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Automobiles 2 – 3 wheelers:

Introduction

As you all know we believe in value investing, but we don’t practice the way any classic value investor does. We look at the growth of the business and invest in the businesses with healthy growth with good quality business and are selling for cheap.

Sector

A population of almost 1.2 billion people where every 10 people out of 100 own a two wheeler. We are talking about a sector of 120 million two wheelers! These figures make India the biggest rider of two wheelers of the world. With the easy finance available to buy two wheelers, the bigger business houses in the sector have witnessed a growth of more than 100% in their earnings in last 5 years.

The question now rises, is two wheelers sector is beyond value territory?

In this blog we will look at the 3 major two wheelers that are listed on National stock exchange and are part of NSE 500 index.

Companies

Quality & Performance ratings

Bajaj Auto

A2 (2013)

Hero Motocorp

B1 (2012)

TVS Motors

C2 (2013)

Let’s look each of the following companies a bit in detail.

Bajaj Auto:

Bajaj Auto is the leader in 2-3 wheeler business in India and a well-established brand in other developing nations. They now generate almost more than one quarter of their revenues from exports.

Let’s go back and rewind in the year of 2009, the shareholders contribution so far in this business was around Rs 1,800 Crore and had a debt of around Rs 1,600 Crore. They were generating revenues of Rs 8,700 Crore. It was the gloomy environment all around the globe and everyone was hit by financial crisis. But overall this sector and specially Bajaj Auto was pumped up by unbelievable growth by expanding their businesses in other developing nations.

In 2010 their revenues grew by almost 36% and 39% for 2011. Many other participants within this sector started taking their products to those markets after looking at the Bajaj Auto’s success. The market started to saturate and suddenly the momentum of that growth started diminishing.

Last year Bajaj Auto had just witnessed a growth of 2% in their revenues and in the first quarter of 2014 we expect them to report a negative growth in their revenues.

The managers of this business the Bajaj’s have really managed shareholders fund efficiently. They have got rid of debts and were generous with the dividends payout to shareholders. The falling Indian rupee might turn out to be positive for Bajaj Auto but will not be able to fill the gap of missing growth in the business at the moment.

Year

2009

2010

2011

2012

2013

Q&P rating

B3

B2

B2

A1

A2

Bajaj Auto does business in developing nations and they all are facing decline in their currencies values against US dollars, high inflation and high interest rates which is dominating on their future growth.  But this will change as economies progress in other cycles. The important thing is how the managers of these businesses perform during hard times. Also, businesses with high returns on their equity will attract many other players to grab their share and will dilute there returns. This is where your competitive edge helps you to survive and stay ahead of your competitors.

Coming to the valuations and returns, if you had invested in this business 4 years ago then your returns are 272% and for the same period the intrinsic values have risen by 168%.

Year

2009

2010

2011

2012

2013

Intrinsic value

Rs 1,025

Rs 2,359

Rs 2,868

Rs 1,477

Rs 1,371

Bajaj Auto management was not able to add any value to this business last year. The consensus forecast for its 2014 earnings is Rs 122 per share which translates its expected intrinsic value to be Rs 1,695 per share. However, Value Operations platform expects almost around Rs 400 crore less profits than the consensus expectation which translates its earnings to Rs 109 per share and its intrinsic value to be Rs 1,430 per share for the year 2014.

We don’t buy expensive businesses and we are happy to keep this business in our watchlist.

Hero Motocorp

The second biggest business house in two wheelers in India is Hero Motocorp. Well, for us it lost its number one position to Bajaj Auto two years back.

If we go in flashback in the year 2009, the shareholders contribution so far in this business was Rs 3,800 Crore and almost no debt. They were doing business of Rs 12,325 Crore and were generating surplus cash flow and were also paying generous dividends to their shareholders.

Year

2009

2010

2011

2012

Q&P rating

B1

B1

B2

B1

Hero Motocorp was also witnessing a growth of more than 20% in its revenue by 2012 and then suddenly that growth in its revenue disappeared. The real trouble started in the year 2010-11 when they divorced with Honda and came out with their own brand Hero Motocorp. They borrowed money from financial institutes (Rs 1,460 Crore) and also paid dividends more than what they reported Net profits that year. They did the same previous year too and justified it by promoting that this was the right way of paying back shareholders capital back to them!

It is very hard for us to understand the rationale behind repeating same in 2011 and borrowing money to pay those dividends!

Hero Motocorp is trying to catch up its lost ground and its momentum of last decade. If you are one of the shareholders of this business and if you had invested within this business 4 years back then today your returns would be 12% and the same time the intrinsic value had risen by 49%.

Year

2009

2010

2011

2012

2013

Intrinsic value

Rs 841

Rs 553

Rs 338

Rs 2,108

Rs 1,252

The consensus is expecting its earnings for the year 2014 to be Rs 111 per share which translates its expected intrinsic value to be Rs 1,373 per share. Value operations platform expects a negative growth for the year 2014 and expect its earnings to be Rs 98 per share and translates its expected intrinsic value to be Rs 1,179 per share. The managers of this business did not add any value to this business last year and we do not expect it will do this year too!

TVS Motors

TVS Motors is the business working hard to establish as profitable business. Four years back they were loss making company and for the year 2013 they have reported net profits of Rs 199 Crore.

Going back in 2009, the shareholders contribution so far in this business was Rs 630 Crore and had borrowed Rs 1,120 crore from financial institutions. They managed to generate revenues of Rs 3,750 crore and reported losses of Rs 64 Crore.

Year

2009

2010

2011

2012

2013

Q&P rating

C4

C3

C2

C3

C2

They reported revenue growth of more than 40% in the year 2011 and 15% for the year 2012 and last year almost 0% growths.

The business is highly leveraged and returns on equity are not stable. We do not rate this business yet as investment grade but every year we are witnessing improvement in its quality ratings.

The consensus expects its earnings for the year 2014 to be Rs 5.24 per share which reflects its expected intrinsic value to be Rs 44 per share. Value operations platform is yet not so optimist and expects negative earnings for 2014. We expect its earnings to be Rs 3.50 per share and expect its intrinsic value to be Rs 24 per share.

Year

2009

2010

2011

2012

2013

Intrinsic value

Rs 0

Rs 9

Rs 17

Rs 17

Rs 32

Conclusion

So far as of consensus expectations, we will witness almost double digit growth in earnings of all the three businesses. But looking at the real grounds and negative volume growths by most of the companies, it is hard to believe in Consensus expectations. We would go with Value Operations expectations where only Bajaj Auto is expected a positive growth. We would like to pick Bajaj Auto from this basket but keep it under our watchlist and wait for the right price by the market.

We would like your views on this and if they are different to us then will appreciate your rationale behind it.

Watchlist

Bajaj Auto

In our next post we will talk about Automobiles 4 wheelers so stay tuned…v