BUY EicherMotors Religare TG 22500

Financial Highlights

Company Initiation INDIA AUTOMOBILES

9 September 2015

REPORT AUTHORS

Mihir Jhaveri +91 22 6766 3459 [email protected]

Siddharth Vora +91 22 6766 3435 [email protected]

PRICE CLOSE (08 Sep 15) INR 17,234.30 MARKET CAP INR 467.8 bln USD 7.0 bln

SHARES O/S 27.1 mln

FREE FLOAT 45.1%

3M AVG DAILY VOLUME/VALUE 0.1 mln / USD 27.4 mln

52 WK HIGH INR 21,620.00

52 WK LOW INR 10,727.00

BUY TP: INR 22,500.00 30.6%

Eicher Motors EIM IN

Let the good times roll! Initiate with BUY

We initiate coverage on EIM with BUY and a Sep’16 TP of Rs 22,500 (30% upside). EIM continues to dominate the premium motorcycle market with its iconic Royal Enfield brand – we expect a robust 33% volume CAGR over CY14-FY18 as the business builds on its “cult” status and unassailable market position. CV volumes too are expected to post a healthy 19% CAGR as benefits from a cyclical demand recovery and premium launches kick in. Valuations are appealing and the recent correction offers a good entry point for investors.

Royal Enfield (RE) remains a cult brand: Over the years, RE has built a powerful brand image in the lifestyle/cruiser biking segment that remains unmatched by any other mass segment player, as evidenced by its 96% market share. We expect RE volumes to more than double from 0.3mn units in CY14 to 0.77mn in FY18, well on course to reaching 1mn units in the next 4-5 years, as (a) the median age of RE buyers shifts from the early 30s to the early 20s (the upshot of product upgrades), (b) launches add to sales, (c) the dealership network is expanded, and (d) capacity is raised from 300k units in CY14 to 720k in FY17. RE continues to have a waiting period of 4-5 months.

CV cycle recovery to aid VECV growth: After a two-year slump, the CV cycle in India rebounded in FY15. We expect the MHCV truck industry to grow at a 21% CAGR over FY15-FY18 and factor in a volume CAGR of 19% for EIM’s CV business during this period, with a cumulative 600bps increase in margins from higher operating leverage.

Initiate with BUY for 30% upside: With strong volume momentum in the RE business and higher CV margins, we expect EIM to post a revenue/PAT CAGR of 30%/50% over CY14-FY18 and ROE expansion from 27% to 39%. EIM’s share price surged 75% YoY till early Aug’15 before correcting 20% in the past month and is now trading at 27x FY17E earnings. We see strong upside potential and value EIM at Rs 22,500 as follows: (1) RE at Rs 19,450 based on 33x fwd P/E – a premium to peers due to its superior earnings, margin and returns profile, (2) VECV at Rs 3,050 on 10x fwd EV/EBITDA. BUY.

Y/E 31 Mar CY13A CY14A FY16E* FY17E FY18E

Revenue (INR mln) 68,098 87,383 1,46,932 1,70,374 2,05,837

EBITDA (INR mln) 7,137 11,148 23,110 31,209 39,420

Adjusted net profit (INR mln) 3,945 6,154 12,923 17,764 23,055

Adjusted EPS (INR) 145.9 227.1 476.9 655.5 850.7

Adjusted EPS growth (%) 21.5 55.6 110.0 37.5 29.8

DPS (INR) 30.0 50.0 70.0 80.0 90.0

ROIC (%) 30.8 33.5 63.6 85.9 101.3

Adjusted ROAE (%) 20.7 26.9 42.4 40.9 37.7

Adjusted P/E (x) 118.1 75.9 36.1 26.3 20.3

EV/EBITDA (x) 64.4 41.4 20.0 14.7 11.3

P/BV (x) 22.7 18.6 13.0 9.1 6.6

Source: Company, Bloomberg, RCML Research | *FY16 is a 15-mth period due to a change in Y/E from Dec to Mar

This report has been prepared by Religare Capital Markets Limited or one of its affiliates. For analyst certification and other important disclosures, please refer to the Disclosure and Disclaimer section at the end of this report. Analysts employed by non-US affiliates are not registered with FINRA regulation and may not be subject to FINRA/NYSE restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.

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BUY TP: INR 22,500.00 30.6%



9 September 2015 of 25

Strong upside potential Even accounting for the recent 20% correction, EIM’s share price has run up by over 55% in the last year and is currently trading at 27x FY17E earnings. We expect sustained stock outperformance backed by robust revenue/PAT growth of 30%/50% (CAGR) over CY14-FY18E, as the company continues to enjoy volume and margin gains in both businesses.

We model for volume growth of 33% in Royal Enfield (RE – low competition, strong brand recognition, market leadership, new launches, network expansion) and 19% in Volvo Eicher Commercial Vehicles (VECV – CV cycle recovery, premium launches) over our forecast period, accompanied by consolidated EBITDA margin expansion to 19.2% in FY18 from 12.8% in CY14.

Fig 1 - Stock outperformance vs. Sensex Fig 2 - Stock performance

Source: RCML Research, Company Source: RCML Research, Company

Fig 3 - EIM stock up from Rs 500 to Rs 3,000 over FY09-FY13... Fig 4 - …and up a further 6 times over FY13-FY15


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RE launches Continental GT in the UK; volumes keep growing at 50%+

Stock has run up 55% in the past year but still holds plenty of upside

BUY TP: INR 22,500.00 30.6%




Royal Enfield: A cult brand The bulk of EIM’s value is derived from the motorcycle business which contributed 66% of its operating profits in CY14 (and forms 86% of our SOTP target price). The company owns the iconic Royal Enfield motorcycle business, which leads the premium end of the market in India. RE is one of the world’s oldest motorcycle brands with the Bullet enjoying the longest continuous production run in the history of motorcycles since 1948. EIM forayed into this business with the acquisition of Enfield India in 1991. Originally a UK-based company, RE set up its Indian arm in 1955 to build motorcycles for the Indian government. While the UK business was shut down in 1970, Enfield India continued to exist independently until the acquisition by EIM.

Fig 5 - RE share in EIM’s revenue has risen sharply… Fig 6 - …contributing 65% of operating profits in CY14


Resurgent volume growth

CY10 was a watershed year for EIM marking the run-up to an astonishing revival of fortunes in the RE business – from a mere 9% CAGR over CY03-CY10, RE’s volume growth accelerated to a 55% CAGR through to CY14 when 300,000 motorcycles were sold versus just 52,000 in CY10. Demand for RE motorcycles currently exceeds supply with buyers encountering a waiting period of 4-5 months. This despite steady capacity expansion from 60,000 units in CY10 to 300,000 in CY14 and 500,000 units by Q3FY16; we expect capacity to double by FY19. The brand continues to enjoy iconic status with 96% market share in >250cc motorcycles and strong brand recognition in leisure biking.

We look at the key factors behind EIM’s transformational journey and examine why this “cult” brand will continue to fascinate the Indian buyer.

2010 a watershed year for Eicher RE volumes clocked a mere 9% CAGR over CY03-CY10 and growth plummeted to 1.2% in CY10 as the company was in transition mode, involving a change in engine platform, which constrained production. At the time, EIM also discontinued discounts being handed out to push weak sales.

In Oct’10, the company completed transition to the new engine platform bringing with it key benefits such as better fuel efficiency and lower maintenance costs; this also paved the way for new, improved model launches such as the Classic – all of which yielded handsome dividends as volume growth surged to a 55% CAGR over CY10-CY14, with sales rising six-fold to 300k units in CY14. We discuss the key contributing factors behind this turnaround below.

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0102030405060708090

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0102030405060708090

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Owns the iconic Royal Enfield motorcycle brand, which leads the premium end of the market in India

RE sold 300,000 motorcycles in CY14 versus just 52,000 units in CY10

BUY TP: INR 22,500.00 30.6%




Fig 7 - Stellar volume growth since CY10

Source: Company, RCML Research

Improvement in product mechanicals: At the end of CY10, the company had completed a transition from cast iron engines to the all-aluminum unit construction engine (UCE) platform. This platform has an integrated assembly for the engine, gear-box and clutch which reduces friction between moving parts. This resulted in lower transmission losses, in turn boosting fuel efficiency and lowering maintenance costs – critical factors for Indian customers. Features like placement of the gear shift on the left side and introduction of a self-starter further improved the ease of use.

Bullet got a “Classic” makeover: After improving product quality, RE introduced several new products which included the Classic 350. The styling of the Classic was almost identical to the original Bullet but with a ‘premium’ touch in the form of brighter colours, split seats and a new taillight assembly. The Classic has now become the company’s best-selling brand, constituting more than 55% of the last 12-month volumes.

Fig 8 - Royal Enfield Bullet Fig 9 - Royal Enfield Classic 350

Source: Company Source: Company

New state-of-the-art facility and dealer network expansion: RE had a legacy plant that was nearly 50 years old; as demand grew EIM invested heavily in a new state-of-the-art manufacturing and product development facility at Oragadam near Chennai, and also raised capacity from ~60,000 units in CY10 to ~300,000 units in CY14. The number of dealers has also increased from 140 in CY10 to 425 currently.

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BUY TP: INR 22,500.00 30.6%




Fig 10 - Rapid capacity expansion… Fig 11 - …along with a growing dealer network


A “cult” brand at affordable prices for affluent Indian masses To decipher the future volume growth potential of RE, we look at the features that make an RE product so compelling in India:

Brand image: Royal Enfield is a well-recognised brand in both urban and rural India. Owning an RE motorcycle is a matter of pride and is considered a status symbol – this powerful brand image remains unmatched by any other mass segment player.

Engine power at an affordable price: RE is the leader in India’s lifestyle/cruiser biking segment and holds 96% market share. Its range of products employs 350-500cc engines with 20-27bhp and is sold at price points of Rs 105-192k – the only motorcycle range in India available at this price and specification.

Fuel efficiency and low maintenance cost: After the CY10 revamp, fuel efficiency has risen to 50kmpl for 350cc and 40kmpl for 500cc engines. Reliability and durability have also improved substantially. As per our dealer interactions, the cost of maintenance is only slightly higher than mass market offerings but significantly lower than the premium offerings of other players in the 350cc and above category.

For the value conscious Indian buyer, RE is seen as the perfect mix of brand status, quality, fuel efficiency, durability and low-cost maintenance. Competitors will thus face an uphill task should they look to replicate the brand experience of owning an RE.

Fig 12 - Players in the premium motorcycle range Company Model Engine (cc) Price (Rs '000) Bajaj Avenger 220 80

Bajaj KTM 200 130

Bajaj KTM 390 190

Bajaj Ninja 300 350

Bajaj Ninja 650 460

Suzuki Inazuma 250 310

Honda CBR 250 160

Royal Enfield Bullet 350 350 100 Royal Enfield Classic 350 350 120 Royal Enfield Thunderbird 350 350 130 Royal Enfield Bullet Electra 350 350 155 Royal Enfield Bullet 500 500 145

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RE’s powerful brand image remains unmatched by any other mass segment player

BUY TP: INR 22,500.00 30.6%




Company Model Engine (cc) Price (Rs '000) Royal Enfield Classic 500 500 155 Royal Enfield Thunderbird 500 500 167 Royal Enfield Continental GT 535 190 Harley-Davidson Street 750 750 410

Harley-Davidson 883 IRON 880 670

Harley-Davidson FATBOY 1,700 1,550

Suzuki Hayabusa 1,500 800

Suzuki Intruder 1,800 1,000

Triumph Daytoma 675 1,015

Triumph Street Triple 675 745

Triumph Boneville 800 660


Fig 13 - Royal Enfield brand portfolio Fig 14 - Royal Enfield volume split by platform


Capacity addition to strengthen volumes

EIM is expanding its RE capacity from 360,000 units in Jan’15 to 720,000 units in FY17. The company has already indicated that capacity will touch 50,000 units per month by Dec’15 from 30,000 in Jan’15. In phase II of the Oragadam plant in Chennai, total production will be raised to 60,000 units per month by mid-FY16. RE has also bought land at Vallam Vadagal in Chennai for a third plant which will be ready for production by FY18.

Despite the rapid expansion drive, RE products continue to have a waiting period of 4-5 months. Thus, the only hindrance to volume growth in the near term would be supply constraints – we build in a volume CAGR of 33% to 769k units over FY15-FY18E and believe the company is well on course to selling 1mn units in the next 4-5 years.

Fig 15 - Royal Enfield capacity addition Fig 16 - We expect 33% volume CAGR over CY14-FY18

Source: RCML Research, Company | Growth normalized for 15-month FY16 Source: RCML Research, Company | Growth normalized for 15-month FY16

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0102030405060708090

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RE capacity being expanded from 360,000 units in Jan’15 to 720,000 units in FY17

BUY TP: INR 22,500.00 30.6%




New launches will keep growth moving

EIM plans to launch at least one new RE product every year till 2020. The company is in the final stages of developing two platforms, speculated to be in the 400cc and 750cc categories, which will expand the RE offering to the desired 250-750cc range. These two platforms are expected to spawn multiple products suited for both domestic and international markets. EIM recently trademarked the Himalayan brand name which is expected to be a scrambler-style RE model suited for hilly terrain.

The company has chalked out plans for a new technology centre in Leicestershire, UK, and has already started assembling a team which will focus on design and development. One of the high profile recruits includes legendary former Ducati designer Pierre Terblanche.

To strengthen its design and development capabilities further, EIM recently acquired UK-based Harris Performance Products, a motorcycle design and engineering firm. Harris Performance has had a longstanding relationship with the RE brand and was responsible for chassis development of the Continental GT model. Notably, Harris Performance was the only UK manufacturer to have been officially commissioned by Yamaha and Suzuki to design, develop and manufacture race bikes for the Grand Prix and World Superbike series.

A Harley perspective

Similarities have been drawn between Harley Davidson (HD) and Royal Enfield (RE) by investors and customers alike. We favour the idea of RE being India’s Harley Davidson, as both players operate in the leisure biking and lifestyle segment; but in our view, RE’s potential is significantly higher as it competes at a lower price point and has a larger target customer base globally.

On average, an HD costs US$ 15,000 as compared to US$ 2,500 for an RE. HD reached peak volumes of 350,000 units in 2006, growing at 12% CAGR over 1986-2006. We expect RE to achieve sales of 582,000 units in FY16 (15 months) from 52,576 units in CY10. While the current growth rate has been super-normal, we see potential for a 15% CAGR in the next 10 years – similar to HD’s run over 1986-2006.

Fig 17 - HD volumes started gaining momentum in CY00, hit a peak in CY06 and tapered off

Fig 18 - Valuation multiples peaked around CY00 when volumes started gaining momentum


We expect RE to benefit significantly from its HD-style brand-building strategy in the long run. EIM has shied away from mass media advertising for RE, concentrating more on building its brand around the perceived cult status. The company promotes leisure motorcycling as a lifestyle. It organises annual events and rides such as the Himalayan

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Plans to launch at least one new product every year till 2020

RE is India’s Harley Davidson but with stronger growth potential

Premium brand-building strategy has been the key to success

BUY TP: INR 22,500.00 30.6%




Odyssey, the Tour of Rann of Kutch, the Tour of NH17 (Mumbai to Goa), the Tour of Rajasthan and the Southern Odyssey. Dealers regularly update customers about group rides and other events. An RE motorcycle gives the owner entry to an exclusive club of Enfield riders who are typically seen in groups, drawing the envious attention of people around. EIM’s current strategy of a showroom makeover only further differentiates the brand experience compared to other manufacturers in the market.

Fig 19 - Brand new concept RE store opened in New Delhi... Fig 20 - …to promote leisure biking


Low competition, low penetration equals immense opportunity

In the 250cc-and-above category of motorcycles, RE holds 95.6% market share (FY15), which declined 40bps YoY. RE faces virtually nil competition in the >250cc cruiser bike segment, while Bajaj Avenger (220cc) sells ~44,000 units and is the only credible competitor in the sub-250cc segment. The >250cc category grew 60% in FY15 and is expected to do well going forward – we expect RE to maintain or marginally lose market share in the category, but to grow its share in the overall market.

In the 150cc-and-above category which is a potential RE customer base, the brand expanded its market share to 37.3% in FY15 from 34.6% in FY14. We expect RE to gain further market share in this category with new launches. RE holds 3% share of India’s overall motorcycle market, implying massive scope for growth.

Fig 21 - Market share of Royal Enfield in India’s motorcycle market


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BUY TP: INR 22,500.00 30.6%




Leadership brands – Classic to join the likes of Activa, Pulsar

Over the decades, we have seen some brands go from strength to strength while competition has been a mere spectator. Two such examples are ‘Honda Activa’ and ‘Bajaj Pulsar’. Right from a first-mover advantage to having the highest market share, these brands remain the epitome of success in India’s two-wheeler industry despite new launches by competitors.

We believe the common ingredients for this success are their first-mover advantage and strong reputation in terms of reliability, cost of maintenance, ownership status and ease of use. As time goes by, these brands have become synonymous with the segment, creating a following among customers which helps maintain their sales momentum. We believe the Classic launched by EIM in CY10 is one such brand in the making – it has all the qualities we mentioned above and in the coming years could become synonymous with the cruiser category.

Fig 22 - Honda Activa sales have risen steadily over the years Fig 23 - We expect RE Classic to gain a similar fan following


Dealer checks point to sustained, buoyant demand

Based on our dealer checks and interactions with the management, we observe that the median age of an RE customer has reduced dramatically from the late 20s to early 30s to someone who is in his early 20s. This change in profile has been led by product improvements such as the introduction of a self-starter and left gear shift as well as products with weight distributed across the motorcycle.

An individual who has learnt to drive on an entry-level motorcycle feels a sense of achievement when he “graduates” to an RE. There are also instances of first-time riders aged 18-22 years now considering owning an RE as their first motorcycle. At the other end of the spectrum, the number of executives aged over 35+ taking up leisure biking as a hobby is on the uptrend as well.

Our interactions with dealers indicate that the demand buoyancy continues, with volumes up 30-80% YoY in the recent months. The Classic continues to be the model most in demand across regions and dealers expect a new product in the 400cc range to be a volume driver, as higher powered motorcycle still don’t sell in good numbers, as evident from flagging sales of the Continental GT. Dealers also believe that the new RE showrooms help draw customers in, but sizeable revenues from accessory sales are still a few years away.

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Classic likely to garner a loyal customer following and become synonymous with the cruiser category

Demand growing rapidly with fall in median age of customers

BUY TP: INR 22,500.00 30.6%




Export strategy in place

Exports currently constitute only 2-3% of overall volumes in the RE business as management’s focus has been predominantly on the domestic market. With the domestic business stabilising, we expect management to shift focus towards exports. While EIM aspires to grow exports to 6-7% of total volumes by FY18, we build in a conservative 2% share by FY18.

In CY13, RE launched its Continental GT globally in London to mark its importance in global markets. Going forward, the company plans to launch models with higher sales potential in global markets than in India. EIM is steadily entering both developed and developing markets such as the US, UK and Indonesia. The company will continue to position RE as an aspirational brand with a few exclusive stores to create awareness among customers and fuel demand, providing products manufactured in India. The company currently has no plans to set up a manufacturing base outside India.

Fig 24 - Export growth subdued due to capacity constraints Fig 25 - Expect the proportion to sales to remain steady

Source: RCML Research, Company | Growth normalized for 15-month FY16 Source: RCML Research, Company

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Steadily entering both developed and developing markets such as the US, UK and Indonesia

BUY TP: INR 22,500.00 30.6%




CV recovery to boost VECV volumes India’s CV cycle is on the path to recovery after a slump of two years. Formation of a single-party majority at the Centre after three decades has buoyed consumer and business sentiments in India, boosting demand in both the passenger car and CV markets. MHCV truck sales have gained momentum, growing at +24% in FY16YTD from a 27% decline in FY14 and 21% growth in FY15 – this revival has been led by capacity addition by organised fleet operators as well as replacement demand.

We expect the recovery to gather pace in the next two years and forecast a 21% CAGR in overall industry MHCV truck volumes over FY15-FY17 given (1) the ongoing macro recovery, (2) the cyclical nature of CV demand where sales dip sharply (much higher than the automobile industry) during an economic slowdown and pick up swiftly during the ensuing cyclical recovery, (3) a softer interest rate environment (90-100% of CV purchases are financed, per our dealer check), (4) recent lifting of mining restrictions along with more stringent safety norms (ban on overloading, restriction on age of vehicles on road), implying an increase in transport loads and (5) GST implementation by Apr’16 which will support demand for newer, faster vehicles, given enhanced turnaround time post-removal of state tax checkposts.

Fig 26 - Improving business sentiments have led to higher MHCV truck demand over the past few months

Fig 27 - Volume growth for the CV sector – historical trends and our assumptions for future performance

(%) Total CV MHCV LCV CAGR FY85-FY15 6.4 4.4 8.5 FY95-FY15 6.3 4.5 7.8 FY05-FY15 6.8 1.6 12.3 FY10-FY15 2.9 (1.0) 5.8 Annual FY14 (20.2) (25.3) (17.6) FY15 (2.8) 16.0 (11.5) FY16E 16.1 20.7 13.4 FY17E 18.5 21.9 16.5 FY18E 17.6 19.3 16.5

Source: Company, RCML Research Source: Company, RCML Research

Cyclical nature of demand

CV volume growth, being cyclical in nature, has historically exhibited sharp demand growth and decline patterns. A year (or two) of decline is generally followed by high double-digit growth in the segment (Fig 28). Accordingly, following the sharp 43% correction in MHCV volumes over FY12-FY14 (~25% drop each in FY13 & FY14), we expect a sharp recovery in the segment over FY15-FY17.

Fig 28 - Periods of steep decline in MHCV vols. are generally followed by sharp pickup

Source: SIAM, RCML Research

(60)

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(%) MHCV Trucks YoY %

8 9

(0)

(23)

13

3623 21

(39)

(10)

34

(23)

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2939

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5

33

(0)

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33 32

8

(23)(25)

16 21 22 19

(60)

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60

FY90

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(%) MHCV YoY %

We forecast a 21% CAGR in overall industry MHCV truck volumes over FY15-FY17

Demand slump in CVs is typically followed by high double-digit growth as pent-up demand unwinds

BUY TP: INR 22,500.00 30.6%




Higher tonnage MHCVs in the lead, reflecting higher industrial activity

Early trends suggest that volumes in the higher tonnage segment have rebooted sharply. Our dealer interactions suggest this can be attributed to a pick-up in the construction segment (mainly roads), where higher tonnage vehicles are used. This also possibly reflects the shift in demand in the last few years from 12-16t vehicles to >25t multi-axle vehicles (MAV), as MAV trailers are preferred for transporting heavy capital goods and automobiles, among others, while tippers are used for the mining industry.

Fig 29 - Domestic MHCV growth led by higher tonnage (>16t) segment…

Fig 30 - …while growth in lower tonnage (<16t) segments is also following suit


Fig 31 - Share of the >25t segment has increased over the past 4-5 years

Source: SIAM, RCML Research

(100)

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Jan-

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-14

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4

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-14

Nov

-14

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-14

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15

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15

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-15

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-15

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-15

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15

Jul-1

5

(%)16.3-25t >25.1tTrailers 26.5-35.2t Trailers >35.2tTotal Domestic CV

(60)

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20

40

60

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14

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14

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-14

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-14

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-14

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5

(%) 7.5-12t 12.1-16.2t

11 12 12 15 18 15 17 19 22 20 22 26 26 19

49 47 45 40 3426 26 29 24 22 20

22 2017

11 13 14 13 22 49 45 4238

31 2625 27

25

29 28 29 32 2610 12 11 16

27 31 28 2839

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100

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

(%) 7.5-12 T 12.1-16.2 T 16.3-25 T >25T

Construction activity pushing up demand for higher tonnage vehicles

BUY TP: INR 22,500.00 30.6%




VECV to gain from new heavy-duty launches

EIM’s joint venture (JV) with Volvo has added the heavy-duty truck segment to its portfolio. Earlier the company was predominantly in the 7.5-12t segment where it held 45% market share as of FY15. A wider portfolio coupled with access to Volvo’s technology and resulting product improvement has helped EIM post market share gains in the MHCV truck segment, from 7% in FY07 to 11% in FY15.

Fig 32 - Market share of VECV at ~11% currently


In Dec’13, EIM unveiled its planned Pro series trucks and buses. These included 11 products in the range of 5-49t Gross Vehicle Weight (GVW) which offered higher power and durability, greater comfort and value-added features at economical costs – tapping into the surging demand for such products in the emerging mid-to-premium market segment.

In 2014, it began commercialising the Pro series range in a phased manner, starting with the Light Medium Duty (LMD) segment – Pro 1000 and Pro 3000 trucks. Thereafter, the company launched the heavy-duty Pro 6000 and Pro 8000 to a very encouraging response. The Pro range of products became available across EIM’s distribution points in the country from the start of FY16. The company commercialised a modern medium-duty engine manufacturing facility in mid-2013 and invested Rs 5.2bn in CY14, mainly towards commercialising these new products.

Fig 33 - Eicher PRO series of trucks and buses

Source: Company

50%

60%

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80%

90%

100%

FY02

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TTMT AL VECV Others(Companywise market share)

EIM’s JV with Volvo adds the heavy-duty truck segment to its portfolio

BUY TP: INR 22,500.00 30.6%




Fig 34 - Split of VECV sales indicates pickup in MHCV cargos above 12t

Fig 35 - Pro series has raised market share for VECV in the 7.5-12t category


VE Powertrain to serve as global engine hub

VECV rolled out a new powertrain plant in Pithampur, Madhya Pradesh, in CY13. The plant has an initial capacity of 25,000 engines that can be ramped up to 100,000 units depending on demand. Importantly, it is expected to serve as a global hub catering to global engine requirements for VECV. It manufactures two main variants at present – 4-cylinder 5-litre and 6-cylinder 8-litre engines, with output of 180-350hp capable of meeting Euro 6 norms, Japanese PNLT and US EPA norms. We expect volumes to ramp up to 48,000 engines in FY18, a CAGR of 52% over CY14-FY18.

Upsides from Eicher–Polaris JV

In CY13, EIM signed a 50:50 JV with Polaris to manufacture personal vehicles in India. The first of these called ‘Multix’ was launched in June’15 and has the unique feature of functioning as a people carrier, a goods carrier for business and a power generator. The closest rivals are entry-level LCVs that can match Multix’s 1,918ltr luggage space. EIM’s target audience is small business owners, farmers, skilled workers, contractors and small factory owners, basically tier III and IV markets. Capacity stands at 60,000 vehicles initially which can be scaled up depending on demand. We have not built any estimates for Multix into our financial assumptions.

Fig 36 - Multix in seating for four and open loading bay configuration

Fig 37 - Multix in closed loading bay configuration


45.0

16.610.7 12.3

15.4

41.8

19.4

10.613.7 14.4

05

101520253035404550

MHCV goods(7.5-12T)

MHCV goods(above 12T)

MHCVpassenger

(above 7.5T)

LCVPassenger

(below 7.5T)

LCV Goods(below 7.5T)

(%) FY14 FY15

16.8

37.7

18.0

40.3

0

5

10

15

20

25

30

35

40

45

7.5-12T Passenger carriers 7.5-12T Goods Carriers

(%) FY14 FY15

VE Powertrain to be global hub for Volvo’s engine requirement

In a 50:50 JV with Polaris to manufacture personal vehicles in India

BUY TP: INR 22,500.00 30.6%




High operating leverage pays off in an upcycle

Past CV cycles suggest that companies with a higher fixed cost structure are worst hit during periods of downcycle because falling utilisation levels weaken their operating leverage and hence margins. The opposite holds true in an upcycle when CV companies benefit from significant leverage gains amid rising volumes and utilisation. We expect VECV to expand margins to 12.7% in FY18 from 6.7% in CY14 as new launches support a volume CAGR of 19% over this period.

Fig 38 - VECV margins and return ratios to improve with volume recovery…

Fig 39 - …we expect a similar sharp rebound for peer, Ashok Leyland


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(%)(%) ROE EBITDA (R)

High operating leverage for the sector due to large fixed costs implies stronger margin gains in an upcycle

BUY TP: INR 22,500.00 30.6%




Financials Revenue/PAT CAGR of 30%/50% over CY14-FY18E

We build in consolidated revenue CAGR of 30% over CY14-FY18, supported by a robust 33% volume CAGR in RE and 19% CAGR in CVs during the same period. While we expect RE to form 41% of overall revenues by FY18, the business is likely to contribute 62% of operating profits by then.

Fig 40 - RE volume growth to normalise to 20% in FY18, VECV to turnaround in FY16

Fig 41 - PAT growth higher than revenues due to expansion in overall margins

Source: Company, RCML Research | Growth normalized for 15-month FY16 Source: Company, RCML Research | Growth normalized for 15-month FY16

Fig 42 - RE has gained prominence in overall revenues… Fig 43 - …contributing 66% of operating profits in CY14


Margin expansion ahead

EIM’s operating margins have remained best-in-class over the past few years as RE’s resurgence led to a more than doubling of the segment’s margins over CY10-CY14, from 10.3% to 24.2%. Going forward, we expect margin gains from both businesses, with a more prominent contribution from VECV, as a CV recovery would support VECV margins of 12.7% in FY18 from 6.7% in CY14. Overall, we expect consolidated margins to increase to 19.2% in FY18 from 12.8% in CY14.

57.0

69.9

54.0

37.4

20.2

(15.5)(1.1)

12.8

31.5

19.6

(20)(10)

01020304050607080

CY13 CY14 15MFY16E FY17E FY18E

(%) RE CV

6.6

28.334.5

44.9

20.821.7

56.0

68.071.8

29.8

0

10

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70

80


(%) Revenues PAT

16.425.2

34.7 40.4 39.9 41.0

83.674.8

65.3 59.6 60.1 59.0

0102030405060708090

100


(%)Revenues

RE VECV & Others

26.545.5

65.8 67.7 61.6 61.6

73.554.5

34.2 32.3 38.4 38.4

0102030405060708090

100


(%) EBITDARE VECV & Others

Volume momentum to support strong topline

CV recovery to take VECV margins to 12.7% in FY18 from 6.7% in CY14

BUY TP: INR 22,500.00 30.6%




Fig 44 - RE margins to improve steadily; VECV margins to near-double between CY14-FY18E

Fig 45 - Pick-up in VECV volumes will boost consolidated margins along with contribution from RE


Fig 46 - Key metrics

CY13 CY14 FY16E FY17E FY18E Royal Enfield Volumes (000s) 178.1 302.6 582.3 640.0 769.3 Revenues (Rs bn) 17.1 30.3 59.3 67.9 84.5 EBITDA (Rs bn) 3.2 7.3 15.6 19.2 24.3 EBITDA Margin (%) 19.0 24.2 26.4 28.3 28.7 PAT (Rs bn) 2.9 5.6 11.4 14.3 18.4 VECV

Volumes (000s) 41.3 40.8 57.5 60.5 72.4 Revenues (Rs bn) 51.3 57.6 87.8 102.7 121.7 EBITDA (Rs bn) 4.0 3.8 7.7 12.3 15.5 EBITDA Margin (%) 7.7 6.7 8.8 11.9 12.7 PAT (Rs bn) 2.9 1.9 3.9 7.7 10.2 EIM (Consolidated)

Revenues (Rs bn) 68.1 87.4 146.9 170.4 205.8 EBITDA (Rs bn) 7.1 11.1 23.1 31.2 39.4 EBITDA Margin (%) 10.5 12.8 15.7 18.3 19.2 PAT (Rs bn) 3.9 6.2 12.9 17.8 23.1 Source: RCML Research, Company

Sharp upswing in return ratios

With a strong operating performance, ROE/ROCE should improve dramatically from 21%/24% in CY13 to 38%/41% in FY18. The company plans to incur capex of Rs 20bn over the next two years for capacity expansion and R&D. With healthy operating cash flows despite the capex, we model for robust free cash flows of Rs 30bn in the next two years.

Fig 47 - Return ratios likely to rise dramatically by FY17 Fig 48 - Expect Rs 30bn of FCF in FY16-FY17


19.0

24.226.4

28.3 28.7

7.7 6.78.8

11.9 12.7

0

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(%) RE VECV

4.88.4

10.6 11.3 11.85.7

4.45.1

7.0 7.410.5

12.8

15.718.3 19.2

0

5

10

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(%) RE VECV Consol

20.7

26.9

42.4 40.937.7

24.027.7

44.8 45.4

41.1

15

20

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30

35

40

45

50


(%) ROE ROCE

7.210.5

22.226.8

32.2

(7.1)(9.7) (9.9) (9.5) (9.8)

0.0 0.8

12.3

17.322.5

(15)(10)

(5)05

101520253035


(Rs mn) CFO Capex Free Cashflow to Firm

ROE/ROCE to improve dramatically from 21%/24% in CY14 to 38%/41% in FY18

BUY TP: INR 22,500.00 30.6%




Valuations – plenty of steam left Initiate with BUY

We initiate coverage on EIM with a Sep’16 TP of Rs 22,500, offering 30% upside. Using the SOTP method, we value RE at 33x one-year forward P/E (Rs 19,450) – a premium to peers due to its robust earnings profile, superior margins and solid return ratios expected over the next 2-3 years.

For VECV, we assign a 10x forward EV/EBITDA multiple, in line with Ashok Leyland as the company is well positioned to (a) deliver strong volume growth and margin gains in both domestic sales and exports, (b) benefit from engine export potential as VECV’s global engine hub, and (c) maintain a superior debt-free balance sheet.

Fig 49 - One-year forward P/E Fig 50 - Valuation summary

SOTP Valuation 1 yr forward Standalone (RE) EPS (Rs) 590.5 P/E Multiple (x) 33 RE Value per share (Rs) 19,450 VECV EBITDA (Eicher share 54.4%) (Rs bn) 7.5 EV/EBITDA multiple (x) 10 EV (Rs bn) 75.5 Net Debt (Rs bn) (7,6) Equity Value of VECV (Rs bn) 83.1 No of Shares (units mn) 27.1 VECV Value per share (Rs) 3,050 Target Price (Rs) 22,500


The stock has corrected 20% from its peak and offers an attractive investment opportunity. Our target price offers 30% upside and we see scope for EIM’s share price to more than double over a five-year period given the high earnings visibility.

Key risks RE capacity expansion could run into trouble, leading to lower volume growth and

higher waiting periods, driving away potential customers.

New products from RE may fail to gain customer acceptance.

Failure of VECV to gain market share and deliver on volume growth.

01020304050607080

Mar

-10

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10

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-11

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11

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-12

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-13

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13

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-14

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14

Mar

-15

Sep-

15(x) P/E 5-yr Avg - 1 s.d

+ 1 s.d 3-Yr Avg.

3 year Avg: 30x

Peer Comparison (FY17)

Source: RCML Research

28.320.6

14.9

52.1

31.439.4

47.1

31.2 34.3

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RE Bajaj Hero

(%) EBITDA ROE ROCE

BUY TP: INR 22,500.00 30.6%




Company profile EIM is the flagship of the Eicher Group, responsible for production of India’s first agricultural tractor in 1959. The company is now a leading player in the Indian automotive space.

Fig 51 - Ownership structure of Eicher Motors (EIM)

Source: Company

EIM owns the iconic Royal Enfield motorcycle business, which leads the premium motorcycle segment in India. RE has created the mid-size motorcycle segment in India with its unique and distinctive blend of classic modern bikes. Equipped with an enhanced manufacturing base in Chennai, RE is able to grow production rapidly to meet the surge in demand for its motorcycles. With 50% growth every year for the last three years, RE is fast becoming a key player in the global mid-size motorcycle market and is working towards reinventing this space with new innovative products.

RE’s product line-up includes the Bullet, Classic and Thunderbird models in both 350 and 500cc displacements, and the recently introduced Continental GT 535cc café racer. RE operates through 12 company-operated stores and 425 dealers in all major cities and towns in India, and exports to over 50 countries including the USA, Japan, UK, several European and Latin American countries, as well as the Middle East and South Asia.

EML’s joint venture with the Volvo group, VE Commercial Vehicles, began operations in Jul’08. The company includes the complete range of Eicher branded trucks and buses, VE Powertrain, EIM’s components and engineering design services businesses, the sales and distribution business of Volvo Trucks as well as aftermarket support to Volvo Buses in India. VECV’s vision is to be recognised as the industry leader driving modernisation in commercial transportation in India and the developing world.

In 2012, EIM signed a strategic JV agreement with US-based Polaris Industries to design, develop, manufacture and sell a new range of personal vehicles suitable for India and other emerging markets. The JV allows EIM to enter into a new vehicle segment. In 2013, the JV company Eicher Polaris Pvt Ltd (EPPL) set up its manufacturing facility in Jaipur, Rajasthan, and in 2014 launched its first vehicle Multix in the Indian market. The JV does not have any export plans currently.

Promoter

4.6%

DII

27.5%

FII

1.7%

CorporateBodies

Retailinvestors

50%54.4%

AB Volvo

45.6%

EML

PolarisIndustries

100% 50%

54.9%

13.0%

BUY TP: INR 22,500.00 30.6%




Key management

Siddhartha Lal – MD & CEO, Eicher Motors Siddhartha Lal is the CEO of Royal Enfield, Chairman of VECV and Chairman of Eicher-Polaris Pvt Ltd (EPPL). He holds a Master’s degree in Automotive Engineering from University of Leeds and is a Cranfield University qualified mechanical engineer.

Lalit Malik – CFO, Eicher Motors Prior to joining EIM, Lalit worked at Max India as VP – Corporate Development, where his primary responsibility included managing the investments of Max India in the insurance space. From Apr-Dec’08, Lalit also worked at AIG as Head of Business Strategy, Business Development & Insurance (cross sell) for the Consumer Finance Group in India. Here he was responsible for conceptualizing and executing inorganic and organic growth of the company through portfolio buyouts, securitisation, strategic partnerships, collaboration and introduction of new products.

Rudratej Singh – President, Royal Enfield Rudratej ‘Rudy’ Singh joined the company in Jan’15 and has over 18 years of experience in leading the Brand and Marketing mandate for well-known companies in India and across the globe. As President of Royal Enfield, Rudy is responsible for building thought leadership for the brand and leading the commercial business. This includes global sales and after sales, brand and marketing, new product strategy, and creating and growing new business opportunities such as apparel, accessories, and other adjacencies. Prior to joining Royal Enfield, Rudy was based in Singapore with Unilever as Vice President – South Asia, HPC & Foods Marketing Operations.

B Govindarajan – COO, Royal Enfield B Govindarajan has been the Chief Operating Officer (COO) at RE since Jan’13. He joined RE in Jun’11 as Senior Vice President – Industry for his second stint with the company, where he was actively involved in ramping up production at RE’s Thiruvottiyur facility to 100,000 units per annum. He is now spearheading the setup of RE’s second plant at Oragadam near Chennai and is implementing extensive cost management in sourcing and operations. He had joined RE as Manager – Engineering in 1995 and in 2004, became the GM – Manufacturing where he was responsible for the entire manufacturing activity and implementation of Lean and Quality Management Systems. In 2006, he was promoted to Divisional General Manager at RE. Soon after, he moved to the Commercial Vehicle Manufacturing unit of EIM in Pithampur as the Head of Operations.

BUY TP: INR 22,500.00 30.6%




Per Share Data Y/E 31 Mar (INR) CY13A CY14A FY16E* FY17E FY18E Reported EPS 145.9 227.1 476.9 655.5 850.7 Adjusted EPS 145.9 227.1 476.9 655.5 850.7 DPS 30.0 50.0 70.0 80.0 90.0 BVPS 760.1 928.4 1,323.3 1,885.2 2,630.7

Valuation Ratios Y/E 31 Mar (x) CY13A CY14A FY16E* FY17E FY18E EV/Sales 6.7 5.3 3.1 2.7 2.2 EV/EBITDA 64.4 41.4 20.0 14.7 11.3 Adjusted P/E 118.1 75.9 36.1 26.3 20.3 P/BV 22.7 18.6 13.0 9.1 6.6

Financial Ratios Y/E 31 Mar CY13A CY14A FY16E* FY17E FY18E Profitability & Return Ratios (%) EBITDA margin 10.5 12.8 15.7 18.3 19.2 EBIT margin 8.6 10.2 12.9 15.9 16.7 Adjusted profit margin 5.8 7.0 8.8 10.4 11.2 Adjusted ROAE 20.7 26.9 42.4 40.9 37.7 ROCE 24.0 27.7 44.8 45.4 41.1 YoY Growth (%) Revenue 6.6 28.3 68.1 16.0 20.8 EBITDA 30.0 56.2 107.3 35.0 26.3 Adjusted EPS 21.5 55.6 110.0 37.5 29.8 Invested capital 28.6 25.7 4.8 8.7 7.2 Working Capital & Liquidity Ratios Receivables (days) 27 23 12 16 15 Inventory (days) 40 37 29 35 38 Payables (days) 69 69 57 73 81 Current ratio (x) 1.2 1.0 1.0 1.2 1.4 Quick ratio (x) 0.3 0.2 0.3 0.4 0.7 Turnover & Leverage Ratios (x) Gross asset turnover 3.6 3.2 3.9 3.5 3.5 Total asset turnover 1.4 1.5 2.0 1.7 1.5 Net interest coverage ratio 0.0 0.0 0.0 0.0 0.0 Adjusted debt/equity (0.3) (0.2) (0.3) (0.4) (0.5)

DuPont Analysis Y/E 31 Mar (%) CY13A CY14A FY16E* FY17E FY18E Tax burden (Net income/PBT) 58.8 62.0 63.6 61.0 60.8 Interest burden (PBT/EBIT) 115.0 110.9 107.5 107.6 110.2 EBIT margin (EBIT/Revenue) 8.6 10.2 12.9 15.9 16.7 Asset turnover (Revenue/Avg TA) 143.3 154.3 203.8 171.9 154.5 Leverage (Avg TA/Avg equities) 249.4 247.7 236.3 227.9 217.8 Adjusted ROAE 20.7 26.9 42.4 40.9 37.7

*FY16 is a 15-mth period due to a change in Y/E from Dec to Mar

BUY TP: INR 22,500.00 30.6%




Income Statement Y/E 31 Mar (INR mln) CY13A CY14A FY16E* FY17E FY18E Total revenue 68,098 87,383 1,46,932 1,70,374 2,05,837 EBITDA 7,137 11,148 23,110 31,209 39,420 EBIT 5,837 8,950 18,911 27,049 34,382 Net interest income/(expenses) 874 977 1,409 2,067 3,517 Other income/(expenses) 0 0 0 0 0 Exceptional items 0 0 0 0 0 EBT 6,711 9,926 20,320 29,116 37,899 Income taxes (1,452) (2,909) (5,618) (7,863) (10,196) Extraordinary items 0 0 0 0 0 Min. int./Inc. from associates (1,314) (864) (1,780) (3,488) (4,648) Reported net profit 3,945 6,154 12,923 17,764 23,055 Adjustments 0 0 0 0 0 Adjusted net profit 3,945 6,154 12,923 17,764 23,055

Balance Sheet Y/E 31 Mar (INR mln) CY13A CY14A FY16E* FY17E FY18E Accounts payables 11,914 15,127 21,025 30,949 37,873 Other current liabilities 5,699 6,750 8,034 11,585 14,075 Provisions 2,159 3,213 4,358 5,371 6,212 Debt funds 839 584 584 584 584 Other liabilities 0 0 0 0 0 Equity capital 270 271 271 271 271 Reserves & surplus 20,284 24,888 35,591 50,819 71,020 Shareholders' fund 20,554 25,159 35,862 51,090 71,291 Total liabilities and equities 51,562 61,682 82,492 1,15,697 1,50,802 Cash and cash eq. 6,826 4,806 9,832 21,332 39,139 Accounts receivables 5,125 5,622 4,991 7,266 8,631 Inventories 5,268 6,455 8,569 12,392 14,955 Other current assets 6,695 9,135 11,562 17,035 21,021 Investments 8,255 10,777 17,230 22,521 27,845 Net fixed assets 16,561 23,093 31,014 37,753 42,466 CWIP 4,636 4,188 2,000 600 600 Intangible assets 0 0 0 0 0 Deferred tax assets, net (1,805) (2,394) (2,705) (3,202) (3,854) Other assets 0 0 0 0 0 Total assets 51,561 61,682 82,492 1,15,697 1,50,802

Cash Flow Statement Y/E 31 Mar (INR mln) CY13A CY14A FY16E* FY17E FY18E Net income + Depreciation 5,245 8,352 17,122 21,925 28,092 Interest expenses 79 98 78 78 78 Non-cash adjustments (1) (2) 0 0 0 Changes in working capital 1,491 2,020 4,415 3,826 2,997 Other operating cash flows 348 7 606 932 1,051 Cash flow from operations 7,162 10,475 22,221 26,761 32,218 Capital expenditures (7,123) (9,720) (9,932) (9,500) (9,750) Change in investments (1,518) (1,778) (6,453) (5,291) (5,325) Other investing cash flows 743 625 1,488 2,145 3,595 Cash flow from investing (7,898) (10,872) (14,897) (12,646) (11,480) Equities issued 17 79 0 0 0 Debt raised/repaid 610 (255) 0 0 0 Interest expenses (80) (98) (78) (78) (78) Dividends paid (1,020) (1,348) (2,219) (2,537) (2,854) Other financing cash flows 0 0 0 0 0 Cash flow from financing (474) (1,622) (2,298) (2,615) (2,932) Changes in cash and cash eq (1,209) (2,020) 5,027 11,500 17,807 Closing cash and cash eq 6,826 4,806 9,833 21,332 39,139

*FY16 is a 15-mth period due to a change in Y/E from Dec to Mar


RESEARCH TEAM

ANALYST SECTOR EMAIL TELEPHONE

Mihir Jhaveri Auto, Auto Ancillaries, Cement, Logistics [email protected] +91 22 6766 3459

Siddharth Vora Auto, Auto Ancillaries, Cement, Logistics [email protected] +91 22 6766 3435

Misal Singh Capital Goods, Infrastructure, Utilities [email protected] +91 22 6766 3466

Prashant Tiwari Capital Goods, Infrastructure [email protected] +91 22 6766 3485

Gaurang Kakkad Consumer [email protected] +91 22 6766 3470

Premal Kamdar Consumer [email protected] +91 22 6766 3469

Nitin Tiwari Energy [email protected] +91 22 6766 3437

Parag Jariwala Financials [email protected] +91 22 6766 3442

Vikesh Mehta Financials [email protected] +91 22 6766 3474

Rumit Dugar IT, Telecom, Media [email protected] +91 22 6766 3444

Saumya Shrivastava IT, Telecom, Media [email protected] +91 22 6766 3445

Pritesh Jani Metals [email protected] +91 22 6766 3467

Arun Baid Mid-caps [email protected] +91 22 6766 3446

Praful Bohra Pharmaceuticals [email protected] +91 22 6766 3463

Arun Aggarwal Real Estate [email protected] +91 22 6766 3440

Pawan Parakh Utilities [email protected] +91 22 6766 3438

Jay Shankar Economics & Strategy [email protected] +91 11 3912 5109

Megha Arora Economics & Strategy [email protected] +91 22 6766 3433


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BUY EicherMotors Religare TG 22500

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