Bajaj Auto's Q3FY19 results (Underperformer) - Margins disappoint; further marketshare gains could be challenging

Q3FY19 results

• PAT ahead; Operating performance below expectations: Bajaj Auto’s Q2FY19 PAT at Rs 11.01 bn (up 16% yoy) was ~5% ahead of our estimates. However, the operating performance remained weak with margins showing a greater than expected decline. This was offset by treasury gains led higher other income.
• Revenues in-line; Operating performance weak: Revenues at Rs 74.1bn (up 16% yoy) reflected the strong volume growth (up 26% yoy) while realizations continued to drop (-1.7% qoq; -8% yoy)). Realisations declined due to price cut led marketshare gains, particularly in the economy segment (CT100 grew by 77% yoy) and geographical mix (the low value African business grew by 38%). Notably, export revenues grew by 17% (in US$ terms) in 3QFY19 against a volume growth of 23% reflecting weaker realisations. The company attributed the decline in margins to (a)forex hedges (USD realized rate declined to Rs68.9 versus Rs 69.4) (b) absorption of higher commodity costs in export markets (40bps) and (c) lower share of high margin 3 wheelers in the mix. Additionally, the weaker geographical mix in exports led to a further decline in margins
• Concall Highlights: (a) The management indicated that it expects the EBITDA margins to improve in Q1FY20 as the product mix improves (higher share of the newly launched Platina 110), forex benefits flow through (INR USD to be at Rs71) and commodity costs ease. However, Q4FY19 would be affected by elevated advertisement expenses on account of a specific campaign (b)The growth in the industry has slowed down, however, the company expects double digit growth in the medium term.(c) While in the past year the company has made marketshare gains on the back of price cuts, the management expects incremental gains to come from its new product launches (Platina 110, Pulsar Neon).

Key positives: Higher than expected other income

Key negatives: Higher RM costs and lower realizations

Impact on earnings: We cut our FY20 estimates by ~6% as stronger volume growth is offset by lower margins.

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 continue to outweigh benefits from volume growth. We believe price cut led marketshares may have run their course and volume growth could be  more sedate in FY20.  With the risk of a potential slowdown in volumes due to regulatory price hikes (insurance/ABS/BSVI), we remain cautious on the space. Maintain Underperformer with a target price of Rs2370 (14xSept 2020E EPS).