast-growing per capita income, favourable demographics, shifting consumption patterns, and easier availability of credit. Our analysis also shows that monetary tightening would only have a limited impact on growth.

Macro drivers favour the sector

Our economist, Samiran Chakraborty, believes the auto sector’s structural growth story is supported by many factors, such as a high rate of increase in per capita income, favourable demographics, shifting consumption patterns and urbanisation/infrastructure development.

Per capita income rising fast India’s per capita income has doubled in the past five years to ~US$1,000, whereas it took 33 years to rise from US$100 to US$500. Even with such growth in incomes and car sales doubling from 2003 to 2009, India still stands near the bottom of the motor vehicle ownership charts, with just 12 vehicles per 1,000 persons compared with China’s 128, Brazil’s 156, Russia’s 213 and South Korea’s 293. As per capita income increases, driven by strong GDP growth, we expect the auto sector to benefit.

Most developed countries experienced exponential growth in auto sales once their per capita income crossed the US$5,000 mark. In India’s case, however, the exponential growth could come even at a lower level of per capita income because of two reasons. First, the cost of a car is lower in India than in developed countries. Second, certain urban pockets in India could be much closer to the US$5,000 per capita income threshold.

Fig 19 – India: Per capita income growth Fig 20 – India: Passenger car sales

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Strong structural support

India’s per capita income doubled in the past five years

Fig 18 – Motor vehicle ownership

Countries

Motor vehicles per 1,000 persons

USA 765 Germany 558 Japan 543 UK 458 Greece 455 South Korea 293 Malaysia 273 Russia 213 Brazil 156 China 128 Indonesia 21 India 12 Source: US Department of Energy


14

Labour markets, too, favour income growth, with salary increases back in vogue as employment outlook improves.

Fig 21 – India: Wage increases Fig 22 – India: Employment

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India’s demographics supportive India’s demographics map favours consumption growth, given that 28% of the increase in the global working age population is to come from India in the next decade. In addition, shifting consumption patterns show a steady rise in the share of transportation in total consumption. The proportion of income spent on transportation and communication has almost doubled in the past 20 years.

Fig 23 – India’s demographics better than China’s (addition over the decade in millions)

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2010-20 (Working age) 2020-30 (Working age) 2010-20 (Senior citizens) 2020-30 (Senior citizens)

China India

Source: RBI, Standard Chartered Research

Fig 24 – Shifting consumption patterns

Items (%) FY91 FY01 FY08 FY08* FY10* Food & beverages 58 48 42 36.8 35.3

Transport & comm. 10 14 16 18.7 19.7

Rent, fuel & power 13 11 9 11.4 11

Medical 3 5 6 4.4 4.4

Recreation, education 3 4 5 3.5 3.4

Clothing & footwear 6 6 5 8.5 7.9

Furniture, hotels 3 3 4 4 3.9

Misc. (personal care, etc.) 6 8 12 12.8 14.4 *Base is 2004. For years FY01 and FY08 the base is 2000 Source: NSSO, Economic Survey

Demographics would help India sustain consumption growth

Steady rise in the share of transportation in total consumption


15

Macro factors impacting the various segments

Two-wheeler (2W) segment: The improvement in farm incomes, urban demand and availability of financing and consumer sentiment would have a positive impact on the segment.

Passenger vehicle (PV) segment: Higher agricultural incomes and improved consumer confidence would impact auto demand positively in segments such as passenger cars and multi-utility vehicles (MUVs).

Commercial vehicle (CV) segment: Positive traction in industrial production (strong co-relation); government thrust on infrastructure investment; good agri-GDP growth and healthy freight rates.

Rural demand Rural demand in India remains secular, driven by 1) the National Rural Employment Guarantee Act (NREGA), which is having a positive impact on rural consumption; 2) higher agricultural income arising from better minimum selling prices (MSP) for essential commodities, which have increased by a CAGR of 10% (on average) for key crops, leaving more disposable income for farmers; and 3) recent monsoon rainfall data suggesting a normal to above-normal monsoon with good spatial distribution that should augur well for agri-GDP growth in FY11.

Urban demand We believe urban demand is recovering, driven by 1) rising wages; 2) renewed hiring by the IT/ITES sector; 3) improved availability of financing; and 4) still attractive interest rates (despite monetary tightening).

Fig 25 – India: Farm income Fig 26 – India: Infra invest. as a % of GDP

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Source: RBI, Standard Chartered Research Source: RBI, Standard Chartered Research

Farm income, finance, urban demand

Agri income, consumer confidence

Industrial production, infra investment


16

A rewind of FY10

For Indian auto companies, with the exception of Ashok Leyland, FY10 was a landmark year, with unit sales at an all-time high and strong volume growth. Further, most OEMs set new records in terms of volume and profitability. This strong performance came on the heels of an economic downturn, making it more remarkable. Looking forward, we expect volume to grow at a CAGR of 17% for the industry over FY10-13, compared with the 25.6% reported in FY10.

Fig 27 – Segment-wise volume growth in FY10

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Sector volume assumptions – FY11-13e

Fig 28 – Auto sector volume CAGR

CAGR (%) FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e FY02 onwards 16.9 86.2 16.4 15.8 15.6 12.4 11.0 12.8 14.0 14.1 13.8

FY04 onwards 17.4 15.7 15.3 10.7 9.1 11.7 13.5 13.7 13.4

FY06 onwards 14.6 5.9 5 9.8 12.7 13.0 12.8

FY08 onwards 3.2 13.9 17.4 16.8 15.7

FY10 onwards 24.9 19.8 16.7


Fig 29 – Segment-wise volume CAGR (FY10-12e)

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FY10 a landmark year for the Indian auto sector


17

Segment-wise volume growth assumptions

Fig 30 – Two-wheelers Fig 31 – Motorcycles

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Fig 32 – Passenger cars (excl. Nano) Fig 33 – Passenger cars (incl. Nano)

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Two-wheelers to report 19.7% CAGR over FY10-12e… Motorcycles to lead

Passenger cars (including Nano) likely to grow at 28.7% and 23.8% in FY11e and FY12e

Passenger vehicles likely to report 23.2% CAGR over FY10-12e


18

Fig 36 – Commercial vehicles Fig 37 – M&HCVs

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Commercial vehicles likely to grow at 19.3% and 13.4% in FY11e and FY12e; M&HCV to grow at 17%


19

Monetary tightening would push up ownership costs

Financing plays an important role in Indian vehicle sales (40% for two-wheelers, 80% for passenger vehicles and 90% for commercial vehicles). The onset of monetary tightening is expected to push up interest rates and, thereby, the cost of ownership.

Fig 39 – Rates rising Fig 40 – Liquidity tightening

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Industrial growth has moderated in May and June 2010, the latest data we have, and we believe it is just not the base effect catching up.

Fig 41 – Industrial production moderates Fig 42 – Not just the base effect

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But car sales do not seem to have been affected, as clearly shown in the sales numbers.

Fig 43 – Passenger car sales rising

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80% of passenger vehicles financed

IIP moderates

But car sales buoyant


20

Scenario analysis – Impact of higher interest rates

Our analysis (see below) reveals that the impact of hikes in prices and/or interest rates on equated monthly instalments (EMIs) would be marginal. Moreover, financing – the key driver of automobile demand – is more easily available now than during previous periods and at better rates across dealer locations.

Assumptions Average cost of vehicles to increase 2%, 3% and 4% in Scenarios I, II and III, respectively

Interest cost to increase 50bps, 100bps and 150bps in Scenarios I, II and III, respectively

Monthly maintenance cost to increase 5%, 10% and 15% in Scenarios I, II and III, respectively

Fig 44 – Two wheelers

(Rs) FY06 FY07 FY08 FY09 FY10 Scenario I Scenario II Scenario III Average cost of a two-wheeler 40,000 40,000 40,000 41,000 41,000 41,820 43,075 44,798 % Finance 90.0 90.0 85.0 70.0 70.0 70.0 70.0 70.0 Loan Amount 36,000 36,000 34,000 28,700 28,700 29,274 30,152 31,358 Interest rate (%) 17.0 19.0 21.0 23.0 23.0 23.5 24.0 24.5 Duration (months) 36 36 36 36 36 36 36 36 Monthly EMI 1,283 1,320 1,281 1,111 1,111 1,141 1,183 1,239 Per day usage (km) 30 30 30 30 30 30 30 30 Fuel efficiency (km/lt) 50 50 50 50 50 50 50 50 Petrol price (per lt) 46 51 50 51 55 55 55 55 Fuel cost per month 828 918 900 918 990 990 990 990 Monthly maintenance cost 400 420 441 452 463 486 511 536 2W ownership cost (per month) 2,511 2,658 2,622 2,481 2,564 2,617 2,684 2,765 % yoy increase 5.8 -1.3 -5.4 3.4 2.1 4.7 7.8

Fig 45 – Commercial vehicles

(Rs) FY06 FY07 FY08 FY09 FY10 Scenario I Scenario II Scenario III Average cost of a CV 960,000 1,000,000 1,040,000 1,102,400 1,124,448 1,146,937 1,181,345 1,228,599 % Financed 90.0 90.0 90.0 90.0 90.0 90.0 90.0 90.0 Loan Amount 864,000 900,000 936,000 992,160 1,012,003 1,032,243 1,063,211 1,105,739 Interest rate (%) 10.0 13.0 14.0 15.0 13.5 14.0 14.5 15.0 Duration (months) 60 60 60 60 60 60 60 60 Monthly EMI 18,357 20,478 21,779 23,603 23,286 24,018 25,016 26,305 Per day usage (km) 280 280 280 280 280 280 280 280 Fuel efficiency (km/lt) 4 4 4 4 4 4 4 4 Diesel price (per lt) 32 35 34 35 40 40 40 40 Fuel cost per month 67,830 72,660 71,400 73,500 84,000 84,000 84,000 84,000 Monthly maintenance cost 1,200 1,250 1,500 2,000 2,000 2,000 2,000 2,000 CV ownership cost (per month) 87,387 94,388 94,679 99,103 109,286 110,018 111,016 112,305 % yoy increase 8.0 0.3 4.7 10.3 0.7 1.6 2.8

Fig 46 – Passenger vehicles

(Rs) FY06 FY07 FY08 FY09 FY10 Scenario I Scenario II Scenario III Average cost of a PV 300,000 300,000 309,000 324,450 324,450 330,939 340,867 354,502 % Financed 80.0 80.0 80.0 80.0 80.0 80.0 80.0 80.0 Loan Amount 240,000 240,000 247,200 259,560 259,560 264,751 272,694 283,601 Interest rate (%) 11.0 13.0 14.0 15.0 12.0 12.5 13.0 13.5 Duration (months) 60 60 60 60 60 60 60 60 Monthly EMI 5,218 5,461 5,752 6,175 5,774 5,956 6,205 6,526 Per day usage (km) 30 30 30 30 30 30 30 30 Fuel efficiency (km/lt) 12 12 12 12 12 12 12 12 Petrol price (per lt) 46 51 50 51 55 55 55 55 Fuel cost per month 3,450 3,825 3,750 3,825 4,125 4,125 4,125 4,125 Monthly maintenance cost 750 788 827 910 955 1,003 1,053 1,106 PV ownership cost (per month) 9,418 10,073 10,329 10,909 10,854 11,084 11,383 11,756 % yoy increase 7.0 2.5 5.6 -0.5 1.6 4.3 7.8 Source: Companies, Standard Chartered Research estimates


21

Margins to stabilise lower, yet remain healthy From the FY10 peak, we expect margins to decline by 120-130bps after factoring in a 200bps increase in raw material costs. This builds in a cushion against any commodity price fluctuation. Notwithstanding this, the sector’s FY11 EBITDA margin is likely to be a healthy 12-13%, aided by productivity improvements and operational leverage, and still respectable vs historical performance.

Raw material costs to increase 200bps

Key input prices for auto companies rose by ~50% in FY10. The raw material (RM) to sales ratio, which had edged down to ~69.6% in 1Q FY10, rose back to 72.5% in 1Q FY11. This coupled with the increase in excise duty and the cost of implementing new emission norms led to most auto OEMs raising prices over the past 12 months. The key positive is that even with the price increases, demand growth has continued unabated.

We expect raw material costs as a percentage of sales to increase 200bps from 69.9% in FY10 to 71.9% in FY12, helping to stabilise auto sector EBITDA margins at around 12-13%, 140bps lower yoy, but still healthy compared with historical margins.

Fig 47 – RM trend, annual data Fig 48 – RM cost as % of sales

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Fig 49 – RM trend, quarterly data Fig 50 – Quarterly RM cost as % of sales

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Assumptions for our forecast period

Discount to the spot rate for raw material purchases: 10% each in FY11e, FY12e and FY13e.

INR/USD conversion at Rs45, Rs42 and Rs42 in FY11e, FY12e and FY13e, respectively.

Productivity and cost cutting gains of 7% each in FY11e, FY12e and FY13e.

RM to sales ratio climbs

Sector EBITDA margin to stabilise at 12-13%


22

Fig 51 – Auto sector – Contribution and EBITDA margins

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09

2QFY

09

3QFY

09

4QFY

09

1QFY

10

2QFY

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3QFY

10

4QFY

10

1QFY

11

FY11

e

FY12

e

%

8

10

12

14

16

%

Contribution (LHS) EBITDA Margins (RHS)


Two-wheeler companies, which procure raw materials on a spot basis, have already felt the impact of higher raw material costs in 1Q FY11, on a yoy basis. On the other hand, four-wheeler companies, which have long-term contracts, have seen a lesser decline in EBITDA margins than two-wheeler companies.

We believe the auto industry can cope with rising raw material costs. Our analysis indicates that the cumulative price increase of 3-5% by passenger vehicle and two-wheeler manufacturers in a year and of 5-6% by CV makers offset almost 60-70% of the increase in raw material costs.

In addition, higher operating leverage because of higher utilisation on account of volume growth (which we expect in FY11) and the ramping up of operations at tax- and excise-free facilities (for some players) would further arrest the decline in operating margins.

Flexible strategies that auto OEMs can adopt

Auto OEMs take regular price increases Given a stable to negative outlook for input costs, auto companies could choose one of two strategies: resort to price cuts to gain market share or maintain prices over the medium term to attain better per-unit profitability. Analysing data for the past 10 years, we expect auto companies to select the latter option. (In FY02, when commodity prices slid, only Maruti showed a sizeable reduction in per-unit net realisations in FY03.)

Fig 52 – Trend in realisation compared to raw material costs (indexed)

0

100

200

300

400

500

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Realisation per unit RM trend


Lower impact on four-wheeler companies

Price increases offset most cost increases


23

We acknowledge that this trend analysis does not completely capture any change in a company’s product mix. However, it suffices to illustrate the change in weights of products on a per-company basis (such as Hero Honda displaying the highest volume growth in FY02 in the sector, contributing to the dip in industry realisations for the year). Since we are factoring in blended net realisations per vehicle, the question of price reduction due to excise duty cuts that we have seen over the past decade is not captured in the analysis.

Despite competitive pressure, we expect the auto companies to follow a rational pricing strategy rather than a price-based strategy.

Industry utilisation to improve to 88.7% in FY11e

Since global companies entered India post-2003, competition has intensified and companies are in the process of completing, or have already completed, their capacity expansion projects.

Fig 53 – Higher utilisation provides operating leverage for the sector

80

100

120

140

160

FY99

FY00

FY01

FY02

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FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

60

70

80

90

100

Realisation per unit (indexed) (LHS) Capacity utilisation (RHS)

%


We believe, however, that the precedent set in the past could come true once again – we may see an extreme scenario where companies resort to selective price increases for premium products as the gap between capacity utilisation and realisation widens. Our analysis, however, leads us to believe that companies would prefer a qualitatively rather than quantitatively enhanced performance.

We believe that the net result of either of these two strategies would be the same quantum of profitability as the benefits and drawbacks of opting for either the qualitative or quantitative strategies would balance out in the final analysis.


24

Fundamentals intact, competition intensifies We believe Indian auto companies will continue to report strong cash flows and good return ratios, even though competition is intensifying given the entry of more global majors.

Cash generation likely to improve

Rising competition and customer aspirations are driving auto companies to refresh their products more frequently thereby pushing up their capex. We expect capex to remain higher than historical levels over FY10-12, but do not see this as a source of concern as cash generation is likely to improve on a stable margin outlook (though margins may be lower on a yoy basis) and we expect strong volume growth in each segment. In addition, we think the majority of capacity expansion is well behind us.

Fig 54 – Auto companies’ free cash flow generation after investment income

Rs/share FY09 FY10 FY11e FY12e FY13e Ashok Leyland -12.0 3.0 0.6 3.7 4.4 Bajaj Auto 40.1 210.0 76.5 184.8 218.5 Hero Honda 69.2 129.7 68.3 139.9 143.4 M&M (Standalone) 33.2 46.4 85.9 63.9 111.3 Maruti Suzuki 4.0 13.4 12.1 19.2 25.4 Tata Motors (Standalone) -78.9 74.8 4.9 18.7 50.0 Tata Motors (Consolidated) -49.0 8.0 7.4 17.8 - TVS Motor 2.5 7.3 6.9 12.5 15.8


Fig 55 – Sector operational snapshot

FY07 FY08 FY09 FY10 FY11e FY12e Sector volume (Units) 9,194,131 8,790,251 8,933,266 11,166,669 13,922,763 16,076,178 CAGR (FY10-12e) 20.0 Sector revenue (Rsm) 827,780 887,471 901,638 1,230,256 1,544,301 1,826,093 CAGR (FY10-12e) 21.8 Sector revenue (cons)* (Rsm) 874,502 955,635 1,356,314 1,799,518 2,247,496 2,648,194 CAGR (FY10-12e) 21.3 Sector EBITDA (Rsm) 102,163 103,388 87,283 175,352 200,936 233,849 CAGR (FY10-12e) 15.5 Sector EBITDA (cons)* (Rsm) 106,959 115,529 93,620 219,711 304,664 345,095 CAGR (FY10-12e) 25.3 Sector net profit (Rsm) 70,889 67,467 52,988 105,200 124,778 150,512 CAGR (FY10-12e) 19.6 Sector net profit (cons)* (Rsm) 71,521 68,423 18,781 102,236 178,665 210,159 CAGR (FY10-12e) 43.2 Sector OPM (%) 12.3 11.6 9.7 14.3 13.0 12.8 Sector OPM (%) (cons) 12.2 12.1 6.9 12.2 13.6 13.0

*Only Tata Motors is considered in the sector consolidated calculation. M&M is not considered as its consolidated financial statements include many companies other than those in the auto sector; Bajaj Auto, Maruti Suzuki, Ashok Leyland and TVS Motor are not considered as the impact of consolidation is very marginal relative to a standalone basis.


Cash generation likely to improve on stable margins


25

Fig 56 – RoE of auto companies, FY11e (%) Fig 57– RoCE of auto comp., FY11e (%)

11.5

12.8

18.4

22.4

25.7

42.6

52.6

0 10 20 30 40 50 60

Tata Motors

TVS Motor

Maruti Suzuki

Ashok Leyland

M&M

Hero Honda

Bajaj Auto

12.0

14.6

17.1

24.3

24.7

50.3

56.1

0 10 20 30 40 50 60

Tata Motors

Ashok Leyland

TVS Motor

M&M

Maruti Suzuki

Hero Honda

Bajaj Auto

Source: Standard Chartered Research estimates Source: Standard Chartered Research estimates

Competition intensifies across segments

Competition has been steadily rising in recent years: incumbents continue to dominate each auto sub-segment. We believe competition is set to rise even more over FY10-12, driven by the entry of Toyota and Nissan into the small/mid-size car segment and also the current success of GM’s Beat, VW’s Polo, Ford’s Figo, M&M’s entry into CVs, and Yamaha and HMSIL becoming more aggressive in two-wheelers following M&M’s entry through Kinetic. Still, we believe that the incumbents have built multiple competitive advantages that will enable them to maintain their dominance.

Fig 58 – Bajaj Auto’s market share Fig 59 – Hero Honda’s market share

34.134.0

29.7

27.627.4

23.9

20

25

30

35

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Motorcycles Overall - 2W

%

47.5

16.0

51.948.2

14.914.3

40.740.943.8

0

15

30

45

60

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Motorcycles Scooters Overall

%

Source: Company, Standard Chartered Research estimates Source: Company, Standard Chartered Research estimates

Bajaj Auto – We expect market gain of 440bps over FY10-12e in the motorcycle segment Hero Honda – We expect market share loss of 450-500bps over FY10-12e in the motorcycle segment


26

Fig 60 – Maruti Suzuki’s market share Fig 61 – Tata Motors’ PC market share

46.8

43.9

47.5

51.5

45.1

50.7

40

45

50

55

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Of total PCs Of total PCs Incl. Nano

%

11.6

14.4

10.5

8

11

14

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%


In the CV segment, recovery by industry players to normative levels as compared to FY10 will lead to the normalisation of market shares, in our view.

Fig 62 – Tata Motors’ M&HCV mkt share Fig 63 – AL’s M&HCV market share

62.7

63.163.4

60.5

61.5

62.5

63.5

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%

26.226.0

23.7

22

24

26

28

30

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%


Maruti Suzuki – We expect market share loss of 600bps over FY10-12e including the Nano impact Tata Motors – PC market share to increase on account of Nano volume

Ashok Leyland – Market share to normalise


27

Company section


28


Company updates

Ashok Leyland

In-Line (initiating coverage) Positives priced in, initiate with In-Line PRICE as at 26 Aug 2010

Rs72

Bloomberg code Reuters code

AL IN ASOK.BO

Market cap 12 month range

US$2.1bn Rs39-73

Year end: March FY10 FY11e FY12e FY13e

Sales (Rs m) 72,447 96,496 113,103 129,901EBIT (Rs m) 5,587 8,088 10,063 10,855EBITDA (Rs m) 7,628 10,711 13,120 14,159Pretax profit (Rs m) 5,448 7,116 9,076 9,969Earnings (Rs m) adjusted 3,821 5,835 7,533 8,274Diluted EPS (Rs) adjusted 2.87 4.39 5.66 6.22Diluted EPS growth (%) adj. 120.0 52.7 29.1 9.8DPS (Rs) 1.50 2.00 2.00 2.00DPS growth (%) 50.0 33.3 0.0 0.0EBITDA margin (%) 10.5 11.1 11.6 10.9EBIT margin (%) 7.7 8.4 8.9 8.4Net margin (%) 5.3 6.0 6.7 6.4Div payout (%) 52.2 45.6 35.3 32.2Book value/share (Rs) 17.56 19.61 22.94 26.83Net gearing (%) 72.1 92.7 83.1 68.9ROE (%) 16.4 22.4 24.7 23.2ROACE (%) 12.0 14.6 16.9 17.0FCF (INRm) 5,490.9 1,788.7 6,092.4 7,072.1EV/Sales (x) 1.5 1.2 1.0 0.8EV/EBITDA (x) 14.3 10.4 8.3 7.5PBR (x) 4.1 3.6 3.1 2.7PER (x) 24.9 16.3 12.6 11.5Dividend yield (%) 2.1 2.8 2.8 2.8

Source: Company, Standard Chartered Research estimates

Share price performance

354045505560657075

Aug‐09 Nov‐09 Feb‐10 May‐10 Aug‐10

Ashok Leyland Ltd BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares - 19 79 Relative to Index - 12 65 Relative to Sector -4 4 27 Major shareholder Promoter: 38.61% Free float 47.96% Average daily vol US$7.6m

We initiate coverage on Ashok Leyland (AL) with an In-Line rating and fair value of Rs79. We believe positives such as likely market share gains over FY10-12e, uptrend in commercial-vehicle cycle and improving profitability are in the price and recommend accumulating the stock on declines.

Market share to improve – We expect AL’s market share to improve 250bps from a low 23.7% in FY10 to 26.2% by FY12e (management expects a gain of 300-400bps in FY11e). In our view, this improvement is mainly because production levels in the industry are recovering to normal levels post the FY09-10 crunch.

Uttarakhand plant – key to FY11/12e profits – Vehicles manufactured at AL’s Uttarakhand plant are exempted from excise duty and value-added tax, which at current rates would be around Rs60,000 per vehicle. In addition, being fully integrated, the plant has scope for margin improvement. AL’s profitability would be sensitive to production from the Uttarakhand plant, in our view.

Management guidance seems achievable – Management expects the industry to register volume growth of 15-20% in FY11 and AL to outperform industry volume growth by a wide margin. We expect the company to register a volume CAGR of 22.5% over FY10-12e (FY11e – 33% YoY) and an earnings CAGR of 40.4% over the same period.

Valuation – The stock trades at a PE of 12.6x and an EV/EBITDA of 8.3x FY12e. In our view, AL’s current stock price has factored in the CV cycle uptrend, market share gains and improved profitability. We think it is expensive on an EV/EBITDA basis when compared with its long-term average of 6.5x. We assign it a fair value multiple of 14.0x FY12e earnings, which is in line with its long-term PE multiple of 13.3x, and arrive at a fair value of Rs79.

Source: Company, Bloomberg


29

Investment argument and valuation Following a two-year downswing in FY08-09, we expect the commercial vehicle (M&HCV) segment to report a 16.8% volume CAGR over FY10-12. AL’s current valuations, in our view, reflect expectations of strong gains in market share over FY10-12 and improved profitability as the company raises utilisation at its Uttarakhand plant. We, therefore, believe upside is limited and recommend accumulating the stock on declines. Since the new non-cyclical businesses that AL has ventured into are likely to be revenue and earnings accretive only from FY12-13, we have not factored them into our estimates.

Goods commercial vehicle segment in cyclical upswing

We expect the goods commercial vehicle segment to post 18% volume CAGR over FY10-12, after registering a low base-driven 37% yoy growth in FY10. In FY08 and FY09, the segment was in a severe slump, registering -4.2% and -36% growth, respectively

The segment’s demand drivers are growth in manufacturing, infrastructure and excavation and mining. All macroeconomic indicators show healthy signs of growth in India, supporting strong demand for goods commercial vehicles.

Fig 1 – CV sales and GDP growth (%) Fig 2 – CV sales and IIP growth (%)

0

50

100

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200

250

300

FY00

FY01

FY02

FY03

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12

%

CV sales (LHS) GDP growth (RHS)

'000

uni

ts

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%

CV sales (LHS) IIP growth (RHS)

'000

uni

ts

Source: SIAM, GoI Source: SIAM, GoI

Availability of financing crucial for volume growth Financing is crucial to commercial vehicle sales – 90% of sales are financed. We expect monetary tightening to push up interest rates and thereby the cost of owning commercial vehicles. Nevertheless, our analysis reveals that the impact of a hike in prices and/or interest rates on EMIs has been marginal.

Fig 3 – CV financing rates vs industry goods CV demand

-45

-30

-15

0

15

30

45

FY05

FY06

FY07

FY08

FY09

FY10

% g

row

th

0

4

8

12

16

%

M&HCV growth (LHS) Interest rates (RHS)

Source: SIAM, RBI

We expect the goods commercial vehicle segment to post 18% volume CAGR over FY10-12

Financing availability crucial as 90% of CV sales are financed


30

In the short term, regulatory measures could have a positive impact We expect demand for commercial vehicles to improve in the remaining 9M of FY11, given the 50% accelerated depreciation on commercial vehicles the government has allowed for those vehicles purchased between January and March 2011.

Change in emission norms – to Euro IV for 16 cities and Euro III for the rest of the country –should also help. The new norms and costs could prompt transporters to pre-purchase trucks given that they would need to pay around Rs40,000-50,000 more if they delay purchases beyond the deadline.

AL key beneficiary of CV cycle uptrend AL, a core CV manufacturer, should benefit from the structural CV cycle upswing, in our view. Management has guided for an FY11 volume of 87,000-89,000 units. In our view, there is a strong possibility that AL will outperform the industry.

We expect AL to post 22.5% volume CAGR over FY10-12 (FY11e growth – 33% yoy), above our estimate of industry volume CAGR of 16.8%. For FY10-12, we peg domestic vehicle sales growth at 23.4% and export growth at 12.4%. For the same period, we expect goods commercial vehicles to grow at 27% (domestic -28%, exports - 13.5%), and the passenger bus segment to grow at 11.4%.

AL’s volume has shown very strong growth of 239% ytd on a very low base of FY10; we expect 9% residual growth in volume for the rest of FY11, driven by the high base in 2H FY10. We expect growth rates to normalize.

Fig 4 – AL: Total volume growth Fig 5 – AL: Breakup of M&HCVs

0

20

40

60

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100

FY03

FY04

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e

FY12

e

-40

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-100

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% g

row

th

Volume (units) (LHS) Growth (RHS)

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e

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e

.

T rucks Buses

'000

uni

ts


Sri Lanka, Bangladesh and the Middle East (Saudi Arabia and Dubai) are AL’s main export markets. We expect volume to Sri Lanka and Bangladesh to double in FY11 (the company recently received orders for 1,000 units from Sri Lanka – the largest in AL’s history from that country).

Regulatory measures could support CV sales growth

We expect AL to benefit from the structural CV cycle upswing

AL is likely to report 22.5% volume CAGR over FY10-12e


31

Fig 6 – AL: Export growth

3,782 3,999

4,879

6,025

7,2866,812

5,9796,794

7,556

0

2,000

4,000

6,000

8,000

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

One time Iraq

order excluded

units


Fig 7 – AL: Product mix: Domestic and export sales

50

60

70

80

90

100

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Domestic Exports

%


AL’s market share to improve

We estimate AL’s market share will improve 250bps from a low 23.7% in FY10 to 26.2% by FY12 given its low base. Management expects a gain of 300-400bps in FY11. In our view, this improvement would be mainly due to the normalization of industry production (especially at AL) compared with FY10.

In our analysis, we have not factored in any price wars during the forecast period, as the industry is a virtual duopoly with the top two players enjoying above 90% market share. Although AL has a significant advantage with a new plant in a tax-free zone, we believe that the main focus of auto companies would be cash flow generation, and not gaining market share through price wars.

Fig 8 – AL: M&HCV market share Fig 9 – AL: Buses/truck market share

26.0 26.2

23.7

22

24

26

28

30

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%

% market share

40.0

39.640.0

23.8

20.223.6

15

25

35

45

55

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Buses Trucks

%


Exports likely to grow at 12.4% over FY10-12e

AL’s M&HCV market share to improve 250bps over FY10-12e, driven by goods M&HCV segment


32

Recovery in volumes is also helping AL to regain its lost market share (actual market-share loss was lower since retail sales were higher than dispatches, and AL cleared its accumulated channel inventory). The key to AL’s expectation of outperforming the industry would be successful execution of its order book and a sustained commercial vehicle recovery, in our view.

Uttarakhand plant: strategic edge, key to FY11-12 profits

The Uttarakhand plant provides AL the benefits from the exemption of excise-duty and value-added tax. It gives AL a strategic edge over competitor Tata Motors. Considering 60% localization at a 10% excise duty rate, the company would benefit by around Rs60,000-80,000 per vehicle. As it is a fully integrated plant, there is higher scope to improve margin.

In FY11, we expect the plant to have a capacity of 25,000-30,000 units, whereas by end-FY11 capacity should rise to 50,000pa. We expect incremental revenue from the plant to be 3.3% in FY11 and 4.4% in FY12 on our volume assumptions of 18,400 units and 27,600 units for FY11 and FY12, respectively. We expect profit to rise 9% and 11.2% in FY11 and FY12, respectively.

Fig 10 – AL: Benefits likely to accrue from the Uttarakhand plant

FY08 FY09 FY10 FY11e FY12e FY13e Units manufactured 83,307 54,431 63,926 84,769 95,860 105,395 YoY growth (%) -34.7 17.4 32.6 13.1 9.9 At Uttarakhand 0 0 800 18,400 27,600 34,500 At other plants 83,307 54,431 63,126 66,369 68,260 70,895 Net sales (Rsm) 70,484 48,020 58,796 83,560 99,279 114,162 % increase due to new plant 0.0 0.0 0.2 3.3 4.4 5.0 Increase in net profit (%) 0.0 0.0 0.4 9.1 11.2 13.5


AL’s profitability is likely to be sensitive to production from its Uttarakhand plant. If it produces 3,000 more units than our volume assumptions for FY11 and FY12, our margin estimates would rise by 25-30bps and the tax rate estimate would fall by 120-150bps.

Steady non-cyclical revenue to support profitability

AL has diversified into areas such as buses, spare parts, exports, defense supplies and engine sales. These products constituted 46% of FY10 revenue (passenger HCVs and exports – 28%; engines and defense – 18%).

We expect the steady growth in the non-cyclical segments to support overall profitability. Nevertheless, as the cyclical business picks up momentum, we expect the non-cyclical business to stabilise at around 35-39% of revenue over FY10-12.

Fig 11 – AL: Non-cyclical revenue, FY10 Fig 12 – AL: Non-cyclical revenue, FY12e

Sales to

defense;

sale of spare

parts

27%

Exports

19%

Passenger

buses

42%

Engine

sales

12%

Sales to

defense;

sale of spare

parts

27%Passenger

buses

41%Exports

20%

Engine

sales

12%


AL would benefit by around Rs60,000-80,000 per vehicle

Non-core revenue now at 46% of total


33

Valuation

AL’s current valuations, in our view, reflect expectations of strong gains in market share over FY10-12 and improved profitability as it raises utilization at its Uttarakhand plant. We, therefore, believe upside is limited and recommend accumulating on declines.

The stock trades at a PE of 12.7x and an EV/EBITDA of 8.4x FY12e. It is expensive on EV/EBITDA when compared with its long-term average of 6.5x. We assign it a fair value multiple of 14.0x FY12e earnings, which is in line with its long-term PE multiple of 13.3x, and arrive at a fair value of Rs79.

Fig 13 – AL: 12-month forward PE band

6x

9x

12x

15x

18x

21x

0

20

40

60

80

100

120

Apr-0

5

Aug-

05

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Apr-0

8

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Dec

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Apr-0

9

Aug-

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10

Rs


Fig 14 – AL: 12-month forward EV/EBITDA band

2x

3x

4x

0

10

20

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40

Apr-0

5

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10

Rs

1x


Risks

A double-dip recession would lead to a decline in global economy.

A decline in India’s commercial vehicle volume FY11 on a slower-than-anticipated macroeconomic recovery.

Fair value of Rs79 at 14x FY12e earnings


34

New businesses

AL has ventured into a number of new non-cyclical businesses, which would provide revenue and earnings accretion from FY12-13; this upside has not yet been factored into our estimates.

Hinduja Leyland Finance New finance company to support vehicle sales.

Focus area would be those pockets not currently serviced by existing finance networks and would also address the need for promoting specific model/product segments. It has operations across 130 centres in 16 cities.

AL would cap its equity injection to not more than Rs1.5bn; it also plans to induct strategic investors.

JV with Nissan Motors Will roll out its first LCV product in April 2011.

Will also manufacture and assemble engines and drivetrain components for LCVs.

Develop LCV products/related powertrains and target emerging markets.

JV with John Deere New company formed in June 2009 with 50-50 partnership with John Deere.

Product rollout by October 2010, serial production by Feb 2011.

Product plans in place, testing is underway, land has been identified, negotiation is underway.

JV with Continental AG Focus on consolidating the execution plan for existing projects, which were aligned with a

roadmap for stabilization and growth.

Develop low-cost products for the company and Continental, and engage in engineering services to align with Continental’s product development process.

Avia Ashok Leyland Motors s.r.o. Acquired in 2006 through an SPV.

Currently focused on restructuring operations, strengthening dealerships, and introducing products in new export markets; Operations cash broke even in FY10

Albonair GmbH Made an investment in this company to develop vehicle emission treatment/control systems

and products.

Will focus on development, production and sales of exhaust after treatment systems for environment friendly diesel engines.

Over the long term, these engines are expected to find application in the US and Europe

Venture has commenced operations and strengthened through recruitment of technical personnel; production to commence by 2010-11.


35

Financials We estimate AL to report 25% revenue CAGR over FY10-12 supported by strong volume growth of 22.5%. EBITDA and profitability growth, in our view, are likely to be higher at 31% and 40%, respectively, during the period on account of higher utilisation at its tax-free plant.

Fig 15 – AL: Sales and sales growth Fig 16 – AL: RM and RM as % of sales

0

20,000

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60,000

80,000

100,000

120,000FY

02FY

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eFY

12e

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% g

row

thNet Sales (LHS) Growth change (RHS)

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e

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e

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e

64

66

68

70

72

74

76

%

RM (LHS) % of Sales (RHS)

Rsm


Fig 17 – AL: EBITDA and EBITDA margins Fig 18 – AL: Realization per vehicle

0

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Fig 19 – AL: Contribution per vehicle Fig 20 – AL: EBITDA per vehicle

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36

Capex at Rs20bn The company has maintained its capex plan at Rs20bn over the next two years, with Rs8bn being dedicated to its joint-venture companies. The bulk of its capex on the standalone entity would be on expanding production capacities.

The Nissan JV to manufacture LCVs is expected to roll out its first vehicle by early 2011, while the John Deere JV is expected to start production in October 2010.

Interest and depreciation costs to increase in FY11 The commissioning of the Pantnagar plant in March 2010 means that interest costs, which were being capitalised until now, would hit the P&L in FY11 (it capitalised Rs320m of interest costs in FY10). Similarly, depreciation would also increase next year as the Pantnagar plant ramps up its capacity.

Return ratios to improve We expect the improvement in profitability over FY10-12 to impact AL’s return ratios positively – to an RoE of 24.7% and an RoCE of 16.9% in FY12 (from 16.4% and 12% respectively in FY10).

Fig 21 – Ashok Leyland: Quarterly Performance

FY10 FY11

Rs m 1Q 2Q 3Q 4Q 1Q FY10 FY11e Total volume (nos) 7,698 14,301 16,129 25,798 21,402 63,930 84,769 Realisation 1,185,310 1,103,199 1,125,634 1,139,251 1,097,083 1,133,151 1,138,332 Net sales 9,125 15,777 18,155 29,390 23,480 72,442 96,496 Total cost 9,003 14,116 16,093 25,606 21,126 64,819 85,785 EBITDA 122 1,660 2,062 3,784 2,354 7,624 10,711 EBITDA margin (%) 1.3 10.5 11.4 12.9 10.0 10.5 11.1 Yoy growth (%) -91.9 7.9 226.4 316.5 1834.7 66.1 40.5 Non-operating income 91 56 20 23 47 189 314 Net non-operating income -167 -114 -143 -198 -269 -622 -972 Interest 258 170 162 221 316 811 1,286 EBIT -45 1,546 1,920 3,586 2,085 7,002 9,739 Less: depreciation 435 506 513 588 615 2,041 2,623 PBT -480 1,040 1,407 2,998 1,470 4,961 7,116 Tax -53 146 351 768 244 1,211 1,281 Effective tax rate (%) 11.1 14.0 24.9 25.6 16.6 24.4 18.0 Adj. PAT (before extraord) -427 895 1,056 2,231 1,226 3,750 5,835 Extraordinary income 515 0 0 -20 0 515 0 Extraordinary loss 10 9 10 4 0 33 0 PBT after EO 25 1,032 1,397 2,974 1,470 5,443 7,116 Tax -53 146 351 768 244 1,211 1,281 Effective tax rate (%) -217.0 14.1 25.1 25.8 16.6 22.2 18.0 Rep. PAT 78 886 1,046 2,207 1,226 4,232 5,835 yoy growth (%) -84.6 31.8 452.1 313.9 1478.0 122.7 37.9 Adj. PAT (after ext ord) -376 894 1,055 2,228 1,226 3,798 5,835 yoy growth (%) -145.8 31.2 -1,708.0 641.3 na 118.7 53.6



37

Fig 22 – Ashok Leyland: Income statement

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Volume (units) 54,431 63,926 84,769 95,860 105,395 Volume growth (%) -34.7 17.4 32.6 13.1 9.9 Net realisation (Rs) 1,098,836 1,133,296 1,138,332 1,179,879 1,232,519 YoY growth (%) 18.4 3.1 0.4 3.6 4.5 Net Sales 59,811 72,447 96,496 113,103 129,901 Change (%) -22.6 21.1 33.2 17.2 14.9 Total expenditure 55,221 64,819 85,785 99,983 115,742 EBITDA 4,590 7,628 10,711 13,120 14,159 Change (%) -42.1 66.2 40.4 22.5 7.9 % of net sales 7.7 10.5 11.1 11.6 10.9 Depreciation 1,784 2,041 2,623 3,057 3,304 EBIT 2,805 5,587 8,088 10,063 10,855 Interest & fin. charges 1,603 1,019 1,452 1,626 1,626 Other income 696 417 480 640 740 PBT before EO 1,898 4,985 7,116 9,076 9,969 Non-recurring expense 617 33 - - - Non-recurring Income 804 495 - - - PBT 2,084 5,448 7,116 9,076 9,969 Tax 185 1,211 1,281 1,543 1,695 Effective rate (%) 8.9 22.2 18.0 17.0 17.0 Rep. PAT (after. EO) 1,900 4,237 5,835 7,533 8,274 Change (%) -59.5 123.0 37.7 29.1 9.8 Adj. PAT 1,737 3,821 5,835 7,533 8,274 Change (%) -60.3 120.0 52.7 29.1 9.8 % of net sales 2.9 5.3 6.0 6.7 6.4


Fig 23 – Ashok Leyland: Balance sheet

As at end March (Rs m) FY09 FY10 FY11e FY12e FY13e Share capital 1,330 1,330 1,330 1,330 1,330 Reserves 19,760 22,025 24,758 29,188 34,360 Net worth 21,090 23,356 26,088 30,519 35,690 Loans 19,581 22,039 28,039 28,039 28,039 Deferred tax liability 2,634 4,611 4,611 4,611 4,611 Capital employed 43,306 50,006 58,738 63,168 68,340 Gross fixed assets 35,884 46,855 59,469 64,469 69,469 Less: depreciation 15,542 17,691 20,314 23,371 26,675 Net fixed assets 20,343 29,164 39,156 41,098 42,794 Capital WIP 9,983 5,615 - - - Investments 2,636 3,262 8,262 11,262 13,262 Curr.assets, L & adv. 31,656 41,397 43,872 47,910 53,988 Inventory 13,300 16,382 19,828 23,240 26,692 Sundry debtors 9,580 10,221 10,575 12,395 14,236 Cash & bank balances 881 5,189 3,865 2,670 3,456 Loans & advances 7,895 9,605 9,605 9,605 9,605 Current liab. & prov. 21,369 29,608 32,728 37,278 41,880 Sundry creditors 17,713 23,317 26,437 30,987 35,589 Other liabilities 976 2,604 2,604 2,604 2,604 Provisions 2,681 3,687 3,687 3,687 3,687 Net current assets 10,287 11,789 11,144 10,632 12,108 Application of funds 43,306 50,006 58,738 63,168 68,340



38

Fig 24 – Ashok Leyland: Ratios

Year end March FY09 FY10 FY11e FY12e FY13e Basic (Rs) EPS Fully Diluted 1.3 2.9 4.4 5.7 6.2 Cash EPS 2.6 4.4 6.4 8.0 8.7 EPS growth (%) -60.3 120.0 52.7 29.1 9.8 Book value per share 15.9 17.6 19.6 22.9 26.8 DPS 1.0 1.5 2.0 2.0 2.0 Payout (incl. div. tax) % 76.6 52.2 45.6 35.3 32.2 Valuation (x) P/E 54.8 24.9 16.3 12.6 11.5 Cash P/E 27.0 16.2 11.3 9.0 8.2 EV/EBITDA 24.2 14.3 10.4 8.3 7.5 EV/sales 1.9 1.5 1.2 1.0 0.8 Price to book value 4.5 4.1 3.6 3.1 2.7 Dividend yield (%) 1.4 2.1 2.8 2.8 2.8 Profitability ratios (%) RoE 8.2 16.4 22.4 24.7 23.2 RoCE 8.1 12.0 14.6 16.9 17.0 Turnover ratios Debtors (days) 58 51 40 40 40 Inventory (days) 81 83 75 75 75 Creditors (days) 108 117 100 100 100 Core working capital (days) 32 17 15 15 15 Asset turnover (x) 1.4 1.4 1.6 1.8 1.9 Leverage ratio Debt/equity (x) 0.9 0.9 1.1 0.9 0.8


Fig 25 – Ashok Leyland: Cash slow statement

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e OP/(Loss) before tax 2,805 5,587 8,088 10,063 10,855 Interest/dividends received 696 417 480 640 740 Depreciation & amortisation 1,784 2,041 2,623 3,057 3,304 Direct taxes paid -88 765 -1,281 -1,543 -1,695 (Inc)/dec in working capital -7,722 2,688 -679 -682 -690 Other items -745 24 -442 -442 -442 CF from oper. activity -3,270 11,523 8,789 11,092 12,072 Extra-ordinary items 187 462 0 0 0 CF after EO items -3,084 11,985 8,789 11,092 12,072 (Inc)/dec in FA+CWIP -11,785 -6,494 -7,000 -5,000 -5,000 (Pur)/sale of invest. 3,463 -626 -5,000 -3,000 -2,000 CF from inv. activity -8,322 -7,120 -12,000 -8,000 -7,000 Inc/(Dec) in debt 10,706 2,457 6,000 0 0 Interest rec./(paid) -1,603 -1,019 -1,452 -1,626 -1,626 Dividends paid -1,330 -1,996 -2,661 -2,661 -2,661 CF from fin. activity 7,773 -557 1,887 -4,287 -4,287 Inc/(dec) in cash -3,633 4,308 -1,324 -1,195 785 Add: beginning balance 4,514 881 5,189 3,865 2,670 Closing balance 881 5,189 3,865 2,670 3,456



39

Company profile The second-largest commercial vehicle manufacturer in India, Ashok Leyland has a wide range of passenger/goods carriers across all tonnages. Formerly regionally concentrated, it has been successful in the past three to four years in widening its markets both in terms of product range and geographic reach.

The flagship company of the Hinduja group, Ashok Leyland is India’s second-largest commercial vehicle manufacturer. The Hinduja group has been in existence for over 90 years and operates in over 32 countries with more than 35,000 employees in nine business sectors.

Expanding its reach Ashok Leyland operates in the >7.5-ton gross vehicle weight (GVW) truck and bus segment. An erstwhile southern and regional player, it has instituted measures to widen its geographic reach to other parts of the country. Other measures to diversify its truck and bus range are also in place. These include various JVs (with Nissan for LCVs, with Alteams for a foray into high-pressure die casting, with Continental AG for infotronics products, with John Deere for excavators, etc).

Stable management team AL’s management team comprises chairman R. J. Shahney, co-chairman D. G. Hinduja, managing director R. Seshasayee, chief financial officer K. Sridharan and full-time director Vinod Dasari, among others. AL’s fresh initiatives have been undertaken during the stewardship of the current managing director R. Seshasayee. Under this management team, revenue over FY04-10 has grown at a CAGR of 13.5%, and profitability at a 13.9% CAGR.

Fig 26 – AL: Shareholding pattern

FII

14%

Promoter

39%

Others

28%

DII

19%

Source: BSE

Ashok Leyland is India’s second-largest commercial vehicle manufacturer


40


Bajaj Auto

Outperform (initiating coverage) Top two-wheeler pick; initiate with Outperform PRICE as at 26 Aug 2010

Rs2,780


BJAUT IN BAJA.BO


US$8.9bn Rs1,176-2,848


Sales (Rs m) 119,210 168,489 202,772 234,418EBIT (Rs m) 24,561 31,564 35,524 39,822EBITDA (Rs m) 25,926 32,914 37,067 41,642Pretax profit (Rs m) 24,076 34,534 39,195 44,802Earnings (Rs m) adjusted 18,156 25,383 29,396 34,049Diluted EPS (Rs) adjusted 125.49 175.44 203.18 235.34Diluted EPS growth (%) adj. 127.1 39.8 15.8 15.8DPS (Rs) 40.00 44.00 48.00 50.00DPS growth (%) 81.8 10.0 9.1 4.2EBITDA margin (%) 21.7 19.5 18.3 17.8EBIT margin (%) 21.3 19.3 18.0 17.4Net margin (%) 15.2 15.1 14.5 14.5Div payout (%) 39.1 28.8 27.2 24.4Book value/share (Rs) 202.40 333.84 489.02 674.36Net gearing (%) 76.7 42.2 16.0 -17.0ROE (%) 62.0 52.6 41.5 34.9ROACE (%) 60.4 56.1 46.6 40.4FCF (Rs m) 30,564.2 11,068.3 26,731.0 31,608.7EV/Sales (x) 3.3 2.3 1.8 1.4EV/EBITDA (x) 14.4 11.2 9.4 7.8PBR (x) 13.7 8.3 5.7 4.1PER (x) 22.2 15.8 13.7 11.8Dividend yield (%) 1.4 1.6 1.7 1.8



1,0001,2001,4001,6001,8002,0002,2002,4002,6002,8003,000


Bajaj Auto Ltd BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares 5 29 141 Relative to Index 5 22 127 Relative to Sector 0 13 89 Major shareholder Promoter: 49.65% Free float 50.26% Average daily vol US$15.5m

Bajaj Auto is our top pick in the two-wheeler segment; we initiate coverage on it with an Outperform rating and fair value of Rs3,260. We estimate Bajaj Auto would post 29% volume CAGR over FY10-12e, above the industry’s 19.7%, likely resulting in market share gains. Given such growth, we estimate it would post an earnings CAGR of 27% over the same period. We thus expect it to trade at a premium to the two-wheeler industry leader Hero Honda going forward.

Focused strategy bearing fruit – Leaving behind its unsuccessful earlier strategies, Bajaj Auto is now focused on its core segments. No more does it dilute brand equity by spreading itself thin with many brands. It also exited the scooter segment to refocus resources.

Improvement in market share over FY10-12e – Our estimate for Bajaj Auto’s sales are in line with management’s, i.e., 4m vehicles in FY11e (200,000 domestic motorcycles/month, 100,000 exports/month plus 34,000 units/month of 3Ws). We believe they are achievable given the company’s current monthly run rate. We estimate that such growth would translate into a 440bps improvement in market share.

Advantage of a diversified business model – Bajaj Auto’s diversified business model gives it an advantage over competition in key segments. The company has a dominant market share in the 125+cc motorcycle category (high-margin segment) and in passenger three-wheelers. Exports also provide a huge cushion to revenue and profitability (margins similar to the domestic business). This enables the company to maintain the highest profitability profile in the sector.

Valuation – We value Bajaj Auto at 16x FY12e core earnings, which is a 15% premium to Hero Honda. We believe this PE multiple is justified given its strong balance sheet, market share improvement over FY10-12e and profit profile. We value its investments in its Indonesian venture and in KTM Sports AG, the Austrian company, at Rs58, and give a 20% discount to cash on the balance sheet. Our fair value for Bajaj Auto is Rs3,260.



41

Investment argument and valuation The two-wheeler industry is in a secular growth phase, driven by improving farm incomes, urban demand and availability of financing. We estimate the industry will post volume growth of 25% and 15% in FY11 and FY12, respectively. We expect Bajaj Auto to outperform the industry by a wide margin by registering 27.5% volume and 27% earnings CAGR over FY10-12, thereby increasing its market share. Bajaj Auto, thus, is our preferred pick in the two-wheeler space and we expect it to trade at a premium to the two-wheeler industry leader, Hero Honda, going forward.

Focused strategy bearing fruit

Bajaj Auto has moved beyond the period when it kept tweaking its strategy unsuccessfully. Its current successful strategy is to focus on its three motorcycle segments – economy (with Platina), executive (with Discover) and premium (with Pulsar). Going forward, we expect the company to leverage its existing products’ brand equity.

Bajaj Auto recently exited the scooter segment. By doing this, management has ensured that resources would be focused on its core, profitable businesses. Going forward, management expects to focus more on its profitable executive and premium segments, and less on the entry level segment.

Looking at industry volume over FY06-10, we believe Bajaj Auto’s strategy is falling in line with industry reality.

Fig 1 – Entry-level’s share of industry vol. Fig 2 – Executive segment’s share

4338

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Fig 3 – Premium segment’s share

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Current strategy is to focus on its three motorcycle segments – economy, executive and premium


42

Entry level (commuter) segment – Bajaj is decreasing focus in this segment The main brands in the entry level segment are Bajaj Auto’s Platina, Hero Honda’s CD series and TVS’ Star. In FY06, the segment accounted for a good 43% of industry motorcycle volume. By FY10, however, the segment’s share had fallen to just 19%.

Bajaj Auto had dominated the segment, with 54% of its total motorcycles sales in FY06 coming from this segment. Currently, however, only 24% of Bajaj Auto’s overall sales come from the entry level segment. Bajaj Auto has decided not to invest in this low-margin segment, and will concentrate just on its Platina brand.

Executive (mass volume) segment – Bajaj is increasing penetration The executive segment comprises Bajaj’s Discover, Hero Honda’s Splendor, Passion and Glamour, HMSI’s Shine and TVS’ Fiero. This is a fast-growing segment and accounted for 64% of industry volume in FY10, compared with 48% in FY06.

Bajaj had earlier made many unsuccessful attempts to penetrate the segment, where Hero Honda is dominant. But its current focused strategy with Discover DTSI has enabled it to increase sales of the brand from 25% of total motorcycles sold in FY06 to 45% in FY10.

Premium segment – Bajaj is the market leader This segment comprises Bajaj Auto’s Pulsar, Hero Honda’s CBZ, Hunk and Karizma, HMSI’s Unicorn and Stunner, TVS’ Apache and Yamaha’s R15 and FZ16. This segment’s share of industry volume has risen to 17% in FY10 from 9% in FY06. During the same period, Bajaj Auto’s share in this segment to its total volume grew from 21% in FY06 to 31% in FY10. Bajaj remains the market leader in the segment.

Bajaj Auto’s motorcycle segment to outperform industry growth over FY10-12 Given its focused strategy, we expect Bajaj Auto’s motorcycle segment to register volume growth of 28.8% over FY10-12 against industry volume growth of 19.7%. Bajaj Auto’s growth is likely to be driven by 31% growth in the domestic market and 23% in its export markets.

Fig 4 – Bajaj Auto: Domestic volume and growth

16.0

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Domestic volume to remain strong Bajaj Auto currently has a stable product portfolio in the motorcycle segment compared with its past. Management is currently focusing on creating a strong brand franchise for its well-accepted products such as Discover and Pulsar, which will likely boost volume, going forward.

Pulsar and Discover to drive growth – Going forward, we believe that Discover and Pulsar would contribute the most to volume growth. Discover is doing extremely well post the Discover100 launch; it is positioned in the mass market segment where it’s competing with Hero Honda’s best-selling brand Splendor. We expect Discover to sell, on average, 100,000 units per month in FY11 (Bajaj Auto now sells 80,000-90,000 units per month). The recent addition of Pulsar135 to the Pulsar family is likely to incrementally improve Pulsar’s volume. Moreover,

Bajaj’s entry-level segment market share falling

Segment where Bajaj is increasing penetration

Leader in the premium segment

We expect Bajaj’s motorcycle volume CAGR over FY10-12 at 28.8% vs industry’s 19.7%


43

whatever gaps the company had in its product portfolio have been filled. Thus, we expect Bajaj Auto to outperform industry volume growth over FY10-12 by posting 31% growth in domestic sales.

Given its focus on core brands, we expect executive and premium products to account for 79% of Bajaj Auto’s product mix in FY11 compared with 76% in FY10.

Fig 5 – Bajaj Auto: Improvement in product mix

18 18 21 20

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Entry Executive Premium Source: Companies, Standard Chartered Research estimates

Motorcycle exports to grow at 23% over FY10-12 Bajaj Auto has created an identity for Indian motorcycles in the global market. Its exports constituted 26.3% of volume and 28% of its revenue in FY10. Bajaj Auto is India’s largest exporter of two-wheelers and three-wheelers and one of the first to tap fast-growing African, Latin America and Asian (ex-China and India) markets.

Fig 6 – Bajaj Auto: Export volume and growth

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'000

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We expect Bajaj Auto’s product mix to have a high portion of executive and premium products


44

Fig 7 – Bajaj Auto: Export and geographical spread (FY10)

Africa & the Middle east

51%

South Asia (excl. India)

25%

South East Asia

9%

Latin America

15%

Source: Company

We expect a strong 23% CAGR in motorcycle exports despite the high base of a 42% CAGR in export volume over FY05-10. We expect export volume to constitute 26.3% of overall volume in FY12 despite strong growth in its domestic sales.

Strategy for global market penetration Bajaj Auto is preparing to penetrate the top-end and the bottom-end of the global motorcycle market, where it does not yet have a presence. It aims to do this by developing new brands, and retain the Bajaj Auto brand for the middle value segment. The aim is to have at least 80% of revenue from overseas in five years, compared with 30% currently.

Low value segment – The global low-value segment is dominated by Chinese-made bikes. This segment totals 21m two-wheelers, of which 14m are motorcycles. The Chinese market alone accounts for 6-7m bikes annually. Africa accounts for 4m units, of which Nigeria’s share is 1.5m units. Currently, Bajaj Auto has a 15% share of the Nigerian market. The low-end bikes are priced at less than US$1,000 per unit, but they are often shipped for US$300-400 each. Bajaj Auto is targeting 5.5m units in this segment for a market share of 39.3% by FY15.

Bajaj Auto’s strategy for the low-end segment – Bajaj Auto’s strategy is to develop a new brand to take on Chinese competition. It will launch a new bike in Nigeria (the largest market for sub-US$1,000 bikes outside China) that would be cost-competitive with Chinese bikes. The new bike has been designed in India, with development and manufacturing done in China. The bike is likely to be priced at US$600 compared with the cheapest bikes, which are priced around ~US$300.

Mid-segment – The mid segment is dominated by Japanese brands. It constitutes 22m two-wheelers, of which 11m are motorcycles. Bajaj Auto sells the 220cc Pulsar in this segment for around US$2,000 per unit. Bajaj Auto is targeting 2-2.5m units, or a 20% market share.

Bajaj Auto’s strategy for the mid segment – Bajaj Auto intends to maintain its modest target of 20% market share; the key markets would be India, South America, Indonesia and Nigeria. The company intends to increase its market share in India to over 25-27% from 17% in FY10. It intends to follow a platform-sharing strategy for the mid and low segments — as done by international passenger car manufacturers — and price it at two separate price points. Currently, the basic platform for the low and mid segments is the same and, hence, the company is benefiting by targeting economies of scale in manufacturing, suppliers and R&D.

Top-end segment – This segment is dominated by American and European bikes. Japanese players have a presence in this 600cc and above segment, but American and European bikes command pricing power due to higher brand awareness among consumers. The segment constitutes 4m motorcycles. The top three players are Harley Davidson, BMW and KTM. Ducati and Piaggio are also among the top five companies. Bajaj Auto is targeting 0.2m units, which is a market share of 5%.

Bajaj Auto’s aim is earn at least 80% of revenue from overseas markets in five years

Bajaj is to develop a new brand to take on Chinese competition at the low-end


45

Bajaj Auto’s strategy for the top-end segment – It may increase its stake in KTM (31.7% currently), which sells 90,000 bikes annually and is at the top end of the motorcycle market. Its strategy is to develop bikes of 400-500cc and above using KTM; currently KTM focuses on 800cc and 1,000cc bikes.

Bajaj Auto’s three-wheelers likely to post 18.4% volume CAGR over FY10-12e Bajaj Auto commands a stranglehold in the domestic three-wheeler market and is India’s largest exporter of three-wheelers. While passenger 3Ws would be its key growth driver, it is also building a range of light goods vehicles.

Traditionally, the passenger three-wheeler market has been permit-driven, with sales depending on permits issued. However, we believe that the transition to alternative fuel vehicles (owing to the implementation of fuel-emission norms) would be the growth driver over the next two to three years. Older petrol vehicles are being phased out in favour of LPG/CNG powered vehicles. Also, some states have done away with permits for passenger three-wheeler vehicles and they can now be bought freely in those states. We anticipate, going forward, that more and more states will follow the same policy, which is expected to be positive for the segment’s growth. On the back of the global recovery in 2HFY10, the company has seen a pick-up in its three-wheeler exports.

Bajaj Auto has recently become very aggressive in its three-wheeler business: it launched two new products in the passenger carrier segment and is expected to launch a few more in the goods commercial vehicle segment. We expect Bajaj’s three-wheeler business to report 17.4% (domestic) and 19.6% (exports) volume CAGR over FY10-12. Three-wheeler volume accounts for 10-12% of the company’s total volume.

Fig 8 – Bajaj Auto: Domestic 3W volume and growth

0

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%

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FY05-10 CAGR 2.4%FY10-12e CAGR 17.4%


Fig 9 – Bajaj Auto: Export 3W volume and growth

10.0

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%

Exports 3Ws (LHS) Growth (RHS)

FY05-10 CAGR 20.2%

FY10-12e CAGR 19.6%

'000

uni

ts


Bajaj’s strategy is to develop bikes of 400-500cc and above using KTM brand

Transition to alternative fuel vehicles to be a growth driver


46

Fig 10 – Bajaj Auto: Total 3W volume and growth

15.0

22.024.2

0

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.

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%

Total 3Ws (LHS) Growth (RHS)

FY05-10 CAGR 9.0%

FY10-12e CAGR 18.4%

'000

uni

ts


Sustainable improvement in market share over FY10-12e

Our sales estimates for Bajaj Auto are in line with those of management, ie, 4m vehicles in FY11 (200,000 domestic motorcycles per month, 100,000 export units per month plus 34,000 three-wheeler units per month). In our view, this is an achievable target, given its current monthly run rate. We estimate that this growth would translate into a 440bps improvement in market share.

Fig 11 – BA: Motorcycle market share Fig 12 – BA: Overall 2W market share

29.7

34.1

34.0

28.0

26

28

30

32

34

36

FY07

FY08

FY09

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e

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%

Motorcycle market share

610bps improvement in market share

23.9

22.7

27.4

27.6

22

24

26

28

30

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%

Bajaj's overall 2W market share

490bps improvement in market share


Domestic market share driven by executive and premium segments We expect Bajaj Auto to improve its domestic market share for motorcycles to 29% in FY12 from 24.3% in FY10. We expect this to be driven by rising market share in the executive segment from 17% in FY10 to 23% in FY12 and in the premium segment from 44.3% in FY10 to 45.8% in FY12.

Fig 13 – Bajaj Auto: Domestic market share in different segments

21.6 23.0

49.6 45.8

2928.832.233.6

0

20

40

60

80

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

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%

Domestic motorcycle market share Entry level market shareExecutive market share Premium market share


440bps improvement in market share…

…driven by rising market share in the executive and premium segments


47

Diversified business model an advantage

Bajaj Auto has a diversified business model that acts as an advantage for the company’s performance when an entire segment or geography is underperforming. The company has a healthy mix of domestic and export revenues (in the ratio 75:25). It derives close to 20-25% revenue from the three-wheeler segment (19% in FY10). In the motorcycle segment, executive and premium segments (which are high-margin and high-profit segments) constitute 76% of overall sales.

Given this, the company's revenue may not face a major risk in the event of a slowdown in demand in a particular geography or segment.

The three-wheeler and premium segment exports to different markets in Africa, Middle East, Latin America and South East Asia help Bajaj Auto generate volume and simultaneously maintain a healthy margin; this helps the company in mitigating the impact of higher input costs in a way far better than its peers.

Fig 14 – Bajaj Auto: Product mix: 2W & 3W Fig 15 – Bajaj: Product mix: Dom and Exp

70

80

90

100

FY06

*

FY07

*

FY08

*

FY09

*

FY10

FY11

e

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e

%

2Ws 3Ws

0

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100

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%

Domestic volume Export volume

*Scooter volume not included Source: Company, Standard Chartered Research estimates


Fig 16 – Bajaj: Rev break-up: 2W & 3W Fig 17 – Bajaj: Rev break-up: Dom vs Exp

0

20

40

60

80

100

FY06

FY07

FY08

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FY10

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e

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e

%

Domestic Revenue Export Revenue

0

15

30

45

60

75

90

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

%

2W revenue 3W revenue


Note: Spare parts revenue not included Source: Company, Standard Chartered Research estimates


48

Fig 18 – Bajaj Auto: Motorcycle product mix

54 47 41 4324 21 20

25 32 35 3045 48 50

21 21 24 27 31 31 30

0

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40

60

80

100

FY06

FY07

FY08

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FY10

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e

FY12

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%

Entry-Level Executive segment Premium segment


Valuation

We value Bajaj Auto at 16x FY12e core earnings, which is at a 10% premium to our value for Hero Honda. We believe our PE rating for Bajaj Auto is justified considering its strong balance sheet, improvement in market share over FY10-12e and profit profile. We set a value of Rs58 for investments in the Indonesian venture and KTM Sports AG, the Austrian company, and give a 20% discount to cash in the balance sheet. Our fair value for Bajaj Auto comes to Rs3,260, which presents an upside of 24%.

Fig 19 – Bajaj Auto: SOTP valuation

FY09 FY10 FY11e FY12e Core EPS (Rs) 49.1 120.4 154.5 177.4 Multiple (x) 16.0 16.0 16.0 16.0 Value (Rs) 785.2 1,927.2 2,472.5 2,838.8 Cash per share (Rs) 107.6 228.0 253.7 362.8 Price (Rs) 892.7 2,155.2 2,726.1 3,201.6 Inv in KTM Power Sports AG and PT BAI at 20% discount (Rs m) 58.5 58.5 58.5 58.5 Fair value (Rs) 951.2 2,213.7 2,784.6 3,260.1


Fig 20 – Bajaj Auto: 12-month forward PE band

3x

5x

7x

9x

11x

0

500

1,000

1,500

2,000

2,500

3,000

May

-08

Aug-

08

Nov

-08

Feb-

09

May

-09

Aug-

09

Nov

-09

Feb-

10

May

-10

14x

Rs

Source: Bloomberg, Company, Standard Chartered Research estimates

Fair value of Rs3,260 at 16x FY12e core earnings


49

Fig 21 – Bajaj Auto: 12-month forward EV/EBITDA chart

3x

5x

7x

9x

12x

0

500

1,000

1,500

2,000

2,500

3,000

May

-08

Aug-

08

Nov

-08

Feb-

09

May

-09

Aug-

09

Nov

-09

Feb-

10

May

-10

Aug-

10

15x

Rs

Source: Bloomberg, Company, Standard Chartered Research estimates

Risks

Lower-than-expected demand for new launches by Bajaj Auto could hamper its market share gains.

Regulatory or bureaucratic issues in overseas markets may potentially hamper export growth (as seen previously in the context of Sri Lanka).

Subsidiaries

Bajaj Auto International Holdings BV (BAIH BV) It is a Netherlands-based 100% subsidiary of Bajaj Auto Ltd. and was formed to focus on international ventures, including possible acquisitions. In FY08, it acquired a 24.45% equity stake in KTM Power Sport AG of Austria, Europe’s second-largest sports motorcycle manufacturer. Recently, it increased its stake to 31.92%.

PT Bajaj Indonesia (PT BAI) It was incorporated in FY07 as a subsidiary in Indonesia with an issue and subscribed capital of US$12.5m. In FY10, Bajaj increased its stake to 98.9% with a further addition of US$ 17m in capital. The subsidiary assembles and markets Pulsars in Indonesia. In 2H FY11, it is expected to assemble complete knock down parts, which attract lower custom duties in Indonesia.

The subsidiary has not yet broken even but losses have decreased. Losses for FY10 were Rs159m at the PBT level compared with a loss of Rs615m in FY09.


50

Financials The strong volume growth we expect in FY10-12 along with a negative working capital cycle, strong cash flows and good return ratios, points to its strong financials. Over FY10-12, we expect Bajaj Auto to register strong 29% CAGR in volume and 27% in earnings. EBITDA is likely to grow at a CAGR of 20% over the same period. Furthermore, a ramp up of production at the Pantnagar plant from 80,000 units currently to 120,000 units in 3Q FY11 will help improve profitability and counter the impact of any further increase in raw material costs.

Return ratios to remain healthy – We expect that an improvement in profitability over FY10-12 would help maintain the company’s RoE at 52.6% and RoCE at 56.1% in FY11.

Fig 22 – Bajaj: Revenue and growth Fig 23 – Bajaj: RM and RM % of sales

0

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FY06

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% g

row

th

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Rsm

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FY06

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FY09

FY10

FY11

e

FY12

e

66676869707172737475

%

Raw Material (LHS) RM % of sales (RHS)

Rsm


Fig 24 – Bajaj: EBITDA and margins Fig 25 – Bajaj: Realization per vehicle

5,000

13,000

21,000

29,000

37,000

45,000

FY06

FY07

FY08

FY09

FY10

FY11

e

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e

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%

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Rsm

25,000

30,000

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45,000

FY06

FY07

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FY10

FY11

e

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e

Rs


Fig 26 – Bajaj: Contribution per vehicle Fig 27 – Bajaj: EBITDA per vehicle

8,000

9,500

11,000

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14,000

FY06

FY07

FY08

FY09

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7,000

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FY07

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e

Rs


We expect Bajaj Auto to register strong 29% CAGR in volume and 27% in earnings


51

Quarterly Performance

Fig 28 – Bajaj Auto: Standalone quarterly performance

FY10 FY11 1Q 2Q 3Q 4Q 1Q FY10 FY11e Total volumes (nos) 547,662 686,823 809,218 808,929 928,336 2,852,632 4,000,730 Yoy change (%) -11.7 7.3 63.9 83.8 69.5 30.0 40.2 Realisation 42,699 42,042 40,725 42,024 41,904 41,789 42,115 Yoy change (%) 14.6 5.6 -4.4 -1.8 -1.9 4.0 0.8 Total income 23,385 28,875 32,956 33,995 38,901 119,210 168,489 Yoy change (%) 1.2 13.3 56.7 80.5 66.4 35.1 41.3 Total cost 18,831 22,510 25,720 26,224 31,131 93,284 135,575 Expenses capitalised -12.9 -33.8 -51.2 -58.8 -9.0 -156.7 -156.7 EBITDA 4,554 6,365 7,235 7,771 7,769 25,926 32,914 EBITDA margin (%) 19.5 22.0 22.0 22.9 20.0 21.7 19.5 Yoy change (%) 70.7 85.1 136.6 149.9 70.6 115.6 27.0 Other income 231 217 351 425 817 1,225 3,025 Extraordinary expenses 458 458 458 493 0 1,868 0 Extraordinary income 218 0 0 0 0 218 0 Interest 60 0 0 0 6 60 55 Depreciation 331 336 357 341 318 1,365 1,351 PBT 4,155 5,788 6,771 7,362 8,262 24,076 34,534 Tax 1,220 1,760 2,020 2,075 2,360 7,075 9,152 Effective tax rate (%) 29.4 30.4 29.8 28.2 28.6 29.4 26.5 Rep. PAT 2,935 4,028 4,751 5,287 5,902 17,001 25,383 Yoy change (%) 67.6 117.9 189.2 240.4 101.1 159.8 49.3 Adj. PAT 3,103 4,349 5,072 5,632 5,902 18,156 25,383 Yoy change (%) 77.2 91.0 143.4 163.9 90.2 127.1 39.8 PAT margin (%) 13.3 15.1 15.4 16.6 15.2 15.2 15.1



52

Fig 29 – Bajaj Auto: Income statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Volume (units) 2,194,108 2,852,632 4,000,730 4,637,188 5,178,957 YoY growth (%) -10.5 30.0 40.2 15.9 11.7 Net realisation (Rs) 40,019 41,789 42,115 43,727 45,264 YoY growth (%) 8.4 4.4 0.8 3.8 3.5 Operating other income 3,437 4,125 4,744 5,455 6,001 Total Income 87,807 119,210 168,489 202,772 234,418 Change (%) -2.9 35.8 41.3 20.3 15.6 Total expenditure 76,183 93,284 135,575 165,705 192,776 EBITDA 11,624 25,926 32,914 37,067 41,642 Change (%) -11.2 123.0 27.0 12.6 12.3 % of net sales 13.2 21.7 19.5 18.3 17.8 Depreciation 1,298 1,365 1,351 1,543 1,821 EBIT 10,326 24,561 31,564 35,524 39,822 Interest & finance charges 210 60 55 55 55 Other income 1,516 1,225 3,025 3,726 5,035 PBT 9,561 24,076 34,534 39,195 44,802 Tax 3,016 7,075 9,152 9,799 10,752 Effective rate (%) 31.5 29.4 26.5 25.0 24.0 PAT 6,545 17,001 25,383 29,396 34,049 Adj. PAT 7,995 18,156 25,383 29,396 34,049 Change (%) -4.3 127.1 39.8 15.8 15.8 PAT margin (%) 9.1 15.2 15.1 14.5 14.5


Fig 30 – Bajaj Auto: Balance sheet (Standalone)

As at end March (Rs m) FY09 FY10 FY11e FY12e FY13e Share capital 1,447 1,447 1,447 1,447 1,447 Reserves 17,250 27,837 46,853 69,305 96,120 Net worth 18,697 29,283 48,300 70,751 97,567 Deferred tax 42 17 17 17 17 Loans 15,700 13,386 13,386 13,386 13,386 Capital employed 34,439 42,686 61,703 84,154 110,969 Gross fixed assets 33,339 33,793 39,208 44,208 49,208 Less: depreciation 18,079 18,997 20,347 21,890 23,711 Net fixed assets 15,260 14,796 18,861 22,317 25,497 Capital WIP 221 415 0 0 0 Technical know how 163 0 0 0 0 Investments 18,085 40,215 40,215 40,215 40,215 Net current assets 23,253 30,010 40,925 62,333 89,037 Inventory 3,388 4,462 8,075 8,650 10,013 Sundry debtors 3,587 2,728 5,383 6,487 7,510 Cash & bank balances 1,369 1,014 5,661 25,392 49,709 Loans & advances 13,652 20,745 20,745 20,745 20,745 Others 1,257 1,060 1,060 1,060 1,060 Current Liab. & Prov. 24,376 42,750 38,298 40,712 43,779 Sundry creditors 8,000 15,712 17,047 19,461 22,529 Other liabilities 4,134 4,551 4,551 4,551 4,551 Provisions 12,242 22,487 16,700 16,700 16,700 Net current assets -1,123 -12,740 2,627 21,621 45,257 Miscellaneous expenditures 1,833 0 0 0 0 Application of funds 34,439 42,686 61,703 84,154 110,969



53

Fig 31 – Bajaj Auto: Ratios (Standalone)

Year end March FY09 FY10 FY11e FY12e FY13e Basic (Rs) EPS 55.3 125.5 175.4 203.2 235.3 EPS growth (%) -4.3 127.1 39.8 15.8 15.8 Cash EPS 64.2 134.9 184.8 213.8 247.9 Book value per share 129.2 202.4 333.8 489.0 674.4 DPS 22.0 40.0 44.0 48.0 50.0 Payout (incl. div. tax) % 55.9 39.1 28.8 27.2 24.4 Valuation (x) P/E 50.3 22.2 15.8 13.7 11.8 Cash P/E 43.3 20.6 15.0 13.0 11.2 EV/EBITDA 34.3 14.4 11.2 9.4 7.8 EV/sales 4.7 3.3 2.3 1.8 1.4 Price to book value 21.5 13.7 8.3 5.7 4.1 Dividend yield (%) 0.8 1.4 1.6 1.7 1.8 Profitability ratios (%) RoE 42.8 62.0 52.6 41.5 34.9 RoCE 34.4 60.4 56.1 46.6 40.4 Turnover ratio Asset turnover (x) 2.4 2.7 2.7 2.3 2.1 Leverage ratio Debt/equity (x) 0.8 0.5 0.3 0.2 0.1


Fig 32 – Bajaj Auto: Cash flow statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e OP/(loss) before tax 10,326 24,561 31,564 35,524 39,822 Interest/Div. received 1,516 1,225 3,025 3,726 5,035 Depreciation & amort. 1,298 1,365 1,351 1,543 1,821 Direct taxes paid -3,084 -7,100 -9,152 -9,799 -10,752 (Inc)/Dec in working capital -345 11,263 -10,720 736 682 CF from oper. activity 9,711 31,314 16,068 31,731 36,609 Extra-ordinary items -3,904 183 0 0 0 CF after EO items 5,807 31,496 16,068 31,731 36,609 (Inc)/dec in FA+CWIP -3,908 -932 -5,000 -5,000 -5,000 (Pur)/sale of invest. 486 -22,130 0 0 0 CF from inv. activity -3,422 -23,062 -5,000 -5,000 -5,000 Inc. / dec.in net worth -64 241 955 1042 1085 Inc/(dec) in debt 2,357 -2,314 0 0 0 Interest paid -210 -60 -55 -55 -55 Dividends paid -3,660 -6,655 -7,321 -7,986 -8,319 CF from fin. activity -1,577 -8,789 -6,421 -7,000 -7,289 Inc/(dec) in cash 808 -355 4,647 19,731 24,320 Add: beginning balance 561 1,369 1,014 5,661 25,392 Closing balance 1,369 1,014 5,661 25,393 49,711



54

Fig 33 – Bajaj Auto: Income statement (Consolidated)

Year end: Mar (Rs m) FY08 FY09 FY10 FY11e FY12e Sales 90,488 88,297 119,556 171,631 208,304 Gross profit 24,295 23,681 38,518 50,472 58,739 SG&A 9,337 10,305 10,491 15,104 18,956 Other income 1,152 1,070 1,410 3,125 3,826 Operating expenses 2,185 1,985 2,340 4,134 5,051 EBIT 11,027 10,086 24,313 29,869 33,174 Depreciation & amortization 1,746 1,306 1,374 1,366 1,558 EBITDA 12,773 11,392 25,687 31,234 34,732 Net interest 52 219 68 65 65 Associates 231 -622 -1,028 -771 -385 Exceptional items 1,185 2,072 1,624 0 0 Pretax profit 10,942 8,865 24,032 32,929 36,935 Taxation 3,684 2,889 7,035 9,418 10,527 Minority interests 231 -622 -1,028 -771 -385 Net profit 7,496 5,358 15,972 22,743 26,264 Net profit (adjusted) 8,290 6,746 17,060 25,270 29,182 Basic EPS (Rs) 51.81 37.03 110.40 157.20 181.53 EPS (adjusted) (Rs) 57.30 46.63 117.92 174.66 201.70 DPS (Rs) 20.00 22.00 40.00 44.00 48.00


Fig 34 – Bajaj Auto: Balance sheet (Consolidated)

Year end: March FY08 FY09 FY10 FY11e FY12e Cash 712 1,426 1,073 17,047 35,519 Accounts receivables 2,529 2,809 2,719 3,931 4,778 Inventory 3,661 3,718 4,584 6,627 8,055 Other current assets 9,778 16,899 21,908 21,908 21,908 Total current assets 16,681 24,852 30,284 49,514 70,260 PP&E 12,975 15,522 15,249 18,468 20,910 Investment 15,633 14,232 34,452 34,452 34,452 Intangible Assets 3,223 3,835 3,290 3,290 3,290 Total long term assets 31,830 33,589 52,991 56,210 58,652 Total assets 48,511 58,441 83,275 105,724 128,912 Accounts payables 8,852 8,203 15,763 22,790 27,701 Other current liabilities 9,986 16,378 27,050 27,050 27,050 Total current liabilities 18,838 24,581 42,813 49,840 54,751 Long term debt 13,464 15,954 13,610 13,610 13,610 Deferred tax -31 -222 -321 -321 -321 Total long term liabilities 13,433 15,732 13,289 13,289 13,289 Total liabilities 32,271 40,313 56,102 63,129 68,040 Shareholders’ funds 16,236 18,128 27,169 42,592 60,869 Minority Interests 4 0 4 4 4 Total liab and equity 48,511 58,441 83,275 105,724 128,912



55

Fig 35 – Bajaj Auto: Ratio (Consolidated)

Year end: March FY08 FY09 FY10 FY11e FY12e Gross margin (%) 26.85 26.82 32.22 29.41 28.20

EBIT margin (%) 12.19 11.42 20.34 17.40 15.93

Effective tax rate (%) 33.7 32.6 29.3 28.6 28.5

Interest cover (x) 214 46 360 459 510

Op cash/EBIT (x) 0.7 2.9 1.2 1.0 0.0

Depn/capex (x) 0.7 0.1 0.4 0.6

Quick ratio (x) 0.2 0.2 0.1 0.4 0.7

ROE (%) 51.1 37.2 62.8 59.3 47.9

ROCE (%) 41.0 32.9 63.6 59.0 49.9

Net gearing (%) 78.5 80.1 46.1 -8.1 -36.0

Inventory days 17 18 18 17 17

Accounts receivable days 10 11 8 8 8

Accounts payable days 49 46 71 69 68

Total asset turonver (x) 2.9 2.5 2.9 3.0 2.7

PBR (x) 24.8 22.2 14.8 9.4 6.6

EV/Sales (x) 4.5 4.6 3.2 2.1 1.6

EV/EBITDA (x) 30.2 33.9 14.3 11.2 9.6

PER (x) 48.5 59.6 23.6 15.9 13.8

Dividend yield (%) 0.7 0.8 0.9 0.9 0.9

No of shares, fully diluted (m) 145 145 145 145 145


Fig 36 – Bajaj Auto: Cash flow statement (Consolidated)

Year end: Mar (Rs m) FY09 FY10 FY11e FY12e

Pretax profit 10,086 24,313 29,869 33,174

Interest/dividend paid 1,070 1,410 3,125 3,826

Depreciation & Amortization 1,306 1,374 1,366 1,558

Taxes paid -3,079 -7,134 -9,418 -10,527

(Inc)/Dec in Working Capital 116 10,614 3,771 2,636

Others -2,128 -1,459 2 2

Cash flow from operations 7,371 29,117 28,715 30,670

Capex -3,853 -1,101 -4,585 -4,000

Disposals 1,401 -20,220 0 0

Cash flow from investing -2,452 -21,321 -4,585 -4,000

Dividends -3,183 -6,749 -7,321 -7,986

Change in debt -70 130 0 0

Interest Paid -219 -68 -65 -65

Cash flow from financing -3,471 -6,686 -7,386 -8,051

Change in cash 2,160 2,536 17,818 35,666

Free cash flow 11,224 30,218 33,300 34,670



56

Company profile The second largest two-wheeler manufacturer in India, the erstwhile scooter company has re-invented itself by “re-innovating” its product range to turn into the second-largest motorcycle manufacturer in India.

Apart from its two-wheeler business, Bajaj has, through Bajaj Auto Financing, diversified into two-wheeler financing. With the opening up of the insurance sector, it has entered into a joint-venture with Allianz AG, Germany.

In May ’07, to establish clear defining lines between the responsibilities among the Chairman, Mr. Rahul Bajaj’s sons, the company split up Bajaj Auto. This was completed in May ’08, and culminated in the listing of the three hived off entities:

Bajaj Auto — the automobile company headed by Rajiv Bajaj;

Bajaj Finserv — the financial services company, with stakes in insurance ventures, consumer finance and wind power, headed by Sanjiv Bajaj, and

Bajaj Holding & Investments — the holding company, with a 30% stake each in the auto and financial services companies, and cash and investments on the books of the consolidated entity.

Fig 37 –Bajaj Auto: Shareholding pattern

Promoter

49%DII

6%

FII

19%

Others

26%

Source: BSE

Bajaj Auto is India second-largest two-wheeler manufacturer


57


Hero Honda

Underperform (initiating coverage) Dominance peaked; valuation premium unsustainable; initiate with Underperform PRICE as at 26 Aug 2010 Rs1,785


HH IN HROH.BO


US$7.9bn Rs1,497-2,086


Sales (Rs m) 157,582 185,845 216,221 244,571EBIT (Rs m) 25,024 25,432 29,362 32,835EBITDA (Rs m) 26,939 27,598 31,785 35,463Pretax profit (Rs m) 28,317 28,874 33,104 36,906Earnings (Rs m) adjusted 22,318 23,243 26,814 29,894Diluted EPS (Rs ) adjusted 111.76 116.39 134.27 149.70Diluted EPS growth (%) adj. 74.12 4.14 15.36 11.49DPS (Rs ) 110.00 35.00 40.00 45.00DPS growth (%) 450.0 -68.2 14.3 12.5EBITDA margin (%) 17.1 14.9 14.7 14.5EBIT margin (%) 15.9 13.7 13.6 13.4Net margin (%) 14.2 12.5 12.4 12.2Div payout (%) 115.2 35.2 34.9 35.2Book value/share (Rs ) 192.08 273.47 367.74 472.44Net gearing (%) -14.5 -22.7 -44.4 -55.6ROE (%) 58.2 42.6 36.5 31.7ROACE (%) 69.1 50.3 43.4 37.9FCF (Rs m) 25,904.9 13,630.6 27,931.7 28,644.6EV/Sales (x) 2.0 1.7 1.3 1.1EV/EBITDA (x) 11.8 11.2 9.1 7.6PBR (x) 9.3 6.5 4.9 3.8PER (x) 16.0 15.3 13.3 11.9Dividend yield (%) 6.2 2.0 2.2 2.5



1,4001,5001,6001,7001,8001,9002,0002,100


Hero Honda Motors Ltd

BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares -4 -7 21 Relative to Index -4 -14 7 Relative to Sector -9 -22 -30 Major shareholder Promoters: 52% Free float 47.79% Average daily vol US$21.1m

We initiate coverage on Hero Honda (HH) with an Underperform rating and fair value of Rs1,901. We expect HH to maintain its market dominance in the 2W segment given its brand image, distribution strengths, and successful product/variant launches. Nevertheless, we expect HH to lose the premium at which it had traded over the sector given earnings growth 50% below the 2W sector average and market share losses.

Earnings growth likely 50% lower than 2W sector – We estimate HH would report 17.1%, 8.6% and 9.6% CAGRs in revenue, EBITDA and earnings, respectively, over FY10-12e compared with its past eight-year CAGRs of 17.1%, 18.8% and 21.7%. Over the same period, we expect it to underperform the 2W industry earnings CAGR of 18.6%.

Market leadership, but may cede 450-500bps market share – Given the lacklustre performance on the volume front, we expect HH to lose market share of 450-500bps. In the motorcycle segment, market share could drop from 51.9% in FY10 to 47.5% in FY12e, and in the 2W industry it could fall to 40.7% in FY12e from 43.8% in FY10. The bright spot is the scooter segment, which could contribute to 5.7% of its overall volume, up from 4.7% in FY10.

Haridwar ramp-up positive, but insignificant to profit – The increase in production at its Haridwar plant in Uttarakhand to 1.8m units in FY11 (from 500,000–600,000 units in FY09) and increased localization from ancillary units there helped profit growth over FY08-10 (51.9% CAGR), while the tax rate dropped from 31.4% in FY08 to 21.2% in FY10. Nevertheless, we do not expect the incremental benefits from this plant to drive profits.

Best in industry operating performance – With RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e, HH’s operating performance is likely to remain one of the best in the sector. We expect it to generate strong free-cash-flow (post-investment income) of Rs68/share.

Valuation – We value HH at 14.0x FY12e core earnings, in line with its long-term average of 13.7x. We believe such a valuation is justified given expected market share loss and slower earnings growth over FY10-12e. We thus expect the premium to the sector it attracted – during the years of strong profitability growth and market share gains – to decrease. Our fair value for HH is Rs1,901 (6% upside).



58

Investment argument and valuation Hero Honda (HH) is India’s leading two-wheeler manufacturer. It has strong brand value, distribution strengths (widest reach across the country) and has been successful at product and variant launches. Given this dominance, its valuation commands a premium over the sector. We, however, believe this is not sustainable given our expectation it is likely to lose market share and report earnings growth 50% lower than the sector average over FY10-12. While we expect HH to remain the market leader in two-wheelers, we do not see a case for PE-multiple expansion beyond the long-term historical average.

Earnings growth likely 50% below two-wheeler sector average

Volume growth to underperform industry Between FY02 and FY10, HH outperformed the two-wheeler and motorcycle segments on volume – 15.8% growth in two-wheeler volume vs industry’s 11.8% and 15.1% in motorcycle volume vs industry’s 14.1%. This outperformance was driven by its strong brand value, distribution strengths (widest reach among two-wheeler companies), and successful launches of products/ variants.

Fig 1 – HH: Total 2W and motorcycle vol. Fig 2 – Industry: Total and motorcycle vol.

1,000

2,000

3,000

4,000

5,000

FY02

FY03

FY04

FY05

FY06

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HH's total 2W volumeHH's motorcycle volume

'000

uni

ts

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FY02

FY03

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FY08

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Industry's total 2W volumeIndustry's motorcycle volume

'000

uni

ts

Source: Company Source: SIAM, Companies

Going forward, we expect HH to report 15.5% total volume and 15% motorcycle volume CAGR against the industry’s 19.7% and 20.2%, respectively. We believe higher competition would lead to its underperformance. Its closest competitors, Bajaj Auto and TVS Motor, have built up stable product portfolios in each segment, unlike in the past when they had volatile volumes as they tried out different strategies. In addition, the entry of HMSI, Suzuki, Yamaha and M&M has made the industry more competitive.

Fig 3 – HH: CAGR over FY10-12e Fig 4 – Industry CAGR over FY10-12e

1,000

2,500

4,000

5,500

7,000

FY10

FY11

e

FY12

e

HH's total 2W volumeHH's motorcycle volume

'000

uni

ts

0

4,000

8,000

12,000

16,000

FY10

FY11

e

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e

Industry's total 2W volumeIndustry's motorcycle volume

'000

uni

ts

Source: Company, Standard Chartered Research estimates Source: Companies, Standard Chartered Research estimates

HH’s total 2W volume FY02-10 CAGR 15.8%... Motorcycle volume CAGR 15.1% Industry’s 2W volume CAGR FY02-10 11.8%... Motorcycles volume CAGR 14.1%

HH’s 2W volume FY10-12e CAGR likely to be 15.5%... Motorcycles FY10-12e CAGR likely 15.0% Industry’s 2W volume FY10-12e CAGR likely to be 19.7%... Motorcycles FY10-12e volume CAGR likely 20.2%


59

EBITDA and earnings growth to significantly decline compared with FY02-10 We estimate HH would report CAGRs of 17.1%, 8.6% and 9.6% in revenue, EBITDA and earnings, respectively, over FY10-12 compared with its past nine-year average CAGRs of 17.1%, 18.8% and 21.7%.

HH significantly outperformed the industry during the economic crisis in FY08-09, when its volume registered growth of 11.5% against the industry’s -5%. There are many reasons for this: competition was at its weakest ever, HH had a wide distribution network, it had the best rural-urban mix in volume, and it was less dependent on two-wheeler financing than the rest of the industry. Over FY08-09, HH reported revenue, EBITDA and profit growth of 19.2%, 26.7% and 32.4%, respectively, outperforming the industry by a wide margin. At the same time, higher production at its Haridwar plant also helped profitability.

Industry dynamics, however, have changed since FY10, with financing returning and competition intensifying.

Fig 5 – HH: FY02-12e revenue Fig 6 – HH: FY02-12e EBITDA

0

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HH's revenue

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HH's EBITDA

Rsm


Fig 7 – HH: FY02-12e net profit

0

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Rsm


HH’s FY02-10 revenue CAGR was 17.1%; over FY10-12e we expect the same Whereas EBITDA CAGR is falling from 18.8% over FY02-10 to 8.6% over FY10-12e

HH’s profit CAGR of 21.7% over FY02-10 is likely to drop to 9.6% over FY10-12e


60

Fig 8 – HH: Profit CAGR over FY10-12e Fig 9 – 2W ind profit CAGR over FY10-12e

0

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Rsm


Dominates the two-wheeler sector

Hero Honda dominates the Indian two-wheeler sector, commanding a 43.8% market share in FY10 compared to 39.3% in FY07. In the past four years, it has consistently gained market share driven by the spectacular success of its long-running Splendor range, the Passion family, and its scooter models. There has also been an enthusiastic response to its +150cc bikes. However, with Bajaj Auto and TVS Motor revving up their offensives in the executive segment, we expect HH to lose market share in this segment over FY10-12.

Key contributing factors to its dominant market share Among two-wheeler manufacturers, HH has the most widespread network. Bajaj Auto is more

urban-centric and does not have the former’s rural reach; TVS Motor is South-based and focused on “urban” in other regions.

HH has built up the largest dealer network in India over the past decade. This gives it access to a larger customer base and a higher proportion of rural population. It is now focusing on deeper penetration into the north east.

Greater exposure to the rural sector also insulates it from the lack of availability of financing seen by its competitors, since rural purchases are mainly on a cash basis.

Since its rural exposure is high, the company’s volume is less cyclical to the slowdown in urban and semi urban areas. We are optimistic on two-wheelers mainly because we expect strong rural demand on account of rising agri incomes, the suitability of rural roads for two wheelers, and lesser dependence on financing.

…but may cede 450-500bps market share Given the lackluster performance on the volume front, we expect HH to lose 450-500bps in market share. In the motorcycle segment, it could drop from 51.9% in FY10 to 47.5% in FY12, and in the two-wheeler industry, it could fall to 40.7% in FY12 from 43.8% in FY10. The bright spot is the scooter segment, which could contribute to 5.4% of its overall volume, up from 4.7% in FY10.

Industry’s profit CAGR over FY10-12e likely 18.6% vs HH’s 9.6%

HH had a commanding 43.8% two-wheeler market share in FY10

Supported by large dealer network, rural exposure

But is likely to cede 450-500bps in market share given rising competition


61

Fig 10 – HH: Market share Fig 11 – HH: Total market share

51.948.2 47.5

16.014.914.3

0

10

20

30

40

50

60

FY07

FY08

FY09

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%

HH's motorcycle market shareHH's scooter market share

43.8

40.9 40.7

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38

40

42

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46

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%

HH's overall 2W market share


Production ramp-up at Uttarakhand positive

The increase in production at its Haridwar plant in Uttarakhand from nil in FY08 to 1.4m units in FY10 and increased localization from the ancillary units there has helped HH improve profits by 51.9% over FY08-10. The Uttarakhand plant contributed 30.4% of total sales in FY10.

The company is further expanding the capacity at a CAGR of 22.5% over FY10-12 to 2.1m units. We expect contribution of this plant to overall sales to improve to 34.2% over FY10-12 and expect localization to be stabilized at 65-70%, going forward.

Fig 12 – HH: Haridwar plant ramp-up

('000 units) FY09 FY10 FY11e FY12e Capacity 700 1,400 1,800 2,100 % increase 100.0 28.6 16.7 Production* 627 1,400 1,800 2,100 % increase 123.3 28.6 16.7 % of total volumes 16.8 30.4 33.5 34.2

* We have assumed capacity and production to be the same in FY11e and FY12e Source: Company, Standard Chartered Research estimates;

Fig 13 – Hero Honda: Haridwar’s impact on profitability diminishing

19.0

19.521.2

28.1

31.4

0

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e

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PBT (LHS) Profits (LHS) Tax rate (RHS)

Rsm %


But insignificant impact on profits, going forward Most of the benefits from the Haridwar plant have already been accrued over FY08-10. The percentage increase in volume over FY10-12 is expected to be 23% compared with 123% growth in FY10. The company’s tax rate declined from 31.4% in FY08 to 21.2% in FY10. Nevertheless, we do not expect the incremental benefits to significantly drive profits for the company. We have factored in 19.5% and 19% tax rates for FY11 and FY12 and localization at 70% over the same period. HH is planning to build a fourth plant with a planned outlay of Rs20b to meet increasing demand in the future.

Incremental benefits from Uttarakhand plant diminishing


62

One of the best operating performances in the industry

With RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e, HH’s operating performance is likely to be one of the best in the sector. We expect it to generate strong free cash flow (post-investment income) of Rs68/share.

Fig 14 – Hero Honda: RoE & ROCE

38.3 35.5 37.8

58.2

42.636.5

48.5 45.7 48.1

69.1

50.343.4

20

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80

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FY08

FY09

FY10

e

FY11

e

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e

%

RoE ROCE Source: Company, Standard Chartered Research estimates

Valuation

We value Hero Honda at 14 x FY12e core earnings, in line with its long-term average of 13.7x. We believe such a valuation is justified given our expectation of a loss in market share and slower earnings growth over FY10-12. We thus expect that the premium that it enjoyed over the sector – during the years of strong profitability growth and market share gains – would decrease. Our fair value for HH is Rs1,901 (6% upside).

Fig 15 – Hero Honda: SOTP valuation

FY09 FY10 FY11e FY12e Core EPS (Rs) 56.2 99.6 103.4 120.0 Multiple (x) 14.0 14.0 14.0 14.0 Value (Rs) 765 1,354 1,406 1,632 Cash per share (Rs) 143.7 160.3 187.8 268.6 Fair value (Rs) 909 1,515 1,594 1,901


Fig 16 – Hero Honda: 12-month forward PE band

0

500

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5

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Dec

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Apr-1

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Aug-

10

21x18x

15x

12x

9x

6x

Rs

Source: Bloomberg, Standard Chartered Research

HH likely to report RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e

Fair value of Rs1,901 at 14x FY12e core earnings


63

Fig 17 – Hero Honda: 12-month forward EV/EBITDA band

0

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800

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Apr-0

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-05

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16x

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Rs


Risk

A faster-than-anticipated ramp-up at the Haridwar plant may result in more-than-anticipated earnings growth in FY11.

Upturn in demand for its products.

Honda exiting from the joint venture


64

Financials We expect HH to register, over FY10-12, CAGRs of 15.5% in volume and 9.6%% in earnings, the lowest in the two-wheeler universe. We expect revenue and EBITDA to register growth of 17.1% and 8.6%, respectively, over FY10-12.

Fig 18 – HH: Revenue and revenue growth Fig 19 – HH: RM and RM as % of sales

0

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06

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%Revenues (LHS) Growth (RHS)

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64

66

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%

Raw material (LHS) % of sales (RHS)

Rsm


Fig 20 – HH: EBITDA and margins (%) Fig 21 – HH: Realization per vehicle

0

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%


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06

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Rs


Fig 22 – HH: Contribution per vehicle Fig 23 – HH: EBITDA per vehicle

7,000

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Rs


CAGRs of 15.5% in volume and 9.6%% in earnings likely over FY10-12, the lowest in the two-wheeler universe


65

Fig 24 – Hero Honda: Quarterly performance

FY10 FY11 Year end March (Rs m) 1Q 2Q 3Q 4Q 1Q FY10 FY11e Total volumes (nos) 1,118,987 1,183,235 1,111,372 1,186,536 1,234,039 4,600,130 5,366,149 Change (%) 25.1 21.7 29.6 18.9 10.3 23.6 16.7 Realization 34,160 34,308 34,435 34,742 34,817 34,256 34,633 Chg in realisation (%) 7.4 4.6 2.8 1.6 1.9 3.5 1.1 Net sales 38,224 40,594 38,270 41,223 42,966 157,582 185,845 Change (%) 34.4 27.3 33.2 20.8 12.4 27.9 17.9 Total cost 31,723 33,153 31,661 34,106 36,941 130,643 158,247 (Inc) / dec in SIT 124 -50 95 -110 -255 0 0 Raw material 25,773 27,686 26,051 27,794 30,848 107,364 131,950 RM/sales (%) 67.7 68.1 68.3 67.2 71.2 68.1 71.0 Staff cost 1,385 1,387 1,371 1,460 1,450 5,603 6,040 % sales 3.6 3.4 3.6 3.5 3.4 3.6 3.3 Other expenditure 4,441 4,130 4,144 4,962 4,897 17,676 20,257 Other exp. as a % of sales 11.6 10.2 10.8 12.0 11.4 11.2 10.9 EBITDA 6,501 7,442 6,609 7,117 6,025 26,939 27,598 As % of sales 17.0 18.3 17.3 17.3 14.0 17.1 14.9 Change (%) 90.6 76.1 61.3 32.2 -7.3 57.4 2.4 Other income 425 687 550 695 534 3,087 3,224 Interest -55 -61 -46 -45 -27 -206 -217 Depreciation 456 503 469 487 483 1,915 2,166 PBT 6,525 7,686 6,736 7,370 6,103 28,317 28,874 Tax 1,524 1,715 1,378 1,382 1,187 5,999 5,630 Effective tax rate (%) 23.4 22.3 20.5 18.8 19.4 21.2 19.5 PAT 5,001 5,971 5,358 5,988 4,917 22,318 23,243 Adj. PAT 5,001 5,971 5,358 5,988 4,917 22,318 23,243 Change (%) 83.3 95.0 78.3 48.9 -1.7 74.1 4.1



66

Fig 25 – Hero Honda: Income statement

Year end March (Rs m) FY08 FY09 FY10 FY11e FY12e FY13e Volume (units) 3,337,142 3,722,000 4,600,130 5,366,149 6,134,123 6,805,534 YoY growth (%) 0.0 11.5 23.6 16.7 14.3 10.9 Realisation (Rs) 30,960 33,098 34,256 34,633 35,249 35,937 YoY growth (%) 4.3 6.9 3.5 1.1 1.8 2.0 Net sales 103,318 123,191 157,582 185,845 216,221 244,571 Change (%) 4.4 19.2 27.9 17.9 16.3 13.1 Total income 103,318 123,191 157,582 185,845 216,221 244,571 EBITDA 13,494 17,097 26,939 27,598 31,785 35,463 Change (%) 14.3 26.7 57.6 2.4 15.2 11.6 % of net sales 13.1 13.9 17.1 14.9 14.7 14.5 Depreciation 1,603 1,807 1,915 2,166 2,423 2,628 EBIT 11,891 15,291 25,024 25,432 29,362 32,835 Interest & finance charges -358 -317 -206 -217 -229 -241 Other income 1,854 2,207 3,087 3,224 3,513 3,831 Non-recurring expense 0 0 0 0 0 0 PBT 14,103 17,815 28,317 28,874 33,104 36,906 Tax 4,424 4,997 5,999 5,630 6,290 7,012 Effective rate (%) 31.4 28.1 21.2 19.5 19.0 19.0 PAT 9,679 12,818 22,318 23,243 26,814 29,894 % of net sales 9.4 10.4 14.2 12.5 12.4 12.2 Adj. PAT 9,679 12,818 22,318 23,243 26,814 29,894 Change (%) 11.8 32.4 74.1 4.1 15.4 11.5 PAT margin (%) 9.4 10.4 14.2 12.5 12.4 12.2


Fig 26 – Hero Honda: Balance sheet

As at end March (Rs m) FY08 FY09 FY10e FY11e FY12e FY13e

Share capital 399 399 399 399 399 399 Reserves 29,463 37,608 37,959 54,213 73,039 93,947 Net worth 29,862 38,008 38,359 54,612 73,439 94,346 Deferred tax 1,306 1,531 1,531 1,531 1,531 1,531 Loans 1,320 785 785 785 785 785 Capital employed 32,488 40,323 40,674 56,928 75,754 96,662 Gross fixed assets 19,548 25,163 29,368 33,868 36,868 39,868 Less: depreciation 7,825 9,426 11,340 13,506 15,929 18,557 Net fixed assets 11,723 15,737 18,028 20,362 20,939 21,311 Capital WIP 3,924 1,205 0 0 0 0 Investments 25,668 33,688 33,688 33,688 33,688 33,688 Curr.Assets, L & Adv. 9,368 10,135 15,161 25,025 45,355 67,832 Inventory 3,171 3,268 4,749 6,110 7,109 8,041 Sundry debtors 2,974 1,499 2,159 2,546 2,962 3,350 Cash & bank balances 1,311 2,196 6,340 13,198 33,371 53,270 Loans & advances 1,855 3,113 1,855 3,113 1,855 3,113 Others 57 59 59 59 59 59 Current liab. & prov. 18,247 20,528 26,288 22,233 24,314 26,256 Sundry creditors 7,561 7,030 10,793 12,729 14,810 16,751 Other liabilities 5,689 8,228 8,228 8,228 8,228 8,228 Provisions 4,998 5,270 7,267 1,276 1,276 1,276 Net current assets -8,880 -10,393 -11,127 2,792 21,041 41,577 Miscellaneous expenditures 52 87 87 87 87 87 Application of funds 32,488 40,323 40,674 56,928 75,754 96,662



67

Fig 27 – Hero Honda: Ratios

Year end March FY08 FY09 FY10 FY11e FY12e FY13e Basic (Rs) EPS 48.5 64.2 111.8 116.4 134.3 149.7 EPS growth (%) 11.8 32.4 74.1 4.1 15.4 11.5 Cash EPS 56.5 73.2 121.3 127.2 146.4 162.9 Book value per share 149.5 190.3 192.1 273.5 367.7 472.4 DPS 19.0 20.0 110.0 35.0 40.0 45.0 Payout (incl. div. tax) % 45.9 36.5 115.2 35.2 34.9 35.2 Valuation (x) P/E 36.8 27.8 16.0 15.3 13.3 11.9 Cash P/E 31.6 24.4 14.7 14.0 12.2 11.0 EV/EBITDA 24.5 18.8 11.8 11.2 9.1 7.6 EV/sales 3.2 2.6 2.0 1.7 1.3 1.1 Price to book value 11.9 9.4 9.3 6.5 4.9 3.8 Dividend yield (%) 1.1 1.1 6.2 2.0 2.2 2.5 Profitability ratios (%) RoE 35.5 37.8 58.2 42.6 36.5 31.7 RoCE 45.7 48.1 69.1 50.3 43.4 37.9 Turnover ratios Debtors (days) 11 4 5 5 5 5 Inventory (days) 11 10 11 12 12 12 Creditors (days) 27 21 25 25 25 25 Working capital (days) -5 -7 -9 -8 -8 -8 Asset turnover (x) 3.2 3.1 3.9 3.3 2.9 2.5 Fixed asset turnover 8.8 9.0 9.3 9.7 10.5 11.6 Leverage ratio Debt/equity (x) 0.0 0.0 0.0 0.0 0.0 0.0


Fig 28 – Hero Honda: Cash flow statement

Year end March (Rs m) FY08 FY09 FY10e FY11e FY12e FY13e OP/(loss) before tax 11,891 15,291 25,024 25,432 29,362 32,835 Interest/div. received 1,854 2,207 3,087 3,224 3,513 3,831 Depreciation & amort. 1,603 1,807 1,915 2,166 2,423 2,628 Direct taxes paid -4,414 -4,772 -5,999 -5,630 -6,290 -7,012 (Inc)/Dec in working capital 4,174 2,399 4,878 -7,061 1,924 -637 Other items -38 -34 0 0 0 0 CF from oper. activity 15,069 16,897 28,905 18,131 30,932 31,645 Extra-ordinary items 0 0 0 0 0 0 Other items 0 0 0 0 0 0 CF after EO items 15,069 16,897 28,905 18,131 30,932 31,645 (Inc)/dec in FA+CWIP -3,696 -3,102 -3,000 -4,500 -3,000 -3,000 (Pur)/sale of invest. -5,930 -8,019 0 0 0 0 CF from inv. activity -9,626 -11,121 -3,000 -4,500 -3,000 -3,000 Changes in reserves -723 -679 0 0 0 0 Inc/(dec) in debt -332 -535 0 0 0 0 Interest paid 358 317 206 217 229 241 Dividends paid -3,794 -3,994 -21,967 -6,990 -7,988 -8,987 CF from fin. activity -4,491 -4,891 -21,761 -6,772 -7,759 -8,745 Inc/(Dec) in cash 953 885 4,144 6,858 20,173 19,899 Add: beginning balance 358 1,311 2,196 6,340 13,198 33,371 Closing balance 1,311 2,196 6,340 13,198 33,371 53,270



68

Company profile Hero Honda is a joint venture between Honda Corp, Japan, and the Munjal family (each party owns 26%). It has a large dealer network with excellent penetration in rural areas.

HH commissioned its third plant at Haridwar in FY08 (initial installed capacity: 500,000 units and raised to 1.5m in FY10). It has overall annual capacity of 5.5m two-wheelers. In FY11, it has also decided to set up a fourth plant.

The management team is led by chairman Brijmohan Munjal, managing director and chief executive officer Pawan Munjal and joint managing director Toshiaki Nagakawa.

Fig 29 – Hero Honda: Shareholding pattern

DII

6%

Promoter

52%

FII

31%

Others

11%

Source: BSE

Hero Honda is India’s largest two-wheeler manufacturer


69


Company updates

M&M

Outperform (initiating coverage) Core holding; initiate with Outperform PRICE as at 26 Aug 2010

Rs611


MM IN MAHM.BO


US$7.7bn Rs407-663


Sales (Rs m) 185,296 216,641 248,430 281,087EBIT (Rs m) 25,409 28,014 30,101 31,659EBITDA (Rs m) 29,117 32,395 35,562 37,777Pretax profit (Rs m) 28,468 30,375 33,109 34,830Earnings (Rs m) adjusted 19,893 24,300 27,149 28,560Diluted EPS (Rs ) adjusted 33.41 40.81 45.60 47.97Diluted EPS growth (%) adj. 115.84 22.15 11.73 5.20DPS (Rs ) 9.71 12.00 13.00 14.00DPS growth (%) -5.1 23.6 8.3 7.7EBITDA margin (%) 15.7 15.0 14.3 13.4EBIT margin (%) 13.7 12.9 12.1 11.3Net margin (%) 10.7 11.2 10.9 10.2Div payout (%) 31.9 32.7 32.4 33.1Book value/share (Rs ) 138.31 162.12 190.00 222.07Net gearing (%) 14.5 -6.2 -14.3 -30.1ROE (%) 25.4 25.7 24.0 21.6ROACE (%) 25.0 24.3 23.1 21.5FCF (Rs m) 15,039.0 25,307.4 19,256.3 33,368.8EV/Sales (x) 1.6 1.4 1.2 0.9EV/EBITDA (x) 10.1 8.9 8.0 6.9PBR (x) 4.4 3.8 3.2 2.7PER (x) 18.3 15.0 13.4 12.7Dividend yield (%) 1.6 2.0 2.1 2.3



400450500550600650700


Mahindra and Mahindra Ltd

BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares -4 12 49 Relative to Index -4 5 35 Relative to Sector -9 -3 -3 Major shareholder Promoter: 23.88% Free float 68.51% Average daily vol US$27.6m

We initiate coverage on Mahindra & Mahindra (M&M) with an Outperform rating and fair value of Rs762. With its core growing at a good clip, foray into international markets (Ssangyong acquisition) raising its profile and product offerings, and new businesses providing value unlocking potential, we believe M&M should be a core holding for any investor in the sector.

Core growing strong – We estimate M&M’s core segments, utility vehicles and farm equipment, would report volume, sales and profit CAGRs of 14%, 16%, and 17%, respectively, over FY10-12, driven mainly by rising demand and low competitive intensity. In utility vehicles, we expect M&M to improve its market share in FY11e, with new launches driving growth. In farm equipment, M&M’s most profitable segment post the Punjab Tractors acquisition, we expect it to capitalize on its leadership position.

Foray into international markets raising profile – M&M’s aim to become an international player in tractors and SUVs is reflected in its acquisition of Chinese tractor companies and Korean SUV manufacturer Ssangyong. We believe M&M has a sound balance sheet and enough cash flow for its acquisitions despite high capex in coming years.

New business ventures to add value – Over the past 3-4 years, M&M has increased its business portfolio by venturing into two-wheelers (acquired Kinetic), commercial vehicles (JV with Navistar), electric car (Reva) and auto components (Mahindra Systec). It has also carved out separate subsidiaries (defense and logistic) from existing operations. Over the medium to long term, we feel there is substantial value unlocking potential in these businesses.

Valuation – At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-the-parts method to arrive at our fair value of Rs762 (26% upside). To arrive at fair values for M&M’s listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&M’s other investments.



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Investment argument and valuation Mahindra & Mahindra (M&M), a conglomerate, dominates India’s tractor and utility vehicle segments. Its interests span over IT services, automobiles and components, financial services, infrastructure and real estate. M&M has a history of creating good businesses and then unlocking value for investors. We believe many of its current ventures, such as defense and logistics, have value unlocking potential. The recent acquisitions of Kinetic (two-wheeler), Reva (electric car), and Ssangyong gels well with M&M’s strategy to become an auto major in India and internationally.

Core growing strong

M&M’s core businesses comprise utility vehicles, three-wheelers/mini vans and farm equipment – tractors and implants. These segments are witnessing a demand upswing, and we expect M&M to increase its dominance in these low competition segments. We estimate core volume, sales and profit to register 14%, 16%, and 17% CAGRs, respectively, over FY10-12.

M&M plans to launch a completely new SUV (priced higher than the Scorpio) in 3Q FY11. A further 6-7 new products built on existing platforms are likely to be launched to target niche markets in which the company does not have a presence – three variants of Maxximo, a variant of Xylo, and a passenger variant of the Gio.

Automotive segment Utility vehicle & three-wheelers/minivans – In FY11, we expect M&M to improve its market share in both the utility vehicle and the three-wheeler segments, driven by new launches. We expect the utility vehicle and three-wheeler segments to report CAGRs of 14% and 22.3%, respectively, over FY10-12.

Utility vehicle segment – M&M has above 50% market share M&M has had a dominant presence in UVs. It has a wide product range in the utility vehicle segment – Bolero, Xylo and Scorpio. Also, the Maxx range has done well in the pick-up segment, where M&M has a near monopoly (85% of the domestic market share).

Low industry volume (compared with developed countries) and the fact that most sales occur outside the top 10 cities (requires large service and distribution networks) makes this segment unattractive to global players. We, therefore, do not expect new entrants to enter this space and expect competitive intensity to remain low. The main competition in this space is from Tata Motors’ Sumo and Safari brands.

The success of the revamped Bolero and the launch of Scorpio variants (including those fitted with the new mHawk engine) helped M&M regain market share and register a 900bps improvement over FY08-10. The launch of Xylo was to compete with Toyota’s Innova. We expect M&M’s utility vehicle market share to improve 200bps over FY10-12.

Fig 1 – M&M: UV volume and growth Fig 2 – M&M: UV market share

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Likely to increase its dominance in its core segments

M&M has had a dominant presence in UVs.

We expect M&M’s utility vehicle market share to improve 200bps over FY10-12


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Three-wheeler/minivan segment The three-wheeler and minivan segment is very competitive. Currently, the dominant players are Bajaj Auto (in both passenger and goods carriers and which plans to launch a small four-wheeler minivan in the goods segment), Tata Motors with its highly successful Ace and variants, and Piaggio. Going forward, as Hub and Spoke model is developed in India, we expect the segment to become more prominent than at present.

M&M has a decent three-wheeler portfolio. The success of its recently launched new products – Gio and Maxximo – has strengthened its product portfolio. We expect M&M to report 22.3% volume CAGR over FY10-12. Its recently-launched products will be key volume drivers, helping it regain market share.

Fig 3 – M&M: Three-wheeler/minivan volume and growth

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Farm-equipment segment The farm-equipment segment (FES) directly benefits from the government’s support for agricultural, which has grown substantially over the past 4-5 years. Minimum support prices for various crops have also seen strong growth over the past two years. Apart from that, the rise in non-agri sales has made the segment less dependent on agriculture. We believe the segment could grow at 8-10% annually, above its long-term historical average of 5%, driven by increased mechanisation in farming and increased usage in non-agri segments.

M&M dominates the industry with 41% market share We expect M&M to report an 11% CAGR in tractor volume over FY10-12. Post the acquisition of Punjab Tractors, M&M has become the dominant player in the tractor segment, commanding 41% market share. It is well-entrenched in most regions, with above 40% market share in the South, West and East. Even in the North, where the company’s presence is relatively weak, it remains the market leader with 35% market share. Moreover, the company’s portfolio caters to all segments. M&M is well positioned to capitalize on its leadership in the segment.

Post the acquisition with Punjab Tractors, M&M revamped its tractor operations; tractors from Punjab Tractors constitute the lower end of the group’s combined product range, while those from M&M are at the higher end. This segment is M&M’s most profitable division.

The other sub-segment – sales of DG sets, engines, forklifts and harvester combines — is doing well.

Competitive segment

The segment could grow at 8-10% annually…

…where M&M commands ~41% market share


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Fig 4 – M&M: Tractor volume and growth Fig 5 – M&M: Tractor market share

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Foray into international markets – solid foundation in place

M&M’s aim to become an international player in tractors and SUVs is reflected in its acquisition of Chinese tractor companies and Korean SUV manufacturer Ssangyong. We believe M&M has a sound balance sheet and enough cash flow for its acquisitions despite high capex in coming years.

M&M’s main markets for tractors and utility vehicle segments are Africa (mainly Nigeria, Mali, Chad, Gambia, Angola, Sudan, Ghana, and Morocco), Latin America (Chile and Brazil), South Asian countries (Sri Lanka, Bangladesh and Nepal), Middle East (Iran and Syria) and East Europe (Serbia and Macedonia; FES entered Turkey in 2008).

Total exports were only 4.4% of total sales in FY10 (7.2% in FY08). Exports of utility vehicles were 4.6% of total vehicles sold in FY10 (7.7% in FY08) whereas tractor exports constituted 5.3% of total tractor sales in FY10 (8.8% in FY08).

Fig 6 – M&M: Total exports to total volume

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Fig 7 – M&M: Tractor exp. to tractor vol. Fig 8 – M&M: UV exports and to UV vol.

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Farm equipment segment: International aspiration to take off M&M has a presence in all large tractor markets, either with own assembly plants or through acquisitions or JVs. We expect the steps it has taken to move into international markets to bear fruit over the next five years.

Mahindra USA (MUSA): Mahindra USA is a wholly-owned subsidiary of M&M. Over the years, Mahindra USA has reinforced its position in the compact and utility tractor segments. It has a wide network of tractor dealers that provides customers product support and after sales service. The company has three assembly plants in the US – in Houston (Texas), Calhoun (Georgia) and Redbluff (California).

Mahindra Australia: Brisbane-based, it offers a range of 2WD and 4WD compact tractors (20-30 HP range) and utility tractor models (45-80 HP range) along with attachments like loaders, back-hoes and mowers.

Mahindra China Tractor Company Ltd. (MCTCL): A joint venture between Jiangling Motors Company Group and Mahindra & Mahindra FES. It is increasingly becoming a centre for M&M to expand its product range and develop tractors for China and other overseas markets.

JV with Jiangsu Yueda Yancheng Tractor Manufacturing Co: It is a joint venture with Jiangsu Yueda Yancheng Tractor Manufacturing Co. Ltd. (Yancheng Tractor), a leading Chinese tractor manufacturer. M&M is to hold 51 per cent in the JV. Yancheng Tractor’s Huanghai Jinma brand is the No 3 tractor brand in China (in terms of tractor volume in 2007).

With a global footprint in the farm equipment segment in place, M&M intends to increase its international volume from 5.3% of total volume in FY10 to 15% by FY15.

Exports of utility vehicles Utility vehicle exports form a mere 4.6% of the total volume at present. These vehicles are currently sold in Chile, Africa and Australia. We believe M&M can create a market for its vehicles internationally based on the price points at which it would launch in the global markets. Some 250,000 compact UVs are already being sold in the US every year. The Scorpio launch in the US is planned for after the completion of its homologation process there. At present, M&M has a very small presence in Europe. However, it plans to continue selling in the European market; the company may see rapid expansion in the European market now with Ssangyong in its stable.

Acquisition of Ssangyong an important step We see M&M’s successful bid for the Korean SUV manufacturer as an important leap into the international market. The media and management conference call suggests the deal is in the range of US$450-500m. The key rationale for the move is M&M’s aspiration to become a global player in the SUV market.

Ssangyong acquisition


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Our view: Ssangyong has 138 dealers in Korea and another 1,300 dealers across 98 nations worldwide.

Thus, the acquisition gives M&M access to the Korean and European markets.

Access to Ssangyong’s large assembly capacity of 120,000 units per annum on single shift and engine capacity of 150,000 units (both petrol and diesel).

M&M has strengthened the UV/SUV product portfolio by acquiring products like Rexton, Kyron, Actyon and other sedan models. Though it will have to refresh these models as the last new model was launched in 2002 (Rexton) and refreshed in 2007.

The acquisition will add very little to M&M’s technical capability (R&D spend has been much lower in the last eight years) but will bring some synergies, going forward, to R&D spends.

With a sound balance sheet and debt-equity ratio of less than 0.5, M&M is comfortably placed to fund the acquisition.

The acquisition helps M&M garner an SUV market share of 14% in Korea.

Overall, we view this acquisition as a win-win for M&M.

Highlights of the deal from the conference call by M&M management The acquisition is a debt-free one with likely to M&M infuse US$450-500m (according to

media reports) into the company to acquire a controlling stake. The infused money would be used to repay all long-term debts (US$320m as on March 2010 post restructuring). M&M will also provide an additional pre-determined debt to Ssangyong for it to continue operations.

Ssangyong is also launching a new product, Korando C200, in 2010; according to management, no further launches are planned for two years following this launch.

The fixed costs at Ssangyong have been reduced 37% by downsizing; the current operations, on a quarterly basis, are very close to break even levels and, hence, according to management, it will not be too difficult to get the company back in the black. According to management, there are no immediate labour issues either.

The company sold 35,000 units in FY09 and the current monthly run-rate is +7,000 units; with a new product offering lined up this year, we believe there will be an improvement from this level.

New business ventures to add value

Over the past 3-4 years, M&M has increased its business portfolio by venturing into two-wheelers (acquired Kinetic), commercial vehicles (JV with Navistar), electric car (Reva) and auto components (Mahindra Systec). It has also carved out separate subsidiaries (defense and logistic) from existing operations. Over the medium to long term, we feel there is substantial value unlocking potential in these businesses.

M&HCV joint venture with Navistar The joint venture will start production at its Chakan facility with capacity of 250,000 units for

UVs/LCVs and 50,000 units for M&HCVs.

The commercial vehicle industry is a virtual duopoly with enough for a third player. We believe that M&M’s JV with Navistar would enable it to become a major player in the segment over the next five years given its market knowledge and Navistar’s products and technology. Most other new players are unlikely to succeed to this extent given that they have either partnered with weak domestic players or are going it alone.

The JV targets to produce a range of trucks from 9T onwards.


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The JV is ready to launch a 25T truck followed by a 31T truck in FY11.

The JV may use the existing dealer network in rural/semi urban areas for servicing and is also creating an alternate dealership network for the truck venture.

Two wheelers: May remain a niche player M&M has acquired an 80% stake in Kinetic Motor Company (KMC), which has three production plants and a capacity to produce 400,000 two wheelers in a year. The company has also acquired Engines Engineering, Italy, which specialises in designing two wheelers. Kinetic’s market share has improved significantly from 0.5% at the time of the takeover to 6% post the takeover. The company has big plans for both the scooter and motorcycle segments, but the two-wheeler industry is very crowded with the top three players enjoying over 90+ market share. Hence, we believe M&M may remain a niche player in the industry.

Value unlocking potential in new subsidiaries

Defense subsidiary Historically, the defense business had been an integral part of M&M. Seeing the opportunities available in the sector given the government increased spending on defense, the company created a separate subsidiary to cater to defense. In addition, in 2009, it set up a dedicated plant in Haryana to cater to defense requirements.

Strong outlook for defense business – India is one of the world’s largest importers of arms and defense equipment, with nearly 70% of the requirement being met by foreign companies. The government has announced its intent to decrease the import content in military hardware to ~30% over the next seven years. In addition, it announced an offset clause (whereby 30% of the overall expenditure from a foreign company will have to be sourced from Indian companies). Mahindra Defence Systems (MDS) has traditionally provided the entire range of light combat/armoured vehicles for defence/security forces. However, there are clear indications that the company seems to be attaching greater importance to the segment.

Mahindra Logistics Mahindra Logistics, which began as a division supporting M&M’s transportation needs (called transport solutions group), was eventually hived off as a 100% subsidiary in 2008. The company provides inbound and outbound solutions to nearly 200 clients across various verticals, apart from automobiles. It manages more than 35 automotive plants with a warehousing capacity of more than 3m sq ft. In India’s growing logistics sector, with very few organized players, M&M has the potential to grow both organically as well as inorganically. The company has vast experience in inbound and outbound logistics.

Mahindra Systec Mahindra Systec, a division of M&M, has interests in forgings, castings, engineering services (both for autos and airplane manufacturing), gear manufacturing and component sourcing. The company has expanded by acquiring companies in India and Europe. The company today has revenue close to US$1bn.

Valuation

At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-parts method to arrive at our fair value of Rs762 (25% upside). To arrive at fair values for M&M’s listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&M’s other investments.


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Fig 9 – M&M: SOTP valuation

Rs FY08 FY09 FY10 FY11e FY12e Core EPS 13.6 13.3 32.0 39.3 43.8 PE attributable (x) 13 13 13 13 13 Fair value 177 172 416 511 569 Value of listed subsidiaries & associates 1. Tech Mahindra No. of shares held by M&M (m) 54 54 54 54 54 Current price 651 651 651 651 651 Value of holding (Rs m) 35,011 35,011 35,011 35,011 35,011 Value per share of M&M 59 59 59 59 59 Value p.s. of M&M after 20% disc. 47 47 47 47 47 2. M&M Financial Services No. of shares held by M&M (m) 58 58 58 58 58 Current price 576 576 576 576 576 Value of holding (Rs m) 33,546 33,546 33,546 33,546 33,546 Value per share of M&M 56 56 56 56 56 Value p.s. of M&M after 20% disc. 45 45 45 45 45 3. Mahindra Lifespaces No. of shares held by M&M (m) 21 21 21 21 21 Current price 457 457 457 457 457 Value of holding (Rs m) 9,527 9,527 9,527 9,527 9,527 Value per share of M&M 16 16 16 16 16 Value p.s. of M&M after 20% disc. 13 13 13 13 13 4. Mahindra Holidays No. of shares held by M&M (m) 70 70 70 70 70 Current price 484 484 484 484 484 Value of holding (Rs m) 33,873 33,873 33,873 33,873 33,873 Value per share of M&M 57 57 57 57 57 Value p.s. of M&M after 20% disc. 46 46 46 46 46 Total value of listed subsidiaries 188 188 188 188 188 Value considering 20% discount 150 150 150 150 150 Value of Systech Division 1. Mahindra Forgings No. of shares held by M&M (m) 45 45 45 45 45 Current price 101 101 101 101 101 Value of holding (Rs m) 4,484 4,484 4,484 4,484 4,484 Value per share of M&M 15 15 15 15 15 Value p.s. of M&M after 20% disc. 12 12 12 12 12 2. Other Systech PAT excluding MUSCO and MF 1,223 463 -262 -26 660 PE attributable (x) 8 8 8 8 8 Value of holding (Rs m) 9,785 3,706 -2,093 -212 5,279 Value per share of M&M 17 6 -4 0 9 Value p.s. of M&M after 20% disc. 13 5 -3 0 7 Total value of Systech 32 21 11 15 24 Value considering 20% discount 25 17 9 12 19 Mahindra Holdings & Finance @ 50% disc 5 5 5 5 5 Mahindra Renault (at 50% disc to BV) 6 6 6 6 6 Mahindra Navistar (at 50% disc to BV) 4 4 4 4 4 Other investments in books at 50% disc 9 9 9 9 9 Total for others 24 24 24 24 24 Fair value 420 406 639 737 805 Fair value (after 20% discount) 376 364 599 697 762



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Fig 10 – M&M: 12-month forward PE band

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Risks

A slowdown in the Indian economy as both the automotive as well as the farm equipment segments are linked to the India growth story.

Consolidated entity is very complex

Recently, the company ventured into areas such as commercial vehicles, passenger cars, two wheelers and auto components, which will demand a significant part of management’s time.

M&M, as a consolidated entity, has made a number of acquisitions in the recent past. Integration as well as future financial commitment to the newly-acquired business may bring the consolidated balance sheet under pressure.


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Financials (Standalone) We expect M&M to register, over FY10-12, CAGR of 14% in volume, 16% in revenue, 11% in EBITDA and 17% in profit.

Fig 12 – M&M: Revenue and rev growth Fig 13 – M&M: Adj. net profit and growth

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Fig 16 – M&M: Realization per vehicle Fig 17 – M&M: EBITDA per vehicle

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Fig 18 – M&M: Standalone quarterly segmental performance

Rs m 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 Revenue from operations Automotive segment 18,732 19,208 13,702 21,717 22,575 26,145 25,568 31,139 28,798 Farm equipment segment 13,245 13,952 15,018 14,485 19,750 18,556 19,282 21,763 22,739 Other segments 2,016 203 169 311 198 230 212 201 137 Total 33,993 33,363 28,889 36,512 42,524 44,930 45,062 53,103 51,673 Profit/loss before interest and tax Automotive segment 1,501 1,057 -104 1,574 2,302 3,429 2,868 4,065 3,521 Farm equipment segment 1,561 1,480 1,628 1,605 3,344 3,784 3,523 4,358 3,894 Other segments 34 35 25 68 27 52 7 53 2 Total 3,096 2,572 1,549 3,246 5,673 7,264 6,397 8,476 7,418 EBIT margins (%) Automotive segment 8.0 5.5 -0.8 7.2 10.2 13.1 11.2 13.1 12.2 Farm equipment segment 11.8 10.6 10.8 11.1 16.9 20.4 18.3 20.0 17.1 Other segments 1.7 17.3 14.5 21.8 13.8 22.6 3.2 26.5 1.7 Less: interest 97 122 141 209 60 128 82 9 -227 Less: other un-allocable expenditure 865 259 964 -1,869 233 -1,671 442 786 433 Total PBT 2,134 2,192 444 4,906 5,381 8,808 5,873 7,681 7,211


Consolidated financial performance

On consolidated basis, we expect revenue and profit to report CAGRs of 15% and 13.6% over FY10-12, respectively.

Fig 19 – M&M: Consolidated financials

(Rsmn) FY06 FY07 FY08 FY09 FY10 FY11E FY12E Total revenue 125,881 178,418 242,676 267,670 315,905 365,219 418,806 % growth 41.7 36.0 10.3 18.0 15.6 14.7 PBT 18,025 22,024 25,040 22,541 40,300 43,569 48,283 % growth 22.2 13.7 -10.0 78.8 8.1 10.8 PAT 13,996 16,067 18,468 17,120 28,758 33,330 37,178 Reported consolidated PAT 12,697 14,972 15,711 14,054 24,786 28,905 31,973 Adjusted consolidated PAT 9,842 14,091 16,321 14,586 23,004 28,905 31,973 Diluted adjusted cons EPS 16.5 23.7 27.4 24.5 41.6 48.5 53.7



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Fig 20 – M&M: Consolidated segmental revenue, profit, and margins FY09 FY10 FY11e FY12e Common Size (%) Revenue Profit Revenue Profit Revenue Profit Revenue Profit Automotive 31.1 9.7 35.7 28.9 37.2 28.0 38.6 25.7 Farm equipment 25.1 25.1 28.5 32.2 27.1 27.9 25.8 25.7 Total core business (A) 56.2 34.8 64.2 61.1 64.3 55.9 64.4 51.3 Steel trading and processing 2.5 3.6 1.9 1.9 1.7 1.7 1.6 1.7 Financial services 5.2 12.5 5.0 12.0 5.2 12.4 5.3 13.5 Total trade & financial services (B) 7.7 16.1 6.8 13.9 6.9 14.2 6.9 15.1 Infrastructure 1.3 4.2 1.3 2.8 1.5 3.6 1.6 4.1 Hospitality 1.5 3.5 1.6 3.6 1.7 3.9 1.8 4.2 Total infrastructure development (C) 2.8 7.7 2.9 6.4 3.2 7.5 3.4 8.4 Total A + B + C 66.7 58.6 73.9 81.4 74.3 77.6 74.7 74.8 IT services 17.4 42.3 15.3 23.5 14.7 23.2 14.1 23.4 Systech 13.5 0.9 8.1 -2.5 8.4 1.3 8.8 2.8 Others 2.4 -1.8 2.8 -2.5 2.6 -2.0 2.5 -1.0 Margins (%) Automotive 3.1 11.2 10.0 8.4 Farm equipment 9.9 15.6 13.7 12.6 Total core business (A) 6.2 13.2 11.6 10.1 Steel trading and processing 14.2 14.0 13.5 13.5 Financial services 24.0 33.4 32.0 32.0 Total trade & financial services (B) 20.8 28.1 27.4 27.8 Infrastructure 33.0 29.3 32.5 32.5 Hospitality 23.1 31.6 30.0 30.0 Total infrastructure development (C) 27.6 30.6 31.2 31.2 Total A + B + C 8.7 15.2 13.9 12.7 IT services 24.2 21.3 21.0 21.0 Systech 0.7 -4.2 2.0 4.0 Others -7.2 -12.3 -10.0 -5.0 Grand total 10.0 13.8 13.3 12.6 Unallocable expenses (net of income) 0.3 0.5 0.4 0.3 Net unallocable interest income (net of exp) -0.9 -1.4 -1.0 -0.8 Unallocable exceptional items -0.3 0.8 0.0 0.0 PBT 8.4 12.8 11.9 11.5 Tax 2.0 3.7 2.8 2.7 PAT 6.4 9.1 9.1 8.9 Prior period adjustments 0.0 0.0 0.0 0.0 Share of associates 0.0 0.1 0.1 0.1 Minority interest 1.2 1.3 1.3 1.3 Reported consolidated PAT 5.3 7.8 7.9 7.6 Adjusted consolidated PAT 5.4 7.3 7.9 7.6



81

Fig 21 – M&M: Income statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Volume (units) 325,946 451,927 521,274 584,344 646,526 YoY growth (%) 11.0 38.7 15.3 12.1 10.6 Net realisation (Rs) 400,142 410,014 415,598 425,143 434,765 YoY growth (%) 3.0 2.5 1.4 2.3 2.3 Operating other income 3,997 4,916 5,309 5,734 6,020 Total Income 130,425 185,296 216,641 248,430 281,087 Change (%) 14.3 42.1 16.9 14.7 13.1 Total EXPENDITURE 117,961 156,179 184,245 212,867 243,310 EBITDA 12,464 29,117 32,395 35,562 37,777 Change (%) 0.2 133.6 11.3 9.8 6.2 % of net sales 9.6 15.7 15.0 14.3 13.4 Depreciation 2,915 3,708 4,381 5,462 6,118 EBIT 9,549 25,409 28,014 30,101 31,659 Interest & finance charges 453 278 231 231 231 Other income 2,703 1,994 2,592 3,239 3,401 Profit before tax 10,672 28,468 30,375 33,109 34,830 Tax 1,997 7,590 6,075 5,960 6,269 Effective rate (%) 18.7 26.7 20.0 18.0 18.0 Profit after tax 8,675 20,878 24,300 27,149 28,560 Change (%) -21.4 140.7 16.4 11.7 5.2 Adj. Profit after tax 9,217 19,893 24,300 27,149 28,560 Change (%) 5.4 115.8 22.2 11.7 5.2


Fig 22 – M&M: Balance sheet (Standalone)

As at end March (Rs m) FY09 FY10 FY11e FY12e FY13e Share capital 2,726 2,830 2,921 2,977 2,977 Reserves 49,895 75,438 91,782 110,146 129,246 Net worth 52,621 78,268 94,703 113,123 132,223 Deferred tax -183 2,403 2,403 2,403 2,403 Loans 40,528 28,802 28,802 28,802 28,802 Capital employed 92,966 109,473 125,907 144,328 163,427 Gross fixed assets 48,939 52,763 67,405 82,405 85,405 Less: depreciation 23,263 25,378 29,759 35,220 41,338 Net fixed assets 25,676 27,385 37,646 47,184 44,067 Capital WIP 6,467 9,642 0 0 0 Investments 57,864 63,980 63,980 63,980 63,980 Curr. assets, L & Adv. 50,629 60,424 81,834 96,385 124,453 Inventory 10,607 11,888 13,927 15,994 18,128 Sundry debtors 10,437 12,581 14,740 16,927 19,185 Cash & bank balances 15,744 17,432 34,644 44,940 68,617 Loans & advances 13,826 18,014 18,014 18,014 18,014 Others 16 509 509 509 509 Current liab. & prov. 47,978 51,965 57,559 63,228 69,078 Sundry creditors 33,368 32,601 38,195 43,863 49,714 Other liabilities 1,834 1,399 1,399 1,399 1,399 Provisions 12,776 17,965 17,965 17,965 17,965 Net current assets 2,652 8,458 24,274 33,157 55,374 Working capital -13,093 -8,974 -10,369 -11,783 -13,243 Misc. Expenditures 307 7 7 7 7 Application of funds 92,966 109,472 125,907 144,328 163,427



82

Fig 23 – M&M: Ratios (Standalone)

Year end March FY09 FY10 FY11e FY12e FY13e Basic (Rs) Adjusted EPS 15.5 33.4 40.8 45.6 48.0 Consolidated EPS 24.5 41.6 48.5 53.7 63.8 Cash EPS 20.4 39.6 48.2 54.8 58.2 Book value per share 96.5 138.3 162.1 190.0 222.1 DPS 10.2 9.7 12.0 13.0 14.0 Payout (incl. div. tax) % 33.9 31.9 32.7 32.4 33.1 Valuation (x) P/E 39.4 18.3 15.0 13.4 12.7 Consolidated P/E 24.9 14.7 12.6 11.4 9.6 Cash P/E 30.0 15.4 12.7 11.1 10.5 EV/EBITDA 24.1 10.1 8.9 8.0 6.9 EV/sales 2.4 1.6 1.4 1.2 0.9 Price to book value 6.3 4.4 3.8 3.2 2.7 Dividend yield (%) 1.7 1.6 2.0 2.1 2.3 EBIDTA margins 9.9 16.1 15.3 14.7 13.7 Net profit margins 6.9 11.6 11.5 11.2 10.4 RoE 17.5 25.4 25.7 24.0 21.6 RoCE 13.2 25.0 24.3 23.1 21.5 Turnover ratios Debtors (days) 30 25 25 25 25 Inventory (days) 31 24 24 24 24 Creditors (days) 96 66 66 66 66 Working capital (days) -36 -16 -16 -16 -16 Asset turnover (x) 1.4 1.6 1.7 1.7 1.7 Leverage ratio Debt/equity (x) 0.8 0.4 0.3 0.3 0.2


Fig 24 – M&M: Cash flow statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e OP/(loss) before tax 9,549 25,409 28,014 30,101 31,659 Int./dividends received 2,703 1,994 2,592 3,239 3,401 Depreciation & amort. 2,915 3,708 4,381 5,462 6,118 Direct taxes paid -2,747 -5,004 -6,075 -5,960 -6,269 (Inc)/dec in wkg. capital 8,524 -4,119 1,395 1,414 1,459 Other Items CF from oper. activity 20,944 21,988 30,307 34,256 36,369 Extra-ordinary items -1,127 1,343 0 0 0 Other items -171 300 0 0 0 CF after EO items 19,646 23,631 30,307 34,256 36,369 (Inc)/dec in FA+CWIP -11,449 -8,592 -5,000 -15,000 -3,000 (Pur)/sale of invest. -15,714 -6,116 0 0 0 Cf from inv. activity -27,163 -14,708 -5,000 -15,000 -3,000 Change in net worth 3,235 10,267 -853 -987 -1,123 Inc/(dec) in debt 14,657 -11,726 0 0 0 Interest paid -453 -278 -231 -231 -231 Dividends paid -2,788 -5,495 -7,010 -7,740 -8,336 Cf from fin. activity 14,651 -7,233 -8,094 -8,958 -9,690 Inc/(dec) in cash 7,134 1,690 17,213 10,298 23,679 Add: beginning balance 8,612 15,744 17,432 34,644 44,940 Closing balance 15,746 17,434 34,646 44,942 68,619



83

Company profile Mahindra & Mahindra is India’s leading utility vehicle and tractor manufacturer. It has over the years diversified into sectors such as real estate, IT, financial services, logistics. M&M has generally followed an inorganic growth strategy to dominate its business. Recent acquisitions include Punjab Tractors, Satyam Computers, and Ssangyong.

M&M’s auto products include Bolero, Xylo and Scorpio (utility), Alpha, Gio and Maximo (three-wheelers), Logan (car), Kinetic (two-wheelers), Arjun and DI Super Turbo (farm equipment). It will manufacture LCVs in a JV with Navistar that would eventually also manufacture M&HCVs.

Under the management team headed by chairman Keshub Mahindra and vice-chairman and managing director Anand Mahindra, M&M has expanded its business horizons to offer a whole range of products.

Fig 25 – Mahindra & Mahindra: Shareholding pattern

Promoter

26%

FII

23%

DII

25%

Others

26%

Source: BSE

Mahindra & Mahindra is India’s leading utility vehicle and tractor manufacturer


84


Maruti Suzuki

Outperform (initiating coverage) Time to be zen-like; initiate with Outperform PRICE as at 26 Aug 2010

Rs1,218


MSIL IN MRTI.BO


US$7.8bn Rs1,193-1,701


Sales (Rs m) 296,230 364,289 428,318 497,863EBIT (Rs m) 31,293 33,422 41,326 49,756EBITDA (Rs m) 39,543 42,258 51,184 60,739Pretax profit (Rs m) 35,925 35,616 44,999 55,972Earnings (Rs m) adjusted 25,184 26,100 32,856 40,756 EPS (Rs) adjusted 87.1 90.3 113.7 141.0 EPS growth (%) adj. 62.5 3.6 25.9 24.0DPS (Rs) 6.00 7.00 8.00 8.00DPS growth (%) -30.0 71.5 16.7 14.3EBITDA margin (%) 13.3 11.6 12.0 12.2EBIT margin (%) 10.6 9.2 9.6 10.0Net margin (%) 8.5 7.2 7.7 8.2Div payout (%) 6.9 7.8 7.0 5.7Book value/share (Rs) 409.5 491.3 595.4 726.8 Net gearing (%) 6.1 -5.5 -18.8 -31.4ROE (%) 21.1 18.1 18.8 19.2 ROACE (%) 28.6 24.2 25.3 26.0 FCF (Rs m) 20,809 17,431 27,301 36,298 EV/Sales (x) 1.0 0.8 0.6 0.4 EV/EBITDA (x) 7.3 6.4 4.8 3.5 PBR (x) 3.0 2.5 2.0 1.7 PER (x) 14.0 13.5 10.7 8.6 Dividend yield (%) 0.5 0.6 0.7 0.7



1,1001,2001,3001,4001,5001,6001,7001,800


Maruti Suzuki India Ltd BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares 1 -1 -14 Relative to Index 1 -7 -28 Relative to Sector -4 -16 -66 Major shareholder Promoter: 54.21% Free float 45.79% Average daily vol US$22.8m

We initiate coverage on Maruti Suzuki with a contrarian Outperform call and fair value of Rs1,478. We believe the negatives (rising competition, market share loss, and increase in royalty payments) are priced in and that the stock currently offers a good entry point considering its balance sheet strength, cash flow as well as 26% earnings growth in FY12e.

To lose less market share than most expect – We estimate Maruti would lose 600bps in market share over FY10-12e (including the Nano impact). Our view: with industry capacity rising at a 16% CAGR (most added by Maruti and Tata Motors) and with industry volume CAGR of 23%, market share loss could be lower than our expectations. In addition, we have taken a ‘worst-case’ volume CAGR estimate of 16.5% for Maruti over FY10-12e. The company could outperform our expectations given its established brand, strong dealer network, aggressive and innovative marketing strategies and largest and best-reach service network.

Market leader on many fronts – We expect Maruti to maintain its domestic market leadership in passenger cars, especially in small and compact cars. Export-oriented models could provide an added impetus going forward, subject to capacity expansion over the next two years.

Export ramp-up – Although suffering the hangover of the cash-for-clunkers scheme, we expect most European markets to report steady recovery in auto demand over the next three years. We expect Maruti’s exports to benefit from the European recovery and also from its efforts to tap new markets. We estimate Maruti’s exports to record an impressive 12% CAGR over FY10-12 (on base of FY10), raising export’s share of volume to 13.5% by FY12e (from 6.9% in FY08).

Valuation – Our fair value multiple for Maruti is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently the valuation is weighed down on account of intense competition in the PC segment and the surprise higher royalty cost. Our earnings do capture the worst case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside). Source: Company, Bloomberg


85

Investment argument and valuation We believe the negatives (rising competition, market share loss, and increase in royalty payments) are priced in and that the stock currently offers a good entry point considering its balance sheet strength, cash flow as well as 26% earnings growth in FY12e.

Maruti to underperform industry volume growth

We expect the passenger car industry to report 25.5% volume CAGR including Nano; excluding Nano, our growth estimate falls to 22.3%. Our estimates imply domestic growth of 21.6% and export growth of 24.9% over FY10-12.

Compared with industry volume growth, we expect Maruti to register domestic passenger car CAGR of 18.1% and export CAGR of 12% over FY10-12, mainly driven by the A2 and A3 segments.

We have factored in conservative volume growth assumptions for Maruti to assess the worst-case scenario of loss in market share due to the entry of new players.

Fig 1 – Maruti: Total volume and growth

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Fig 2 – Maruti: Domestic vol and growth Fig 3 – Maruti: Export vol and growth

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Maruti likely to report domestic PC CAGR of 18.1% vs industry’s 21.6% over FY10-12e


86

Fig 4 – Maruti and industry: Comparison of volume CAGR

Maruti Suzuki Industry

(%) CAGR (FY04-09) CAGR (FY10-12e) CAGR (FY04-09) CAGR (FY10-12e) Domestic PC sales 12.2 18.1 11.9 21.6/25.5* A1 segment -21.7 -27.6 A2 segment 23.8 19.9 A3 segment 40.5 15.9 Domestic MPV sales 5.5 11.4 13.3 11.0 Domestic UV sales 16.1 4 7.8 13.7 Domestic PV sales 11.4 17.3 11.3 22.8 PC exports 6.6 11.5 21.5 24.9 PV exports 6.6 12 21.1 24.8 Total PC sales 11.6 17.1 13.6 22.3 Total PV sales 10.9 16.5 12.8 23.2

* Including Nano volume Source: SIAM, Company, Standard Chartered Research estimates

Market share loss might be limited

We estimate that Maruti could lose 600bps (our worst-case scenario) in market share over FY10-12 (including the Nano impact). In reality, the loss in market share may be very limited.

Our analysis is based on the assumption that all competitors’ new launches will be released on scheduled and that the new cars in each segment will be 100% successful (which is rare). In addition, we have assumed 75% utilisation (excluding Maruti) for the industry over FY10-12.

Fig 5 – Maruti: Market share excluding/including Nano

46.847.5

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Our view: With industry capacity rising at a CAGR of 16% over FY10-12e (49% added by Maruti and Tata Motors) and with industry volume growing at a CAGR of 23%, the loss in market share could be lower than our expectations. In addition, we have taken a ‘worst-case’ volume CAGR estimate of 16.5% for Maruti over FY10-12. The company could outperform our expectations, given its established brand, strong dealer network, aggressive and innovative marketing strategies and largest and best-reaching service network.

Maruti could lose 600bps (our worst-case scenario) in market share over FY10-12

The company could outperform our expectations


87

Fig 6 – Industry: Capacity from FY05-12e Fig 7 – Industry: Util with/without Maruti

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Note: Capacity also includes UV and SUV capacities Source: SIAM, Standard Chartered Research estimates

Note: Maruti’s utilisation is on nameplate capacity in BS for historical years Source: Companies, Standard Chartered Research estimates

Fig 8 – Industry: Incremental capacity addition over FY10-12e

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New entrants underestimating India demand, which may help Maruti India’s consumption-led economy has prompted global majors to set up shop in India. They all plan to launch cars in the largest selling segment – small/compact cars. But we believe they are underestimating India’s demand growth over the next five years, considering their slow pace of new product launches, investment in creating capacities and sales and distribution networks. Their capacity expansion plans are relatively small compared with those of Maruti, Tata Motors and Hyundai. Although capacity creation can take place in a relatively short time frame, developing India-specific models could be a longer process.

Creation of distribution networks key challenge for new players In addition to creating capacities and aggressively developing new products, setting up a distribution network in India will be a key challenge for new players. Currently, the top 10 cities contribute 45-50% of overall passenger vehicle sales; in our view, these cities have become more or less saturated. Going forward, we see demand in these cities coming mainly from replacement demand. We expect demand from cities other than the top 10 will contribute a lion’s share of incremental demand and customer preferences would be for small and compact cars.

49% of incremental industry capacity to be added by Tata Motors and Maruti over FY10-12e

New entrants underestimating India’s demand growth over the next five years…

…setting up a distribution network a key challenge for them


88

Fig 9 – Industry: Sales by location Fig 10 – Maruti: Dealerships/locations

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Top 10 cities Next 40 cities Others

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Source: Companies, Standard Chartered Research estimates Source: Company

We therefore believe that there is a strong possibility that Maruti could outperform our volume assumptions and, hence, the loss in market share may be limited.

Market leader on many fronts

We expect Maruti to retain market leadership in the domestic passenger car market, especially in the small and compact car segment. Export-oriented models could provide added impetus going forward, subject to capacity expansion over the next two years. Operating performance is expected to improve in the next two years on account of lower royalty payout after two years. Maruti has displayed strength in its balance sheet, cash flows as well as earnings, even during the crisis.

Domestic leadership expected to continue We expect Maruti to retain its dominant market share in the domestic passenger car segment (>45%), fending off local competitors such as Tata Motors and M&M, and overseas majors such as Hyundai, Honda, Ford, General Motors and Fiat. Furthermore, we expect Maruti to retain its dominant overall market share of ~44% (and domestic market share of 50 %+) in the key volume-driver small and compact-car segment (we have excluded the impact of Nano in our analysis).

The key rationale: Maruti has one of best product portfolios in India to satisfy every customer need

New models like A-Star (launched in Nov 2008), Ritz (launched in Apr 2009), Eeco (launched in March 2010), Alto K10 (launched in August 2010) along with refreshing the Swift and WagonR ranges are not only expected to help ward off competition, but also lower losses in market share in FY12.

Maruti has a history of successful innovative and aggressive marketing strategies, resulting in good volume growth over the years, keeping the company ahead of competition.

Fig 11 – Maruti: Innovative marketing campaigns

‘Wheels of India’ for state government employees ‘First Class Offer’ for Railway employees ‘Power Deal’ for NTPC employees ‘Steel Wheel’ for SAIL employees ‘Teachers’ Scheme’ for teachers ‘Dil Se’ for non-resident Indians Direct marketing to Govt. employees Post implementation of 6th Pay Commission recommendations

Source: Company

Market leader in the small and compact car segment


89

Maruti has built a loyal customer base by offering easy service and exchange facilities through its pre-owned-cars True-Value network. By launching attractive models in the A3 class and entering the premium A4 class over the next three to four years, we believe Maruti would retain customers.

Maruti is ahead of the market in creating capacities. Its capacity is expected to increase 40-50% over FY10-14. Also, the expansion at Manesar is expected to address capacity constraints with regards to Swift, DZire and SX4, while creating additional capacity for new models.

Maruti has been the most aggressive company in launching new models in the last 10 years.

Fig 12 – Maruti: Model launches

Key launches FY00 Baleno & WagonR FY01 Alto, Altura & CNG Omni FY02 Versa FY03 - FY04 Grand Vitara FY05 Swift FY06 - FY07 Swift diesel, Zen Estilo, WagonR Duo FY08 SX4, Swift Dzire FY09 A-Star, M-800 Uniq, Estilo Sport FY10e Splash / Ritz, new Omni

Source: Company

Maruti has successfully created and expanded the diesel car segment by launching various diesel variants. Maruti is the market leader in all alternate fuel segments – diesel/LPG/CNG.

Benefits seen from European recovery

Although still suffering from the hangover of the cash-for-clunkers scheme, we expect most European markets to report steady recovery in auto demand over the next three years. We expect Maruti’s exports to benefit from this recovery and also from the company’s efforts to tap new markets. We estimate Maruti’s exports to grow at a CAGR of 12% over FY10-12 (on a high base of FY10), raising exports’ share in volume to 13.4% by FY12 (from 6.9% in FY08).

The A-Star is a key export-oriented model, which has enabled Maruti to re-enter the European market after a gap of two years. Maruti’s top five export markets are Algeria, Chile, Indonesia, Egypt and Sri Lanka. The other key export growth drivers are forays into new markets and the Pixo for export under the Nissan badge.

Fig 13 – Maruti: Export ramp-up Fig 14 – Maruti: Exports and dom. sales

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Maruti’s exports likely to grow at a CAGR of 12% over FY10-12


90

Valuation

Our target multiple for Maruti is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently the valuation is weighed down on account of intense competition in the PC segment and the surprise higher royalty cost. Our earnings do capture the worst case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside).

Fig 15 – Maruti Suzuki: 12-month forward PE band

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Fig 16 – Maruti Suzuki: 12-month forward EV/EBITDA band

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Risks

Intensifying competition

Currency impact: JPY depreciation benefits Maruti, 20/25% costs are in Yen. Euro depreciation hurts exports which form 15% of sales.

Fair value of Rs1,478 at 13x FY12e earnings


91

Financials We expect Maruti to register 16.5%, 20%, 13.4%, and 13.8% CAGR in volume, total income, EBITDA and adj. profit, respectively. EBITDA and earnings could be impacted because of the increase in royalty costs. We expect growth to return to historical levels in FY12 with 26% and 21% expected growth in adj. profits and EBITDA, respectively.

Fig 17 – Maruti: Revenue and growth Fig 18 – Maruti: Adj. net profit and growth

0

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Fig 19 – Maruti: RM and RM as % of sales Fig 20 – Maruti: EBITDA and margins

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Fig 21 – Maruti: Royalty as a % to net sales Fig 22 – Maruti: Realization per vehicle

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92

Fig 23 – Maruti: Contribution per vehicle Fig 24 – Maruti: EBITDA per vehicle

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Fig 25 – Maruti Suzuki: Quarterly performance

FY10 FY11 1Q 2Q 3Q 4Q 1Q FY10 FY11e

Total volumes (nos) 226,729 246,188 258,026 287,422 283,324 1,018,365 1,207,386 Change (%) 17.7 29.9 48.7 21.5 25.0 28.6 18.6 Average realisations: 280,719 287,612 285,733 288,107 285,553 285,741 297,072 % change 13.73 13.30 9.10 7.63 1.72 10.7 4.0% Net Sales 63,647 70,807 73,727 82,808 80,904 290,989 358,681 Change (%) 33.9 47.2 62.3 30.7 27.1 42.4 23.3 Other operating income 1,283 1,219 1,302 1,437 1,411 5,242 5,609 Total Income 64,930 72,026 75,029 84,246 82,315 296,230 364,289 (Inc) / dec in stock -596 -154 -1,312 129 549 0 0 Net raw materials 50,147 54,709 57,213 63,999 63,553 224,134 278,681 RM/sales 76.3 75.7 74.5 76.1 77.9 75.7 76.5 RM/vehicle 221,175 222,226 221,732 222,664 224,312 220,092 230,814 Staff costs 1,336 1,263 1,325 1,534 1,610 5,456 5,829 Staff costs/net sales 2.1 1.8 1.8 1.8 2.0 1.8 1.6 Mfg & other expenses 6,112 7,047 6,464 7,474 8,027 27,097 37,522 Mfg & OE as a % of sales 9.4 9.8 8.6 8.9 9.8 9.1 10.3 Total cost 56,998 62,865 63,689 73,135 73,739 256,687 322,032 EBITDA 7,932 9,161 11,339 11,111 8,577 39,543 42,258 As % of sales 12.2 12.7 15.1 13.2 10.4 13.3 11.6 Change (%) 29.3 55.6 163.1 65.5 8.1 71.6 6.9 Non-operating income 2,165 1,100 913 790 1,002 4,968 3,240 Extraordinary expense 0 0 0 0 652 0 652 Interest 63 60 84 129 80 335 394 PBDT 10,034 10,202 12,168 11,772 8,847 44,176 44,452 Less: depreciation 1,961 2,031 2,028 2,230 2,417 8,250 8,835 PBT 8,073 8,171 10,140 9,542 6,430 35,925 35,616 Tax 2,238 2,471 3,265 2,976 1,777 10,949 9,973 Effective tax rate (%) 27.7 30.2 32.2 31.2 27.6 30.5 28.0 PAT 5,835 5,700 6,875 6,566 4,654 24,976 25,644

Adjusted PAT 5,835 5,700 6,875 6,566 5,110 24,976 26,100

Change (%) 17.6 64.1 123.6 64.8 -12.4 61.2 4.5



93

Fig 26 – Maruti Suzuki: Income statement

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Net sales 203,441 289,585 357,207 420,770 489,937 Change (%) 13.6 42.3 23.4 17.8 16.4 Income from services 970 1,404 1,474 1,548 1,625 Other operating income 4,572 5,242 5,609 6,001 6,301 Total Income 208,983 296,230 364,289 428,318 497,863 Change (%) 13.1 41.7 23.0 17.6 16.2 Total cost 185,561 256,687 322,032 377,134 437,124 EBITDA 23,423 39,543 42,258 51,184 60,739 Change (%) -16.8 68.8 6.9 21.1 18.7 % of net sales 11.2 13.3 11.6 12.0 12.2 Depreciation 7,065 8,250 8,835 9,858 10,983 EBIT 16,358 31,293 33,422 41,326 49,756 Change (%) -27.2 91.3 6.8 23.6 20.4 Def revenue exp. / others -223 -296 -258 -271 -284 Interest & finance charges 510 335 394 394 394 Other income 5,413 4,968 2,982 4,449 6,978 Non-recurring expense 4,867 296 652 652 652 PBT 16,758 35,925 35,616 44,999 55,972 Tax 4,571 10,949 9,973 12,600 15,672 Effective rate (%) 27.3 30.5 28.0 28.0 28.0 PAT 12,187 24,976 25,644 32,400 40,300 Change (%) -29.6 104.9 2.7 26.3 24.4 Adj. PAT 15,495 25,184 26,100 32,856 40,756 Change (%) -14.0 62.5 3.6 25.9 24.0 % of net sales 7.4 8.5 7.2 7.7 8.2


Fig 27 – Maruti Suzuki: Balance sheet

As at end March (Rs m) FY09 FY10 FY11e FY12e FY13e Share capital 1,445 1,445 1,445 1,445 1,445 Reserves 92,004 116,906 140,527 170,614 208,603 Net worth 93,449 118,351 141,972 172,059 210,048 Loans 6,989 8,214 8,214 8,214 8,214 Deferred tax liability 1,551 1,370 1,370 1,370 1,370 Capital employed 101,989 127,935 151,556 181,643 219,632 Gross fixed assets 87,206 104,067 123,943 138,943 153,943 Less: depreciation 46,498 53,820 62,655 72,514 83,497 Net fixed assets 40,708 50,247 61,288 66,429 70,446 Capital WIP 8,613 3,876 0 0 0 Investments 31,733 71,766 71,766 71,766 71,766 Curr. assets, loans 55,100 37,724 54,387 83,719 122,454 Inventory 9,023 12,088 14,971 17,602 20,460 Sundry debtors 9,378 8,099 11,977 14,082 16,368 Cash & bank balances 19,390 982 15,996 40,591 74,182 Loans & advances 16,328 15,707 10,596 10,596 10,596 Current liab. & prov. 34,165 35,678 35,885 40,271 45,035 Sundry creditors 30,358 29,394 31,164 35,550 40,313 Provisions 3,807 6,284 4,721 4,721 4,722 Net current assets 20,935 2,046 18,502 43,448 77,419 No. of days 38 3 19 38 58 Appl. of funds 101,989 127,935 151,556 181,643 219,632



94

Fig 28 – Maruti Suzuki: Ratios

Year end March FY09 FY10 FY11e FY12e FY13e Basic (Rs) Adjusted EPS 53.6 87.1 90.3 113.7 141.0 EPS growth (%) -14.0 62.5 3.6 25.9 24.0 Cash EPS 78.1 115.7 120.9 147.8 179.0 Book value per share 323.4 409.5 491.3 595.4 726.8 DPS 3.5 6.0 7.0 8.0 8.0 Payout (incl. div. tax) % 6.5 6.9 7.8 7.0 5.7 Valuation (x) P/E 22.7 14.0 13.5 10.7 8.6 Cash P/E 15.6 10.5 10.1 8.2 6.8 EV/EBITDA 13.1 7.3 6.4 4.8 3.5 EV/sales 1.5 1.0 0.8 0.6 0.4 Price to book value 3.8 3.0 2.5 2.0 1.7 Dividend yield (%) 0.3 0.5 0.6 0.7 0.7 Profitability ratios (%) RoE 13.0 21.1 18.1 18.8 19.2 RoCE 21.6 28.6 24.2 25.3 26.0 Turnover ratios Debtors (days) 16 10 12 11 11 Inventory (days) 16 15 15 17 17 Creditors (days) 45 29 25 40 39 Asset turnover (x) 2.0 2.3 2.4 2 2 Leverage ratio Debt/equity (x) 0.1 0.1 0.1 0.0 0.0


Fig 29 – Maruti Suzuki: Cash flow statement

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e OP/(loss) before tax 16,581 31,589 33,680 41,597 50,041 Int./dividends received 5,413 4,968 2,982 4,449 6,978 Depreciation & amort. 7,065 8,250 8,835 9,858 10,983 Direct taxes paid -4,721 -11,130 -9,973 -12,600 -15,672 (Inc)/Dec in wkg. capital -2,063 481 -1,442 -351 -380 Other items CF from oper. activity 22,275 34,158 34,083 42,953 51,949 Extra-ordinary items -4,725 -296 -652 -652 -652 Other items 0 0 0 0 0 CF after EO items 17,549 33,861 33,431 42,301 51,298 (Inc)/Dec in FA+CWIP -16,058 -13,052 -16,000 -15,000 -15,000 (Pur)/Sale of invest. 20,074 -40,033 0 0 0 CF from inv. activity 4,016 -53,085 -16,000 -15,000 -15,000 Change in net worth -1,881 1,660 0 0 -2,312 Inc/(dec) in debt -2,013 1,225 0 0 0 Interest paid -510 -335 -394 -394 -394 Dividends paid -1,011 -1,734 -2,023 -2,312 0 CF from fin. activity -5,415 816 -2,417 -2,706 -2,706 Inc/(dec) in cash 16,150 -18,408 15,014 24,595 33,591 Add: beginning balance 3,240 19,390 982 15,996 40,591 Closing balance 19,390 982 15,996 40,591 74,182



95

Company profile Maruti dominates the small and compact car sub-segments. Initially set up as a JV of the government of India and Suzuki Motors, Japan, the government subsequently divested a part of its stake, giving Suzuki a majority stake.

Maruti Suzuki India has a wide network of 802 sales outlets in 555 towns and cities, and employee strength of over 8,000 as of Mar ’10.

The management team has been very stable over the years. RC Bhargava is the chairman and Shinzo Nakanishi the managing director and chief executive officer.

Under this management team, Maruti Suzuki India has seen its volume and revenue shoot up at 14% and 25.4% CAGR respectively over FY04-10; profitability has also grown at a CAGR of 26% over the same period.

Fig 30 – Maruti Suzuki: Shareholding pattern

DII

17%

Promoter

54%

Others

9%

FII

20%

Source: BSE

Maruti Suzuki is India’s largest passenger-vehicle manufacturer


96


Tata Motors

Outperform (initiating coverage) Back on track; initiate with Outperform PRICE as at 26 Aug 2010

Rs991


TTMT IN TAMO.BO


US$12.6bn Rs490-1,054


Sales (Rs m) 355,931 455,147 548,181 640,161EBIT (Rs m) 32,444 37,633 45,237 52,675EBITDA (Rs m) 42,783 50,417 59,483 68,221Pretax profit (Rs m) 28,295 24,015 32,227 39,607Earnings (Rs m) adjusted 14,548 18,011 24,170 29,705Diluted EPS (Rs ) adjusted 23.31 28.86 38.73 47.60Diluted EPS growth (%) adj. 169.5 23.8 34.2 22.9DPS (Rs ) 15.00 18.00 20.00 21.00DPS growth (%) 150.0 20.0 11.1 5.0EBITDA margin (%) 12.0 11.1 10.9 10.7EBIT margin (%) 9.1 8.3 8.3 8.2Net margin (%) 4.1 4.0 4.4 4.6Div payout (%) 57.8 64.2 54.5 46.5Book value/share (Rs ) 262.28 273.85 293.15 320.99Net gearing (%) 99.4 96.1 87.4 68.4ROE (%) 9.7 11.5 14.4 16.2ROACE (%) 10.5 12.0 13.9 15.5FCF (Rs m) 85,592.1 22,881.9 29,554.5 47,193.4EV/Sales (x) 1.4 1.1 0.9 0.7EV/EBITDA (x) 11.5 9.8 8.2 6.8PBR (x) 3.8 3.6 3.4 3.1PER (x) 42.5 34.3 25.6 20.8Dividend yield (%) 1.5 1.8 2.0 2.1



400500600700800900

1,0001,100


Tata Motors Ltd BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares 17 32 104 Relative to Index 18 25 90 Relative to Sector 13 17 52 Major shareholder Promoter: 37.02% Free float 51.16% Average daily vol US$91m

We initiate coverage on Tata Motors with an Outperform rating and fair value of Rs1,452. We expect the strong revival at JLR, increasing commercial vehicle demand in India, and improving operating leverage to lead to consolidated earnings growth of 167% over FY10-12, the highest in the sector. Tata Motors currently trades at the sector average and looks attractive for multiple reasons – uptrend in the CV cycle, Nano production ramp-up, strong product pipleline and re-rating of JLR.

JLR to the fore – Tata Motors’ JLR division reported strong growth in realization and profit in 1Q FY11, driven by an improvement in the global economy and the success of its new products (most priced higher than earlier models). Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating a continued revival in auto demand. In addition, JLR management’s aggressive cost reduction push through various measures turned the division FCF positive in 1QFY11.

Domestic business, cyclical uptrend – Given strong FY11 GDP growth expectations, the government’s thrust on infrastructure and normal monsoons, we expect the commercial vehicle (CV) segment to post good growth in the coming quarters. With Tata Motors’ dominant position in the CV industry, we expect it to benefit the most from this upturn.

Improving balance sheet and cash flow – Driven by the turnaround at the JLR division, uptick in the domestic market and prudent capital issuance, Tata Motors has been able to reduce its net automotive debt to equity ratio from a high of 6:1 to 2.0 in 1Q FY11. With JLR turning free cash flow positive in 1Q FY11 and capital expenditure at the standalone business expected to decline, we believe Tata Motors’ net automotive debt to equity could come down substantially over the next year.

Valuation – Tata Motors currently trades at the sector average valuation, and is attractive given the CV cycle uptrend, Nano ramp-up and re-rating of JLR. Our fair value is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (20% discount), holding in Tata Sons at Rs60, and value of investment in JLR at Rs717 (6x EBITDA). Our fair value is Rs1,452 (47% upside). Source: Company, Bloomberg


97

Investment argument and valuation We expect the strong revival of JLR, increasing demand for commercial vehicles in India, and improving operating leverage would lead to consolidated earnings growth of 167% over FY10-12, the highest in the sector. Tata Motors is currently trading at the sector average and looks attractive for multiple reasons — uptrend in the CV cycle, Nano production ramp-up, strong product pipleline and re-rating of JLR.

JLR to the fore

Tata Motors’ JLR division reported strong growth in realisation and profit in 1QFY11, driven by an improving global economy and successful product launches, most of which were priced higher than the earlier models. Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating continued revival in auto demand. In addition, JLR management’s aggressive cost reduction push through various measures has turned the division FCF positive in 1Q FY11.

JLR to maintain volume momentum Volume at JLR is witnessing strong growth momentum, driven by the improvement in the global economy and successful new product launches. Volume has been increasing steadily every quarter from 35,900 units in 1Q FY10 to 59,200 units in 1Q FY11.

Fig 1 – JLR: Quarterly volume trend Fig 2 – JLR: Quarterly volume break up

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Source: Company Source: Company

All major markets of the company — UK (+23%), North America (+23%), China (+104%), Europe (+18%) and Russia (+13%) — have reported strong growth in volume during 1Q FY11 on a yoy basis. Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating continued revival in auto demand.

Tata Motors’ JLR division reported strong growth in realisation and profit in 1Q FY11

All major markets of the company reported good growth


98

Fig 3 – JLR: Quarterly geographically volume break-up

Global wholesale volumes

('000 units) 4QFY09 1QFY10 qoq ch

(%) 2QFY10

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(%) Jaguar 7.7 11.6 50.6 11.8 1.7 13.1 11.0 10.9 -16.7 15.5 42.1 Land Rover 24.9 24.3 -2.4 32.5 33.7 43.6 34.2 46.1 5.7 43.7 -5.2 Total JLR 32.6 35.9 10.1 44.3 23.4 56.7 28.0 57.0 0.5 59.2 3.9 Retail volumes

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(%) Jaguar - total 12.3 14.1 14.6 12.1 -14.2 13.4 10.7 10.3 -23.1 13.9 35.0 North America 2.9 3.7 27.6 2.8 -24.3 3.5 25.0 2.5 -28.6 3.7 48.0 UK 4.6 4.5 -2.2 4.8 6.7 4.3 -10.4 4.0 -7.0 4.2 5.0 Europe (ex-Russia) 2.7 3.6 33.3 2.3 -36.1 3.1 34.8 2.5 -19.4 3.3 32.0 Russia 0.4 0.2 -50.0 0.2 0.0 0.2 0.0 0.1 -50.0 0.2 100.0 China 0.3 0.4 33.3 0.5 25.0 0.6 20.0 0.6 0.0 0.9 50.0 Others 1.4 1.7 21.4 1.5 -11.8 1.7 13.3 0.6 -64.7 1.6 166.7 Land Rover - total 34.6 33.0 -4.6 34.7 5.2 41.9 20.7 32.8 -21.7 45.2 37.8 North America 6.5 6.7 3.1 6.8 1.5 8.7 27.9 7.3 -16.1 8.9 21.9 UK 9.4 6.2 -34.0 9.6 54.8 8.3 -13.5 15.0 80.7 9.1 -39.3 Europe (ex-Russia) 8.5 9.1 7.1 8.0 -12.1 11.5 43.8 10.4 -9.6 11.5 10.6 Russia 3.0 1.9 -36.7 1.9 0.0 2.5 31.6 1.9 -24.0 2.1 10.5 China 1.8 2.9 61.1 2.9 0.0 4.0 37.9 5.2 30.0 5.8 11.5 Others 5.4 6.2 14.8 5.5 -11.3 6.9 25.5 -7.0 -201.4 7.8 -211.4 JLR - total 46.9 47.1 0.4 46.8 -0.6 55.3 18.2 43.1 -22.1 59.1 37.1 North America 9.4 10.4 10.6 9.6 -7.7 12.2 27.1 9.8 -19.7 12.6 28.6 UK 14.0 10.7 -23.6 14.4 34.6 12.6 -12.5 19.0 50.8 13.3 -30.0 Europe (ex-Russia) 11.2 12.7 13.4 10.3 -18.9 14.6 41.7 12.9 -11.6 14.8 14.7 Russia 3.4 2.1 -38.2 2.1 0.0 2.7 28.6 2.0 -25.9 2.3 15.0 China 2.1 3.3 57.1 3.4 3.0 4.6 35.3 5.8 26.1 6.7 15.5 Others 6.8 7.9 16.2 7.0 -11.4 8.6 22.9 -6.4 -174.4 9.4 -246.9

Source: Company

New product launched to sustain momentum JLR has also benefited from the launches of the new Land Rover model in 2010 and the new XJ in 1Q FY11. The new XJ has been well received. While sales have been strong in the US, UK and China, they have been weak in the EU (ex UK). Land Rover sales across markets have been doing well; in the US, Land Rover incentives have steadily decreased, implying strong demand. Higher pricing for the new products has helped realizations and profitability.

Fig 4 – JLR: Total volume and growth Fig 5 – JLR: Sales break up

13.7

26.2

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0

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Nos


Source: Company, Standard Chartered Research estimates; FY09 annualised

Launched the new Land Rover model in 2010 and the new XJ in 1Q FY11


99

Cost reduction initiatives and volume momentum to improve profitability JLR management has been aggressively trying to reduce costs using various measures such as manpower rationalization, low cost sourcing and better cost control. During the downturn, management reduced headcount by 2,000 to around 14,000 employees and also entered into agreements with workers to freeze wages. At present, they are selectively hiring employees, in line with growing auto demand. It is also looking to increase sourcing from low-cost countries from the current level of 20% to more than 30% in the near term and have opened purchasing offices in China and India for the same.

JLR is also looking for greater co-operation with the parent company Tata Motors to design and develop smaller capacity engines. This could reduce costs as well as its dependence on Ford for supply of engines. As part of its medium-term strategy, the company plans to reduce the number of plants from three to two, which could result in further savings by reducing overheads.

At present, the new launches at JLR have a waiting period of two-three months, which gives strong visibility for 2Q FY11 (traditionally also, the second half of the financial year have been strong for JLR). We expect volume, revenue and EBITDA CAGRs of 19.8%, 22.1% and 71.9%, respectively, over FY10-12.

Fig 6 – JLR: Improvement in quarterly performance showcases management efforts on cost reduction

Rs mn 1QFY10 2QFY10 qoq growth

(%) 3QFY10 qoq growth



(%) Land Rover 24,300 32,500 33.7 43,600 34.2 46,096 5.7 43,700 -5.2 Jaguar 11,600 11,800 1.7 13,100 11.0 10,908 -16.7 15,500 42.1 Total Volume 35,900 44,300 23.4 56,700 28.0 57,004 0.5 59,200 3.9 Sales 85,725 113,657 26.2 150,086 32.1 141,312 4.4 151,554 10.4 Realisation 2,387,883 2,565,616 2.3 2,647,017 3.2 2,478,984 3.9 2,560,034 6.4 Less: Expenditure 88,316 110,375 19.0 135,391 22.7 125,166 2.5 128,104 5.4 RM and components 62,027 78,999 21.3 102,404 29.6 89,700 -2.8 93,331 7.2 % of sales 72.4 69.5 68.2 63.5 61.6 Staff expenses 13,373 14,967 6.6 14,695 -1.8 12,075 -8.9 12,797 9.1 % of sales 15.6 13.2 9.8 8.5 8.4 Mfg. & other expenses 12,916 16,408 20.9 18,292 11.5 23,391 41.8 21,976 -3.2 % of sales 15.1 14.4 12.2 16.6 14.5 EBITDA -2,591 3,282 -220.6 14,695 347.8 16,146 21.9 23,450 49.6 EBITDA margin (%) -3.0 2.9 9.8 11.4 15.5 EBDIT -2,591 3,282 -220.6 14,695 347.8 16,146 21.9 23,450 49.6 Product dev. exp. 838 720 -18.2 612 -15.0 1,380 150.0 737 -45.0 Depreciation 5,258 4,642 -15.9 9,031 94.5 4,554 -44.1 5,829 31.8 EBIT -8,687 -2,081 -77.2 5,051 -342.7 10,212 124.2 16,884 70.3 Interest 991 800 -23.1 842 5.2 1,283 69.1 1,139 -8.6 Forex -4,953 1,241 -123.8 -153 -112.3 2,801 -2130.0 67 -97.5 PBT -4,724 -4,122 -16.9 4,363 -205.8 6,127 55.8 15,678 163.5 Tax 152 680 325.0 153 -77.5 1,104 700.0 871 -18.8 ETR -3.2 -16.5 3.5 18.0 5.6 PAT -4,877 -4,802 -6.3 4,209 -187.7 5,023 32.4 14,807 203.6

Source: Company

Aggressively reducing costs

Also co-operating with parent for small engines


100

Fig 7 – JLR: Financials (FY10-12e)

Rs mn FY10 FY11e FY12e Land Rover 146,496 181,200 208,380 Jaguar 47,408 63,500 69,850 Total Volume 193,904 244,700 278,230 Sales 490,780 616,889 731,088 Realisation 2,531,045 2,521,001 2,627,638 Less: expenditure 459,248 537,271 637,874 RM and components 333,131 393,537 471,552 % of sales 67.9 63.8 64.5 Staff expenses 55,110 52,744 63,970 % of sales 11.2 8.5 8.8 Mfg. & other expenses 71,007 90,990 102,352 % of sales 14.5 14.7 14.0 EBITDA 31,532 79,618 93,214 EBITDA margin (%) 6.4 12.9 12.8 EBDIT 31,532 79,618 93,214 Product dev. exp. 3,551 2,882 3,432 Depreciation 23,485 24,094 27,508 EBIT 4,495 52,642 62,274 Interest 3,916 4,454 4,862 Forex -1,064 262 260 PBT 1,643 47,926 57,152 Tax 2,090 2,967 3,429 ETR 127.2 6.2 6.0 PAT -447 44,959 53,723


Cyclical uptrend in domestic business

Given strong FY11 GDP growth expectations, the government’s thrust on infrastructure, and normal monsoons, we expect the commercial vehicle (CV) segment would show strong growth in the coming quarters. Tata Motors would benefit from this, given its dominance in the segment.

Strong growth in the Indian CV industry augurs well After the sharp slowdown in the auto industry in 2009, the commercial vehicle industry grew at 38.3% in FY10. In the first four months of FY11, it has shown growth of 49.8%. Given strong GDP growth expectations of FY11 (8.1% in FY11) and a normal monsoon season, we believe the CV industry will grow well in the coming quarters.

We expect Tata Motors’ volume in the commercial vehicle portfolio to register CAGR of 15.7% over FY10-12 (domestic 15.9%, export 13.6%). It will be driven by M&HCV growth of 16.1% (domestic 16.4%, exports 12.5%) and LCV growth of 15.4% (domestic 15.5%, exports 14.6%) over the same period.

In the first four months of FY11, the CV industry has grown at 49.8%

Tata Motors’ volume in CV likely CAGR of 15.7% over FY10-12


101

Fig 8 – Tata Motors: CV vol. and growth Fig 9 – Tata Motors: M&HCV vol & growth

200,000

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Fig 10 – Tata Motors: LCV vol. and growth Fig 11 – Tata Motors: M&HCV market share

70,000

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LCV volume (LHS) Growth (RHS)

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63.4

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64.5

FY07

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FY11

e

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Healthy product pipeline to counter competition from M&M Tata Motors plans to launch new products in the LCV and M&HCV segment, which could lead to expansion of the commercial vehicle market. Launches of smaller variants of ACE and ACE Magic are also planned for the coming months. Factors such as low cost of ownership, better ergonomics and superior brand image are likely to help Tata Motors further grab share from the three-wheeler industry as well as gain additional customers. We believe the smaller ACE family products will give a further boost to volume and counter increasing competition from M&M. Prima rollout may gradually increase the market for high-end trucks in India, which currently stands at less than 2,000 units.

Passenger vehicles – Nano to improve market share The Indian passenger vehicle industry is set to witness strong growth over the next few years, driven by high growth in per capita incomes, recovering urban demand, and aggressive vehicle financing by private sector banks. We expect industry volume (including Nano) to report CAGR of 25.5% over FY10-12.

We expect Tata Motors to retain dominance and remain among the top 3 players in the segment; we expect it to register volume CAGR of 39.5% (domestic 40.3%; exports 6.8%) over FY10-12. The growth in volume will be driven by growth of 42.9% in passenger cars (domestic 43.7%; exports 8.0%) and 16.9% in utility vehicles (domestic 17.3%; exports -5.1%) over FY10-12.

To launch new products in the LCV and M&HCV segment

Industry volume growth (including Nano) likely to be 25.5% over FY10-12

Tata Motors to remain among the top 3 players


102

Fig 12 – Tata Motors: PV sales and growth Fig 13 – Tata Motors: PC sales and growth

100,000

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Fig 14 – Tata Motors: UV sales and growth Fig 15 – Tata Motors: PC market share

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Utility vehicles (LHS) Growth (RHS)

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11.6

14.4

10.510.8

8

10

12

14

16

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FY08

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e

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Nano wait to end in September: Of the total initial bookings of 100,000 units, the company had ~40,000 cancellations. 52,000 of the remaining 60,000 have been delivered by July 2010. The remaining deliveries will be completed by September this year.

As Nano has been well received by customers, going forward, we expect it to drive volumes for the passenger car segment, once the waiting comes down to zero days; this could help the company regain market share it lost over the past two years.

Product launches already in pipeline Tata Motors is going to launch the UV crossover “Aria” in this segment. As capacity constraints for the Ace family are removed by shifting Nano production from Pantnagar to Sanand, capacity for other products is freed up. Also FY11 will see various launches in both passenger cars as well as goods vehicles: Magic Iris (launched in Rajasthan) will be launched nationwide, Venture will be launched in 2Q FY11 and Penguin will be launched in 3Q FY11.

Tata Motors is still working at a capacity utilization of 65-70%. Hence, in our view, it will incur a capex of Rs25-30b every year on product development and not on capacity expansion.

Improving balance sheet and cash flows

Driven by the turnaround of the JLR business, uptick in the domestic market and prudent capital issuance, Tata Motors has managed to reduce its net automotive debt-equity ratio from a high of 5.9 in FY09 to 2.0 in 1Q FY11. With JLR becoming free cash flow positive in 1Q FY11 and capital expenditure for the standalone business expected to decline, we believe Tata Motors’ net automotive debt to equity would come down substantially over the next year.

Nano likely to drive volume

New launches: Magic Iris (launched), Venture in 2QFY11 and Penguin in 3QFY11

Net automotive debt-equity ratio falls from high of 5.9 in FY09 to 2.0 in 1Q FY11…


103

We believe operational efficiencies and cash flow generation over FY10-12e may strengthen the company’s balance sheet. On our expected strong cash flow generation assumption for the consolidated entity, the leverage could come down to 1.5x in FY12e from 4.3x in FY10. The company has approval for an US$1bn equity raising.

Fig 16 – Tata Motors: Net debt to equity

0.91.3

5.9

4.3

2.4

1.5

0.6 0.8 1.1 1.1 1.1 1.0

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x


Valuation

Tata Motors is currently trading at the sector average valuation, and is an attractive stock given the uptrend in the CV cycle, Nano ramp-up and re-rating of JLR. Our fair value for Tata Motors is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (after 20% discount), holding in Tata Sons at Rs60, and the value of investment in JLR at Rs717 (6x EBITDA). Our fair value for Tata Motors is Rs1,452 (47% upside).

Fig 17 – Tata Motors: SOTP valuation

FY09 FY10 FY11e FY12e Standalone EPS (Rs) 8.7 23.3 28.9 38.7 Less: Dividend from subsidiaries 4.9 0.1 0.2 0.2 EPS Value (Rs) 3.7 23.2 28.7 38.5 PE Multiple (x) 15.0 15.0 15.0 15.0 Value per share (Rs) 56 348 430 578 Subsidiary value per share (Rs) 36 69 81 97 Value of stake in Tata Sons per share (Rs) 60 60 60 60 Fair value (Rs) 152 477 571 735 Value of Jaguar Land Rover -48 243 612 717 Total fair value (Rs) 104 720 1,183 1,452 Subsidiary Contribution to SOTP (Rs/share) FY09 FY10 FY11e FY12e HV Transmission 4 11 13 14 HV Axles 6 13 15 16 Telco Construction Equipment 16 17 14 19 Tata Daewoo CV 28 21 26 36 Tata Technologies 17 24 26 29 TML Financial Services / Tata Motors Finance -29 -2 4 5 TAL Manufacturing Solutions 2 2 2 2 Stake in associates 1 1 1 1 Subsidiary & Associate valuation 45 87 101 122 Subsidiary & Associate valuation (after 20% discount) 36 69 81 97 Stake in Tata Sons (after 20% discount) 60 60 60 60 Total fair value (Rs) 96 129 140 157


…to 1.5x by FY12e

Fair value of Rs1,452 using SOTP


104

Fig 18 – Tata Motors: 12-month forward PE band

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Fig 19 – Tata Motors: 12-month forward EV/EBITDA band

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Risks

Competitive pressures in the passenger vehicle business and slowdown in volume for Nano.

If the global economy goes into a double-dip recession, it may result in a decline in the global luxury car market and JLR sales.

Slower-than-anticipated macroeconomic recovery in India may impact CV volumes negatively in FY11.

Adverse currency movements may impact profitability of JLR as it derives around 52% of its total volumes from European markets. Also a major part of the JLR cost base is denominated in GBP and Euro. This exposes the company to fluctuations in profitability depending on the exchange rate movements.


105

Financials We expect standalone Tata Motors to register CAGRs of 25.2%, 24.1%, 17.9% and 28.9% in volume, total income, EBITDA and adj. profits over FY10-12. The standalone performance is likely to be driven by an improvement in product mix in favour of profitable products, increased utilization of capacities across segments and decrease in interest burden over the forecast period on strong cash flow generation.

On a consolidated basis, we expect Tata Motors to register a CAGR of 21.7%, 40% and 167% in total income, EBITDA and adj. profits over FY10-12. On a consolidated basis, its performance will be driven by JLR (+50% of consolidated revenue; +50% contribution to EBITDA and +60% contribution to profit in FY11e). Other subsidiaries are also expected to register strong performance.

Fig 20 – Tata Motors (Consolidated): Break-up of revenue and profitability

% of Consolidated FY08 FY09 FY10 FY11e FY12e FY08 FY09 FY10 FY11e FY12e Income Tata Motors standalone 285,314 254,712 355,931 455,147 548,181 80.7 35.9 38.5 39.3 40.0 JLR 0 386,022 490,780 616,889 731,088 0.0 54.4 53.0 53.3 53.4 HVTL 1,923 1,429 2,093 2,511 2,825 0.5 0.2 0.2 0.2 0.2 HVAL 2,027 1,585 2,394 2,873 3,232 0.6 0.2 0.3 0.2 0.2 TMF 8,328 9,109 3,643 4,080 4,570 2.4 1.3 0.4 0.4 0.3 TDCV 30,697 25,408 27,338 29,525 31,887 8.7 3.6 3.0 2.5 2.3 Others 25,189 31,124 43,015 47,316 48,499 7.1 4.4 4.6 4.1 3.5 Tata Motors consolidated 353,478 709,389 925,193 1,158,342 1,370,282 100.0 100.0 100.0 100.0 100.0 EBITDA Tata Motors standalone 27,553 15,628 42,783 50,417 59,483 69.4 71.2 49.1 32.7 34.8 JLR 0 -5,148 31,532 79,618 93,214 0.0 -23.4 36.2 51.7 54.6 HVAL 1,120 75 1,390 1,632 1,695 2.8 0.3 1.6 1.1 1.0 HVTL 980 600 1,140 1,580 1,616 2.5 2.7 1.3 1.0 0.9 TMF -850 -2,590 -50 41 46 -2.1 -11.8 -0.1 0.0 0.0 TDCV 2,810 2,220 1,950 2,952 2,551 7.1 10.1 2.2 1.9 1.5 Others 8,082 11,180 8,397 17,904 12,125 20.4 50.9 9.6 11.6 7.1 Tata Motors consolidated 39,695 21,965 87,142 154,145 170,729 100.0 100.0 100.0 100.0 100.0 EBITDA Margin (%) Tata Motors standalone 9.7 6.1 12.0 11.1 10.9 JLR NA -1.3 6.4 12.9 12.8 HVAL 58.2 5.3 66.4 65.0 60.0 HVTL 48.3 37.9 47.6 55.0 50.0 TMF -10.2 -28.4 -1.4 1.0 1.0 TDCV 9.2 8.7 7.1 10.0 8.0 Others 32.1 35.9 19.5 37.8 25.0 Tata Motors consolidated 11.2 3.1 9.4 13.3 12.5 Adjusted profit Tata Motors standalone 19,816 18,091 5,399 14,548 18,011 104.0 -62.8 45.8 20.2 21.5 JLR 0 -23,946 -447 44,959 53,723 0.0 83.1 -3.8 62.5 64.1 HVAL 634 278 639 732 801 3.3 -1.0 5.4 1.0 1.0 HVTL 474 194 526 614 672 2.5 -0.7 4.5 0.9 0.8 TMF 448 -1,207 -75 164 206 2.4 4.2 -0.6 0.2 0.2 TDCV 1,589 1,109 816 1,023 1,400 8.3 -3.8 6.9 1.4 1.7 Others -3,914 -23,329 4,933 9,859 9,004 -20.5 81.0 41.8 13.7 10.7 Tata Motors Consolidated 19,048 -28,809 11,791 71,898 83,818 100.0 100.0 100.0 100.0 100.0



106

Hence, on account of strong performance, the debt-equity ratio is forecast to fall to 1.5 in FY12 from 4.3 in FY10. The return ratios both on a standalone basis (ROE: from 9.7% in FY10 to 14.4% in FY12e; RoCE: from 10.5% in FY10 to 14% in FY12e) and on a consolidated basis (ROE: from 30.7% in FY10 to 39% in FY12e; RoCE: from 10.9% in FY10 to 23% in FY12e) are set to improve over FY10-12e.

Fig 21 – Tata Motors: Segmental performance

Rs million FY08 FY09 FY10 Net Income from operations Tata vehicles, spares, financing 323,542 286,643 403,593 JLR 0 392,707 493,442 Less: inter-segmental 0 0 884 Total automotive 323,542 679,350 896,151 Others 37,038 34,656 34,380 Total revenues 360,581 714,006 930,530 Less: inter-segmental 3,980 4,617 5,338 Net segment revenue 356,601 709,389 925,193 Segment results Tata vehicles, spares, financing 28,451 9,584 37,581 JLR 0 -17,774 538 Total automotive 28,451 -8,190 38,120 Others 5,583 2,175 2,890 Total revenues 34,034 -6,014 41,010 Less: inter-segmental 22 566 1,112 Net segment revenue 34,011 -6,580 39,898 Add: Unallocable income 2,675 7,990 17,931 Less: Interest expense 7,431 19,309 22,397 Add: Exceptional items 1,607 -3,393 -206 PBT 30,863 -21,293 35,226 EBIT Margin (%) Tata vehicles, spares, financing 8.8 3.3 9.3 JLR na -4.5 0.1 Total automotive 8.8 -1.2 4.3 Others 15.1 6.3 8.4 Total revenues 9.4 -0.8 4.4 Less: inter-segmental 0.6 12.3 20.8 Net segment revenue 9.5 -0.9 4.3 Capital employed Tata vehicles, spares, financing 189,833 237,255 229,299 JLR 0 123,361 194,038 Total automotive 189,833 360,616 423,337 Others 8,694 13,540 7,646 Total capital employed 198,527 374,156 430,983 Less: inter-segmental 2,056 1,608 2,975 Net CE 196,471 372,548 428,008 Return on capital employed (%) Tata vehicles, spares, financing 15.0 4.0 16.4 JLR na -14.4 0.3 Total automotive 15.0 -2.3 9.0 Others 64.2 16.1 37.8 Total capital employed 17.1 -1.6 9.5 Less: inter-segmental 1.1 35.2 37.4 Net capital employed 17.3 -1.8 9.3



107

Fig 22 – Tata Motors: Quarterly performance (Standalone)

FY10 FY11 Year end March (Rs m) 1Q 2Q 3Q 4Q 1Q FY10 FY11e Total volumes (nos) 123,113 150,377 159,139 210,057 181,711 642,686 810,299 Change (%) -6.5 12.3 63.0 55.8 47.6 29.0 26.1 Average realisation 520,224 530,588 564,280 582,209 573,232 553,818 561,703 Change (%) -1.1 0.4 15.8 17.1 10.2 8.3 1.4 Total income 64,046 79,788 89,799 122,297 104,163 355,931 455,147 Change (%) -7.6 12.7 88.7 82.4 62.6 39.7 27.9 Total cost 56,766 69,131 78,280 108,970 92,416 313,148 404,731 EBITDA 7,280 10,657 11,519 13,327 11,747 42,783 50,417 EBITDA margin (%) 11.4 13.4 12.8 10.9 11.3 12.0 11.1 Change (%) 37.2 85.2 1,156.9 264.8 61.4 173.8 17.8 Non-operating income 5 510 2 7 693 523 1,023 Interest 2,535 2,856 2,861 2,786 3,140 11,038 12,469 Gross profit 7,884 11,857 8,418 11,916 8,640 40,075 38,311 Depreciation & amort. 2,291 2,634 2,641 2,772 3,074 10,339 12,783 Product dev. expenses 112 154 226 948 190 1,440 1,512 PBT 5,480 9,068 5,550 8,196 5,377 28,296 24,015 Tax 343 1,777 1,549 2,226 1,419 5,895 6,004 Effective tax rate (%) 6.3 19.6 27.9 27.2 26.4 20.8 25.0 PAT 5,138 7,291 4,001 5,970 3,957 22,401 18,011 Change (%) 57.5 110.1 -252.0 1.0 -23.0 123.7 -19.6 Adj PAT 2,001 3,714 4,231 4,602 4,452 14,548 18,627 PAT margin (%) 3.1 4.7 4.7 3.8 4.3 4.1 4.1 Change (%) -51.6 43.4 -541.4 -308.3 122.5 308.8 28.0


Fig 23 – Tata Motors: Quarterly performance (Consolidated)

FY10 FY11 Year end March (Rs m) 1Q 2Q 3Q 4Q 1Q Total Income 163,970 211,002 260,443 289,778 270,556 Change (%) 13.2 -8.2 47.1 83.9 65.0 Total cost 158,011 195,086 229,868 255,087 231,023 EBITDA 5,959 15,916 30,575 34,691 39,533 EBITDA margin (%) 3.6 7.5 11.7 12.0 14.6 Change (%) -64.9 6.8 -636.5 -923.3 563.4 Non-operating income 22 348 47 -1 346 Forex gain / (loss) 3,339 -1,631 -1,244 0 -414 Extraordinary income 3,189 3,719 0 10,579 0 Extraordinary expense 0 553 1,098 2,790 0 Interest 5,835 5,590 5,458 5,514 5,616 Gross Profit 6,674 12,210 22,822 36,966 33,849 Depreciation & amort. 8,442 8,479 13,072 8,878 10,115 Product dev. expenses 930 858 857 2,337 979 PBT -2,699 2,873 8,893 25,752 22,754 Tax 643 2,894 2,429 4,092 2,960 Effective tax rate (%) -23.8 100.7 27.3 15.9 13.0 Reported PAT before MI -3,341 -22 6,464 21,660 19,794 Change (%) -145.0 -99.8 -124.7 564.1 -692.4 Reported PAT after MI -3,288 218 6,503 21,870 19,887 Change (%) -145.7 -102.3 -125.0 592.9 -704.9 Adj PAT -9,816 -1,318 8,845 14,081 20,239



108

Fig 24 – Tata Motors: Income statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Volume (units) 498,147 642,686 810,299 1,007,076 1,209,195 Volume growth (%) -14.5 29.0 26.1 24.3 20.1 Realisation (Rs) 511,319 553,817 561,703 544,330 529,411 Operating other income 5,311 4,389 4,982 5,480 5,973 Total Income 254,712 355,931 455,147 548,181 640,161 Change (%) -10.7 39.7 27.9 20.4 16.8 Expenditure 239,084 313,148 404,731 488,699 571,940 EBITDA 15,628 42,783 50,417 59,483 68,221 Change (%) -43.3 173.7 17.8 18.0 14.7 % of net sales 6.1 12.0 11.1 10.9 10.7 Depreciation 8,745 10,339 12,783 14,246 15,546 EBIT 6,883 32,444 37,633 45,237 52,675 Deferred revenue exp. 512 1,440 1,512 1,588 1,667 Interest & fin. charges 6,737 11,038 12,469 12,469 12,469 Other income 4,057 523 1,023 1,048 1,069 Forex gain / (loss) -653 -696 -660 0 0 PBT 10,138 28,295 24,015 32,227 39,607 Tax 125 5,895 6,004 8,057 9,902 Effective rate (%) 1.2 20.8 25.0 25.0 25.0 PAT 10,013 22,401 18,011 24,170 29,705 Change (%) -50.7 123.7 -19.6 34.2 22.9 Adj. PAT 5,399 14,548 18,011 24,170 29,705 Change (%) -70.2 169.5 23.8 34.2 22.9 PAT margin (%) 2.1 4.1 4.0 4.4 4.6


Fig 25 – Tata Motors: Balance Sheet (Standalone)

As at end March (Rs m) FY09 FY10 FY11e FY12e FY13e Share Capital 5,141 5,706 5,706 5,706 5,706 Reserves 117,161 143,949 150,554 161,563 177,451 Net worth 122,302 149,655 156,260 167,269 183,157 FCIMTDA 1,641 -1,617 -1,617 -1,617 -1,617 Loans 131,656 166,259 166,259 166,259 166,259 Capital employed 255,598 314,297 320,902 331,911 347,799 Gross fixed assets 139,052 184,168 209,168 229,168 249,168 Less: depreciation 62,599 72,129 84,913 99,159 114,704 Net fixed assets 76,453 112,039 124,255 130,010 134,464 Capital WIP 69,540 52,322 52,322 52,322 52,322 Investments 129,681 223,369 223,369 223,369 223,369 Curr.assets 96,917 115,380 141,159 169,491 204,642 Inventory 22,298 29,356 39,903 48,060 56,124 Sundry debtors 15,552 23,919 30,587 36,839 43,020 Cash & bank balances 11,418 17,533 16,097 20,021 40,928 Loans & advances 47,648 44,571 54,571 64,571 64,571 Current liab. & prov. 108,355 173,726 205,116 228,194 251,912 Sundry creditors 87,313 118,247 149,637 172,715 196,433 Other liabilities 2,270 27,845 27,845 27,845 27,845 Provisions 18,773 27,634 27,634 27,634 27,634 Net current assets -11,438 -58,346 -63,958 -58,702 -47,269 Deferred tax -8,658 -15,086 -15,086 -15,086 -15,086 Appl. of funds 255,598 314,297 320,902 331,911 347,798



109

Fig 26 – Tata Motors: Ratios

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e Basic (Rs) EPS 10.5 25.5 31.6 42.4 52.1 EPS fully diluted 8.7 23.3 28.9 38.7 47.6 Cash EPS 22.7 39.9 49.3 61.6 72.5 Book value per share 237.9 262.3 273.9 293.1 321.0 DPS 6.0 15.0 18.0 20.0 21.0 Payout (incl. div. tax) % 94.9 57.8 64.2 54.5 46.5 Valuation (x) Standalone P/E 114.5 42.5 34.3 25.6 20.8 EV/EBITDA 32.0 11.5 9.8 8.2 6.8 EV/sales 2.0 1.4 1.1 0.9 0.7 Price to book value 4.2 3.8 3.6 3.4 3.1 Dividend yield (%) 0.6 1.5 1.8 2.0 2.1 M.Cap./EBITDA 32.6 13.2 11.2 9.5 8.3 Profitability ratios (%) RoE 4.4 9.7 11.5 14.4 16.2 RoCE 4.3 10.5 12.0 13.9 15.5 Turnover ratios Asset turnover (x) 1.0 1.1 1.4 1.7 1.8 Leverage ratio Debt/equity (x) 1.1 1.1 1.1 1.0 0.9


Fig 27 – Tata Motors: Cash flow statement (Standalone)

Year end March (Rs m) FY09 FY10 FY11e FY12e FY13e OP/(loss) before tax 6,371 31,004 36,121 43,649 51,007 Interest/div. received 4,057 523 1,023 1,048 1,069 Depreciation & amort. 8,745 10,339 12,783 14,246 15,546 Direct taxes paid -1,224 534 -6,004 -8,057 -9,902 (Inc)/Dec in wkg. capital -3,805 53,043 4,176 -1,331 9,473 Other items 37,707 11,049 442 0 0 CF from op activity 51,852 106,491 48,542 49,555 67,193 Extra-ordinary items 6,446 7,807 -660 0 0 Other items CF after EO items 58,298 114,298 47,882 49,555 67,193 (Inc)/dec in FA+CWIP -50,216 -28,706 -25,000 -20,000 -20,000 (Pur)/sale of invest. -80,579 -93,688 0 0 0 CF from inv activity -130,794 -122,394 -25,000 -20,000 -20,000 Free cash flow -72,497 -8,096 22,882 29,555 47,193 Issue of shares 1,285 566 0 0 0 Inc/(dec) in debt 68,850 34,604 0 0 0 Interest paid -6,737 -11,038 -12,469 -12,469 -12,469 Dividends paid -3,457 -9,920 -11,848 -13,161 -13,817 CF from fin activity 59,942 14,210 -24,318 -25,630 -26,286 Inc/(dec) in cash -12,555 6,115 -1,436 3,924 20,907 Add: beginning balance 23,973 11,418 17,533 16,097 20,021 Closing balance 11,418 17,533 16,097 20,021 40,928



110

Fig 28 – Tata Motors: Income statement (Consolidated)

Year end: Mar FY08 FY09 FY10 FY11e FY12e Sales 353,478 709,389 925,193 1,158,342 1,370,282 Gross profit 99,015 223,148 303,981 405,982 453,482 SG&A 59,495 161,648 167,324 183,020 199,222 Other income 3,332 841 416 541 622 Operating expenses 10,532 45,220 55,773 75,701 91,103 EBIT 31,215 -6,580 43,288 106,021 118,699 Depreciation & Amortization 7,821 25,068 38,871 43,730 47,010 EBITDA 39,695 21,965 87,142 154,145 170,729 Net interest 7,431 19,309 22,397 23,517 22,341 Exceptional items 1,857 7,149 13,075 0 0 Pretax profit 30,863 -21,293 35,226 83,044 96,979 Taxation 8,515 3,358 10,058 12,457 14,547 Minority interests 1,323 -115 303 379 474 Net profit 21,677 -25,053 25,711 71,898 83,818 Net profit (adjusted) 19,048 -28,809 11,791 71,898 83,818 Basic EPS (Rs) 49.41 -56.04 20.66 126.00 146.89 EPS (adjusted) (Rs) 30.52 -46.17 18.90 115.22 134.32 DPS (Rs) 15.00 6.06 15.06 18.06 20.06


Fig 29 – Tata Motors: Balance sheet (Consolidated)

Year end: Mar FY08 FY09 FY10 FY11e FY12e Cash 38,332 41,213 87,433 108,928 178,418 Accounts receivables 20,605 48,001 71,912 90,108 106,640 Inventory 32,946 101,547 113,120 157,734 186,673 Other current assets 100,790 126,514 152,831 172,831 192,831 Total current assets 192,674 317,276 425,296 529,601 664,562 PP&E 128,634 357,333 385,063 396,333 379,323 Investment 26,658 12,574 22,191 22,191 22,191 Intangible Assets 5,662 37,187 34,229 34,229 34,229 Other long term assets 69 7,226 -1,912 -1,912 -1,912 Total long term assets 161,024 414,319 439,572 450,841 433,832 Total assets 353,697 731,595 864,868 980,443 1,098,393 Accounts payables 109,148 236,584 293,718 368,040 435,562 Other current liabilities 27,298 75,034 123,490 114,900 114,900 Total current liabilities 136,446 311,618 417,208 482,939 550,461 Long term debt 115,849 349,739 351,924 341,924 321,924 Deferred tax 9,745 6,802 11,536 11,536 11,536 Total long term liabilities 125,593 356,541 363,460 353,460 333,460 Total liabilities 262,039 668,158 780,668 836,399 883,921 Shareholders’ funds 86,975 59,406 82,065 141,909 212,337 Minority Interests 4,683 4,030 2,135 2,135 2,135 Total liab and equity 353,697 731,595 864,868 980,443 1,098,393



111

Fig 30 – Tata Motors: Ratio (Consolidated)

Year end: Mar FY08 FY09 FY10 FY11e FY12e Gross margin (%) 28.01 31.46 32.86 35.05 33.09 EBIT margin (%) 8.83 -0.93 4.68 9.15 8.66 Effective tax rate (%) 27.6 -15.8 28.6 15.0 15.0 Interest cover (x) 4 0 2 5 5 Op cash/EBIT (x) -0.2 -23.8 2.8 1.5 0.0 Depn/capex (x) 0.1 1.5 3.9 -2.8 Quick ratio (x) 1.2 0.7 0.7 0.8 0.9 ROE (%) 25.7 -41.5 30.7 49.7 38.8 ROCE (%) 16.2 -0.5 10.9 22.3 22.7 Net gearing (%) 89.1 519.3 322.3 164.2 67.6 Inventory days 35 53 45 50 50 Accounts receivable days 22 25 29 29 29 Accounts payable days 116 123 117 117 117 Total asset turonver (x) 1.6 1.7 2.1 2.3 2.5 PBR (x) 4.4 8.6 6.9 4.0 2.7 EV/Sales (x) 1.3 1.1 0.9 0.7 0.5 EV/EBITDA (x) 10.9 36.7 9.3 5.0 4.0 PER (x) 32.5 n.m 52.4 8.6 7.4 Dividend yield (%) 1.5 0.6 1.5 1.8 2.0 No of shares, fully diluted (m) 386 514 571 571 571


Fig 31 – Tata Motors: Cash flow statement (Consolidated)

Year end: Mar FY08 FY09 FY10 FY11e FY12e Pretax profit 31,865 -3,103 48,270 110,415 123,719 Interest/dividend paid 3,332 841 416 541 622 Depreciation & Amortization 7,821 25,068 38,871 43,730 47,010 Taxes paid -6,944 -6,300 -5,323 -12,457 -14,547 (Inc)/Dec in Working Capital 40,756 -33,383 63,826 -21,473 -2,968 Others 2,142 9,889 10,335 0 0 Cash flow from operations 78,973 -6,988 156,395 120,756 153,836 Capex -60,082 -215,877 -77,835 -55,000 -30,000 Disposals -14,912 14,084 -9,617 0 0 Cash flow from investing -74,994 -201,793 -87,453 -55,000 -30,000 Dividends -6,767 -3,646 -10,051 -12,054 -13,390 Issue of shares -5,822 727 7,540 1,311 1,385 Change in debt 42,830 233,890 2,185 -10,000 -20,000 Interest Paid -7,431 -19,309 -22,397 -23,517 -22,341 Cash flow from financing 22,810 211,662 -22,723 -44,261 -54,346 Change in cash 38,331 41,213 87,434 108,929 178,418 Free cash flow 139,054 208,889 234,231 175,756 183,836



112

Company profile Tata Motors’ product portfolio includes passenger/goods carriers, passenger cars and utility vehicles. Tata Motors became a global player when acquired Daewoo’s Korean CV manufacturing plant and Jaguar Land Rover in the UK.

Incorporated in 1945, Tata Motors is India’s largest automotive company in revenue. According to Automotive World, Tata Motors is the world’s fourth-largest truck manufacturer. Last Auto Omnibus calls it the second-largest bus manufacturer in the above-six-ton category.

In FY10, Tata Motors was the second largest company in the Tata Group in terms of revenue. The Tata Group, founded by Sir Jamshetji Tata in the mid-19th century, is one of India’s largest business conglomerates, operating in seven diverse business sectors in more than 80 countries.

Tata Motors’ manufacturing base in India spans Jamshedpur (in the east), Pune (in the west), Lucknow (in the north) and Pantnagar (also in the north), supported by a nationwide network of dealers, sales, services and spare parts. Its widespread sales and distribution network covers over 1,500 sales outlets for its passenger and commercial vehicles. It has also set up at Sanand (in the west) and Dharwad (in the south).

The management team is headed by chairman Ratan Tata and managing director Ravi Kant. Under this management, the company has made serious attempts to spread its wings globally by acquiring JLR in the UK, Daewoo’s CV plant in Korea and others.

Over the years, it has maintained its leadership in CVs, launching innovative vehicles such as the Ace. A world truck, in collaboration with Tata Daewoo CV, is to be launched in the near future. In Jan 2008, it captured the world’s imagination by showcasing the Nano at the Delhi Auto Expo.

Fig 32 – Tata Motors: Shareholding pattern

FII

23% Promoter

37%

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22%

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18%

Source: BSE

Tata Motors is India’s largest commercial vehicle manufacturer


113


Company updates

TVS Motor

Underperform (initiating coverage) Fairly-valued marginal player; initiate with Underperform PRICE as at 26 Aug 2010 Rs143


TVSL IN TVSM.BO


US$0.8bn Rs48-147


Sales (Rs m) 44,240 58,278 69,973 80,819EBIT (Rs m) 2,394 3,498 4,362 5,236EBITDA (Rs m) 3,417 4,643 5,648 6,608Pretax profit (Rs m) 761 2,324 3,163 4,009Earnings (Rs m) adjusted 1,280 1,906 2,593 3,288Diluted EPS (Rs ) adjusted 5.39 8.02 10.92 13.84Diluted EPS growth (%) adj. 289.57 48.91 36.07 26.77DPS (Rs ) 1.20 1.50 2.00 2.00DPS growth (%) 71.4 25.0 33.3 0.0EBITDA margin (%) 7.8 8.1 8.2 8.3EBIT margin (%) 5.4 6.0 6.2 6.5Net margin (%) 2.9 3.3 3.8 4.1Div payout (%) 37.9 21.5 21.1 16.6Book value/share (Rs ) 36.55 43.08 52.00 63.84Net gearing (%) 89.5 69.1 41.9 16.4ROE (%) 14.7 18.6 21.0 21.7ROACE (%) 12.8 17.3 19.5 20.8FCF (Rs m) 1,283.3 1,711.7 3,041.4 3,820.2EV/Sales (x) 0.9 0.6 0.5 0.4EV/EBITDA (x) 10.9 7.9 6.2 4.9PBR (x) 3.9 3.3 2.7 2.2PER (x) 26.5 17.8 13.1 10.3Dividend yield (%) 0.8 1.1 1.4 1.4



405060708090100110120130140150


TVS Motor Co Ltd BSE SENSEX 30 INDEX (rebased)

Share price (%) -1 mth -3 mth -12 mth Ordinary shares 5 44 183 Relative to Index 5 37 169 Relative to Sector 1 29 131 Major shareholder Promoter: 60.45% Free float 39.55% Average daily vol US$8.9m

We initiate coverage of TVS Motor (TVS) with an Underperform rating and fair value of Rs146. We expect TVS to improve its operating performance over the next two years. Yet, we expect it to remain a sector underperformer given low margins (50-70% below competitors), small market share and valuation on par to the sector, which, in our view, is not sustainable.

Operating profitability 50-70% lower than competitors – Though we expect economies of scale, product mix improvement and ramp-up in 3W volume (3.0% of overall volume in FY12e) to stabilize TVS’ margins at over 8% (from a low 2.2% in FY08) in FY11-12e, it would still be 50-70% below those of competitors. The main reason it lags industry leaders is its product portfolio, which is skewed towards low-margin mopeds and scooters. TVS has had margins higher than 8% only three times in the past 10 years (FY00, FY03 and FY04).

Marginal player, growing at industry rate – We expect TVS’ 2W portfolio to report a 20% CAGR over FY10-12e (in-line with 2W sector growth). Growth will be driven by motorcycles (21.8% CAGR), mopeds (16% CAGR) and scooters (21.5% CAGR). New launches such as the gearless scooter (Wego) and clutchless bike (JIVE) should lead the way and is the key to volume growth.

Exports at 20% CAGR, passenger three wheeler opportunity – We estimate TVS would post export volume CAGR of 20% over FY10-12e, resulting in a monthly run rate of 17-19,000 units (rising from the FY10 average of 13,500/month) and to stabilize at around 11-12% of overall volume. Entry into passenger 3Ws will be an opportunity for the company but will remain a small contributor over the forecast period. We expect 3W volume to register 100% CAGR over FY10-12e and contribute 3.0% of overall volume.

Valuation – We value TVS at 12x FY12e core earnings, which is a 15% discount to Hero Honda. We give it a discount given its low profitability margins (compared with those of Hero Honda and Bajaj Auto) and market share in the 2W space (though market share could improve over FY10-12e). We give a 20% discount to the cash on its balance sheet to arrive at the fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside). Source: Company, Bloomberg


114

Investment argument and valuation We expect TVS to improve its operating performance over the next two years. Yet, we expect it to remain a sector underperformer given low margins (50-70% below competitors), small market share and valuation on par to the sector, which, in our view, is not sustainable.

Volumes to grow in line with two-wheeler industry

TVS has underperformed industry volume growth in the past owing to a relatively weaker and volatile product portfolio in the motorcycle segment. In addition, it has been unable to cash in on the success of various models due to its inability to launch new products and variants frequently to support them.

Fig 1 – TVS’ volume: FY02-10 Fig 2 – Industry volume: FY02-10

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With volatile volume over FY02-10, its market share declined about 600bps.

Fig 3 – TVS’s market share fell 600bps from FY02 to FY10

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Going forward, market share to stabilise The company now has a more stable product portfolio in the scooter and motorcycle segments. Nevertheless, its product portfolio still does not match those of Hero Honda and Bajaj Auto. Going forward, we expect growth to be driven by motorcycles (21.9% CAGR), mopeds, (16% CAGR), and scooters (21.5% CAGR).

We expect good performances from its existing product portfolio and from its recently-launched products such as the gearless scooter, Wego, and the clutchless bike, Jive. In our view, new launches hold the key to volume growth. We estimate its two-wheeler portfolio would grow at 20% over FY10-12, in line with the two-wheeler sector growth rate, and TVS’ market share to

TVS’ motorcycle CAGR at 4.5% underperformed the industry’s 14.1%

Market share has been declining

It is still weaker than Hero Honda and Bajaj Auto in terms of product offerings


115

remain stable at around 14.5%. We do not expect a huge gain in the motorcycle segment either, as the top players in that segment have become more aggressive.

Fig 4 – TVS’ volume: FY10-12e Fig 5 – Industry volume: FY10-12e

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Product mix to improve Going forward, we expect the company to reap benefits from economies of scale; volume growth is expected to be strong, countering its history of underperformance against the industry. Growth could come from motorcycles, scooters and the newly-launched three-wheeler products resulting in an improvement in product mix, which had deteriorated over the years. This is also likely to improve the company’s operating performance.

Fig 7 – TVS: Improvement in product mix

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TVS’ motorcycle CAGR likely to be 21.9%, scooters at 21.4% and mopeds at 15.9% Industry motorcycle CAGR likely to be 20.2%, scooters at 18.1% and mopeds at 15.6%


116

EBITDA margins to improve 40bps against the industry decline of 140bps Economies of scale, improvement in product mix, ramp-up in three-wheeler volume (expected to be 3% of overall volume in FY12), and increased production from the tax-free plant are likely to stabilise TVS’ margin at over 8% in FY11-12 (from a low of 2.2% in FY08). TVS has seen margins higher than 8% only thrice in the past 10 years — in FY00, FY03 and FY04.

Fig 8 – TVS: Margins to improve

6.7

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Still operating profit 50-70% lower than competitors

With a product mix inferior to other industry players (as low-margin products like scooters and mopeds constitute over 50% of overall volumes), TVS’ margins have been historically lower than those of the other players.

Fig 9 – EBITDA margin comparison Fig 10 – EBITDA per vehicle comparison

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Overseas penetration to increase

TVS has plans to increase its export footprint by increasing overseas penetration; currently, it exports to 53 countries. Its contribution from exports has steadily risen from 5.9% of overall volume in FY06 to 14.4% in FY09 before declining to 11% in FY10. Its Indonesian plant is expected to further the company’s export targets by primarily catering to the Asian two-wheeler market, which has cumulative sales of nearly 10m vehicles.

Margin likely to improve, but still below industry

TVS’ margins have been historically lower than competitors’


117

Fig 11 – TVS’ export and growth Fig 12 – TVS’ export contribution to vol.

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Source: Company, Standard Chartered Research estimates; * overall export contribution is coming off mainly on account of 3-W addition in overall volumes

Fig 13 – TVS’ market share of 2W exports

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Entry into the passenger three-wheeler segment seen as an opportunity The company’s entry into the passenger three-wheeler segment is seen as an opportunity. The vehicle is available in multiple fuel variants throughout the country. We expect three-wheeler volume to register 100% CAGR from FY10 to FY12. However, its contribution to overall volume over the same period is expected to remain small at 3%.

Fig 14 – TVS’ three-wheeler volume and growth

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Three-wheeler volume to overall volume likely to remain small at 3%


118

Valuation

We value TVS at 12x FY12e core earnings, at a 15% discount to our multiple for Hero Honda. We believe our PE rating is justified when compared with the profitability margins of Hero Honda and Bajaj Auto and the market share that TVS has in the two-wheeler space (though market share is likely to improve over FY10-12). We assign a 20% discount to the cash in the balance sheet to arrive at the fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside).

Fig 15 – TVS Motor: SOTP valuation

FY09 FY10 FY11e FY12e Core EPS (Rs) 1.3 5.3 7.6 10.5 Mulitple (x) 12.0 12.0 12.0 12.0 Value (Rs) 15.1 63.3 91.0 125.5 Cash per share (Rs) 9.2 12.1 14.4 20.8 Fair value (Rs) 24.2 75.4 105.4 146.3


Fig 16 – TVS Motor: 12-month forward PE band

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Risk

Earnings and margins higher than our estimates.

Increase in motorcycle market share beyond our estimates.

Fair value of Rs146 at 12x FY12e core earnings


119

Financials TVS’ balance sheet is much smaller than Hero Honda’s and Bajaj Auto’s. It also lacks the scale and resources to counter competitors resorting to aggressive pricing.

We expect TVS to register a 20.6%, 25.7%, 28.6% and 42.3% CAGR in volume, revenue, EBITDA and adj. profits over FY10-12.

Fig 18 – Revenue and revenue growth Fig 19 – RM and RM as % of sales

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smSource: Company, Standard Chartered Research estimates Source: Company, Standard Chartered Research estimates

Fig 20 – EBITDA and EBITDA margins Fig 21 – Realization per vehicle

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Fig 22 – Contribution per vehicle Fig 23 – EBITDA per vehicle

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Fig 24 – TVS Motor: RoE and RoCE

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RoE RoCE


Fig 25 – TVS Motor: Quarterly performance

FY10 FY11 Year end March (Rs m) 1Q 2Q 3Q 4Q 1Q FY10 FY11e Total volumes (nos) 349,426 393,648 374,799 419,130 463,840 1,537,003 1,932,155 Volume growth (%) 5.0 6.0 22.8 29.8 32.7 15.2 25.7 Realization 27,921 28,335 28,619 28,450 29,527 28,341 29,705 Increase in realization (%) 2.0 3.7 2.4 3.0 5.8 3.0 4.8 Net sales 9,756 11,154 10,726 11,924 13,696 43,561 57,395 yoy change (%) 7.1 9.9 25.8 33.7 40.4 18.7 31.8 Other operating income 131 145 168 236 234 679 883 yoy change (%) -2.3 -24.3 5.9 35.7 79.0 Total income 9,887 11,299 10,895 12,160 13,930 44,240 58,278 yoy change (%) 6.9 9.3 25.4 33.7 40.9 18.4 31.7 Total cost 9,111 10,438 10,057 11,217 12,893 40,823 53,635 EBITDA 776 860 837 943 1,037 3,417 4,643 EBITDA margin (%) 7.9 7.6 7.7 7.8 7.4 7.8 8.1 yoy change (%) 27.5 34.7 43.4 50.6 33.6 39.0 35.9 Other income 3 28 9 33 41 74 105 Interest 171 153 180 123 170 628 661 Depreciation 254 253 253 263 266 1,023 1,144 Amortisation 150 157 155 155 139 618 618 Extraordinary gain/(exp) -3 -83 -4 -371 1 -461 0 PBT 200 241 254 65 505 761 2,324 Tax 19 -4 19 -138 101 -104 418 Effective tax rate (%) 9.6 -1.7 7.4 -211.6 20.0 -13.7 18.0 Reported PAT 181 246 236 203 404 865 1,906 yoy change (%) 158.0 136.6 -2,552.6 38.7 122.8 178.3 120.3 Adjusted PAT 184 321 239 537 402 1,280 1,906 yoy change (%) 162.4 208.9 -2,585.5 226.9 118.4 289.6 48.9 PAT margin (%) 1.8 2.2 2.2 1.7 2.9 2.0 3.3


Return ratios to improve


121

Fig 26 – TVS Motor: Income statement

Year end March (Rs m) FY08 FY09 FY10 FY11e FY12e FY13e Volume (units) 1,277,524 1,346,468 1,537,003 1,932,155 2,234,864 2,491,267 YoY growth (%) -16.3 5.4 14.2 25.7 15.7 11.5 Net realisation (rs) 25,201 27,263 28,341 29,705 30,905 32,069 Yoy growth (%) -0.2 8.2 4.0 4.8 4.0 3.8 Net sales 32,195 36,709 43,561 57,395 69,068 79,891 Change (%) -16.5 14.0 18.7 31.8 20.3 15.7 Operating other income 0 658 679 883 905 928 Total Income 32,195 37,367 44,240 58,278 69,973 80,819 Total expenditure 31,474 34,909 40,823 53,635 64,325 74,212 EBITDA 721 2,458 3,417 4,643 5,648 6,608 Change (%) -47.5 240.7 39.0 35.9 21.7 17.0 % of net sales 2.2 6.7 7.8 8.1 8.2 8.3 Depreciation 946 1,029 1,023 1,144 1,286 1,371 EBIT -225 1,429 2,394 3,498 4,362 5,236 Amortisation 0 580 618 618 648 681 Interest & fin. ch. 290 550 628 661 661 661 Other income 719 30 74 105 110 115 PBT 354 311 761 2,324 3,163 4,009 Tax 36 0 -104 418 569 722 Effective rate (%) 10.2 0.1 -13.7 18.0 18.0 18.0 PAT 318 311 865 1,906 2,593 3,288 Change (%) -52.3 -2.1 178.4 120.3 36.1 26.8 Adj. PAT 201 329 1,280 1,906 2,593 3,288 Change (%) -69.9 63.7 289.6 48.9 36.1 26.8 PAT margin (%) 0.6 0.9 2.9 3.3 3.8 4.1


Fig 27 – TVS Motor: Balance sheet

As at end March (Rs m) FY08 FY09 FY10e FY11e FY12e FY13e Share capital 238 238 238 238 238 238 Reserves 7,978 7,864 8,444 9,994 12,112 14,924 Net worth 8,216 8,102 8,682 10,231 12,349 15,162 Deferred tax 1,549 1,481 1,481 1,481 1,481 1,481 Loans 6,663 9,060 9,060 9,060 9,060 9,060 Capital employed 16,428 18,673 19,252 20,802 22,920 25,733 Gross fixed assets 17,910 18,654 19,808 21,808 23,308 24,808 Less: depreciation 7,745 8,694 9,717 10,862 12,147 13,519 Net fixed assets 10,165 9,959 10,091 10,946 11,161 11,289 Capital WIP 266 404 0 0 0 0 Investments 3,390 4,777 4,277 4,277 4,277 4,277 Curr.assets, l & adv. 7,748 8,937 10,753 13,343 16,847 21,013 Inventory 4,054 3,206 3,819 5,032 6,055 7,004 Sundry debtors 879 1,816 2,148 2,830 3,406 3,940 Cash & bank balances 37 421 1,291 1,985 3,890 6,574 Loans & advances 2,775 3,495 3,495 3,495 3,495 3,495 Current liab.& prov. 5,668 6,158 6,622 8,517 10,117 11,600 Sundry creditors 5,058 5,503 5,967 7,862 9,461 10,944 Provisions 610 655 655 655 656 656 Net current assets 2,080 2,778 4,131 4,825 6,729 9,413 Miscellaneous expenditures 528 753 753 753 753 753 Application of funds 16,428 18,673 19,252 20,802 22,920 25,733



122

Fig 28 – TVS Motor: Cash flow statement

Year end March (Rs m) FY08 FY09 FY10e FY11e FY12e FY13e OP/(loss) before tax -225 849 1,776 2,881 3,714 4,556 Interest/div. received 719 30 74 105 110 115 Depreciation & amort. 946 1,029 1,023 1,144 1,286 1,371 Direct taxes paid -77 -68 104 -418 -569 -722 (Inc)/Dec in working capital -952 -315 -482 0 1 0 Other items 30 -226 0 0 0 0 CF from oper. activity 441 1,299 2,494 3,712 4,541 5,320 Extra-ordinary items 149 -18 -461 0 0 0 Other items CF after EO items 590 1,282 2,033 3,712 4,541 5,320 (Inc)/Dec in FA+CWIP -1,347 -962 -750 -2,000 -1,500 -1,500 (Pur)/sale of invest. 58 -1,388 500 0 0 0 CF from inv. activity -1,290 -2,350 -250 -2,000 -1,500 -1,500 Changes in reserves 0 0 0 0 0 0 Inc/(Dec) in debt 328 2,396 0 0 0 0 Interest paid -290 -550 -628 -661 -661 -661 Dividends paid -166 -166 -285 -356 -475 -475 CF from fin. activity -128 1,680 -913 -1,018 -1,136 -1136 Inc/(Dec) in cash -828 612 871 694 1,905 2,684 Add: beginning balance 866 37 421 1,291 1,985 3,890 Closing balance 37 649 1,291 1,985 3,890 6,574


Fig 29 – TVS Motor: Ratios

Year end March (Rs m) FY08 FY09 FY10e FY11e FY12e FY12e Basic (Rs) EPS 0.8 1.4 5.4 8.0 10.9 13.8 Cash EPS 4.8 5.7 9.7 12.8 16.3 19.6 Book value per share 34.6 34.1 36.6 43.1 52.0 63.8 DPS 0.7 0.7 1.2 1.5 2.0 0.2 Payout (incl. div. tax) % 60.2 61.5 37.9 21.5 21.1 0.0 Valuation (x) P/E 168.8 103.1 26.5 17.8 13.1 10.3 Cash P/E 29.5 25.0 14.7 11.1 8.7 7.3 EV/EBITDA 51.5 15.4 10.9 7.9 6.2 4.9 EV/sales 1.2 1.0 0.9 0.6 0.5 0.4 Price to book value 4.1 4.2 3.9 3.3 2.7 2.2 Dividend yield (%) 0.5 0.5 0.8 1.1 1.4 1.4 Profitability ratios (%) RoE 2.4 4.1 14.7 18.6 21.0 21.7 RoCE 3.0 7.8 12.8 17.3 19.5 20.8 Turnover ratios Asset turnover (x) 2.0 2.0 2.3 2.8 3.0 3.1 Leverage ratio Debt/equity (x) 0.8 1.1 1.0 0.9 0.7 0.6



123

Company profile Part of the Sundaram Group, TVS Motor Company operates in all two-wheeler segments and recently entered the three-wheeler space.

Its key products are Apache, Star, Jive and Flame (motorcycles), Scooty variants in scooters, and XL Super and XL Heavy Duty in mopeds. With the Scooty EV, it has entered the electric scooters segment.

Chairman and managing director Venu Srinivasan is the grandson of the founder. Over the years, TVS has successfully helped the Indian two-wheeler segment touch new milestones such as launching the country’s first two-seater 50-cc moped in 1980 and pioneered the scooterette, Scooty, for women.

As part of its plans to tap the markets overseas, TVS has commissioned a plant in Indonesia to meet demand in the Asean region.

With both volumes and profitability declining, however, performance in recent years has been disappointing but is expected to improve.

Fig 30 – TVS Motors: Shareholding pattern

Promoter

61%

FII

7%

DII

13%

Others

19%

Source: BSE


124

Disclosures appendix

Global disclaimer

The information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered Bank Singapore Branch, Standard Chartered - STCI Capital Markets Limited and/or one or more of its affiliates (together with its group of companies, ”SCB”) and the research analyst(s) named in this report. SCB makes no representation or warranty of any kind, express, implied or statutory regarding this document or any information contained or referred to in the document. The research analysts responsible for the content of this research report certify that

The view expressed and attributed to the research analyst or Analysts in the research report accurately reflect their personalopinion(s) about the subject securities and issuers and/or other subject matter as appropriate; andNo part of his or her compensation and other benefits was, is or will be directly related to the specific recommendations or viewscontained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisalsof analysts.Our ratings are under constant review.

Additional information with respect to any securities referred to herein will be available upon request. THIS RESEARCH HAS NOT BEEN PRODUCED IN THE UNITED STATES AND MUST NOT BE SENT OR TAKEN OR TRANSMITTED INTO THE UNITED STATES OR DISTRIBUTED DIRECTLY OR INDIRECTLY IN THE UNITED STATES. Disclosures Appendix Where “disclosure date” appears below, this means the day prior to the report date. All share prices quoted are the closing price for the business day prior to the date of the report, unless otherwise stated. Company Ashok Leyland Ltd. At the disclosure date, the following applies:

Ashok Leyland Ltd - current rating is: IN-LINE

35404550556065707580

Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10

Source: FactSet prices / SCB ratings and fair values

Company Bajaj Auto Ltd. At the disclosure date, the following applies:

Bajaj Auto Ltd - current rating is: OUTPERFORM

1,000

1,500

2,000

2,500

3,000

3,500




125

Company Hero Honda Motors Ltd. At the disclosure date, the following applies:

Hero Honda Motors Ltd - current rating is: UNDERPERFORM

1,400

1,500

1,600

1,700

1,800

1,900

2,000

2,100



Company Mahindra & Mahindra Ltd. At the disclosure date, the following applies: Mahindra & Mahindra Financial Services - SCB and/or its affiliates owns 5% or more of any class of common equity securities of this company

Mahindra and Mahindra Ltd - current rating is: OUTPERFORM

400450500550600650700750800



Company Maruti Suzuki India Ltd. At the disclosure date, the following applies:

Maruti Suzuki India Ltd - current rating is: OUTPERFORM

1,100

1,200

1,300

1,400

1,500

1,600

1,700

1,800




126

Company Tata Motors Ltd. At the disclosure date, the following applies: SCB and/or its affiliates have received compensation for the provision of investment banking or financial advisory services within the past one year

Tata Motors Ltd - current rating is: OUTPERFORM

400500600700800900

1,0001,1001,2001,3001,4001,500



Company TVS Motor Company Ltd. At the disclosure date, the following applies:

TVS Motor Co Ltd - current rating is: UNDERPERFORM

405060708090

100110120130140150



Recommendation Distribution and Investment Banking Relationships

% of covered companies currently assignedthis rating

% of companies assigned this rating with whichSCB has provided investment banking services overthe past 12 months

OUTPERFORM 56.5% 10.7%

IN-LINE 27.6% 10.2%

UNDERPERFORM 15.9% 5.9% Research Recommendation

Terminology

OUTPERFORM (OP) ecurity is expected to outperform the relevant market index by 5% or more over the next six months

IN-LINE (IL) ecurity is not expected to outperform or underperform the relevant market index by 5% or more over the next six months

UNDERPERFORM (UP) expected to underperform the relevant market index by 5% or more over the next six months


127

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United States: Neither this document nor any copy of it may be sent or taken or transmitted into the United States or distributed, directly or indirectly, in the United States. GENERAL DISCLAIMER The information on this document is provided for information purposes only. It does not constitute any offer, recommendation or solicitation to any person to enter into any transaction or adopt any hedging, trading or investment strategy, nor does it constitute any prediction of likely future movements in rates or prices or any representation that any such future movements will not exceed those shown in any illustration. The stated price of the securities mentioned herein is as of the date indicated and is not any representation that any transaction can be effected at this price. While all reasonable care has been taken in preparing this document, no responsibility or liability is accepted for errors of fact or for any opinion expressed herein. 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