Bajaj Auto's Q1FY19 results (Underperformer) - Weak performance; Price war to hurt margins

Q1FY19 results

• Adj PAT below est; Operating performance weak: Bajaj Auto’s Q1FY18 PAT at Rs 11.1 bn (up 18% yoy) was 13% below estimates. This was mainly due to weaker than expected operating performance led by sharp drop in realizations and higher RM costs. 
• Revenues below est; Operating performance weak: Revenues at Rs 74.1bn (up 36% yoy) reflected the volume trend (up 38% yoy) while realizations dropped sharply (-7% qoq) due to higher discounting in the economy segment as reflected in the strong volume growth (+74% v/s industry growth of 30% yoy). Export revenues were Rs 31.5 bn in 1QFY19 (+27% yoy). Currency realization in the export market was at 67.4/$ v.s 67.2/$ in 4QFY18. The EBITDA margins at 17.3% (-210 bps qoq) were ~250bp below our estimates. The disappointment was on account of 210bps increase in RM costs while other costs remained fairly stable. Gross margins declined by 210 bps qoq on higher RM costs.
• Concall Highlights: (a)The company has changed its strategy to focus on gaining market share in the entry level segment (target marketshare to 45% from 34% currently) by reducing prices. With this strategy expected to continue for 2-3 years, it is expected to be margin dilutive going ahead (b) It has taken price hikes (range of 1.5%) in most of the segments with the exception of entry level motorcycles to pass on the commodity cost rise (c) Management has guided for exports to be at 1.9mn units and CVs to reach 0.4mn units. It targets total volumes of 4.8mn units in FY19 (up 20% yoy).(d) It has guided for a revenue growth of 15% CAGR over the next 2-3 years led by the entry level segment.(e)Strong rural growth to be led by increase in MSPs and farm incomes.(f)Capex to be ~Rs2.5-3 bn in FY19, with a possibility of Rs 5bn

Key negatives: Higher RM costs and lower realizations

Impact on earnings: We cut FY19/20 earnings by 9-8% respectively

Valuations & view

The company’s strategy of cutting product prices in order to gain market share may benefit it over the longer term. However, in the near to medium term the dilution in margins are likely to outweigh benefits from volume growth. We also note that the strategy entails risking the equity of the company’s only strong brand, the Pulsar. Further, price cuts may not yield the desired results if competition retaliates (a very likely scenario). With limited benefits from the recent INR depreciation and a potential slowdown in the high margin 3W volumes, EBITDA margins could decline further from the current levels. Maintain Underperformer.