Bajaj Auto's Q2FY18 results (Underperformer) - Margin expansion a mild surprise; pressure points persist

Q2FY18 results

• PAT inline, Operating performance ahead: Bajaj Auto’s Q2FY18 adjusted PAT at Rs 11.1bn (down 1% yoy) was ~2% above estimates. The beat was primarily led by higher than expected gross margins and a lower tax rate that offset the sharp decline in other income.
• Gross margin surprise: Revenues at Rs 65bn (up 8% yoy) broadly reflected the volume trend (up 4% yoy)-realizations improved on a sequential basis by ~1%. The EBITDA margins at 19.7% (down 250bp yoy, up 170bp qoq) were ~120bp above estimates (IDFC estimates 18.3%) due to (a) lower raw material costs (down 90 bp qoq) and (b) operating leverage benefits (staff costs were down 100bp qoq, other expenses declined 70bp qoq). The decline in raw material costs despite an inferior motorcycle product mix (share of low margin platina/CT100 increased from 43% of domestic sales in Q1 to 48% in Q2) and higher discounting was surprising. Reported PAT of Rs 11.1bn (down 2% yoy) was impacted by a sharp decline in other income (down 13% yoy, 35% qoq)
• Concall Highlights: (a) The management guided to operating EBITDA (as per the management’s calculation) margins of 20-21% in 2HFY18 - (b) Exports are likely to reach 1.7mn units (v/s previous management estimates of 1.6mn units) implying a growth of xx%. c) New markets contributed to 16% of total exports for 2QFY18 (The company guided for 80k units of exports to come from Nigeria in 3QFY18). d) It has guided for total 3W vols for FY18 at 570k units. e) The management expects RM costs to harden in  2HFY18. g) The management guided for a 8-8.5% industry domestic motorcycle for FY18.

Key positives:  Higher gross margins and lower tax rate

Key negatives: Lower other income

Impact on earnings: We increase our FY18/19 EPS by ~8%/7% on the back of better than expected export recovery.

Valuations & view

Bajaj Auto’s domestic portfolio continues to weaken with new products/brands (Avenger, V, Dominar) failing to enthuse consumers. The increased in discounts in the industry seem to reflect higher competitive pressures. In the near term while the exports are likely to report growth on a low base (we note that on sequential basis export volumes declined despite Q2 being a seasonally strong quarter), they are likely to remain volatile. Moreover, rising commodity costs could be an additional pain point. Maintain Underperformer with a target price of Rs 2,900 (17X Sept19E EPS and Rs 120 for the KTM stake).