Upgrade on higher forecasts, valuation multiples. Despite extended outperformance, we upgrade Eicher Motors Ltd to 'Buy' from 'Underperform'. Key reasons: (i) sharp revision to forecasts, mainly due to motorcycles which contributes over 75% of profit, and (ii) higher valuation multiples, also aided by reversion to FCFs (free cash flows). Our revised EPS (earnings per share) forecasts are 6%-15% ahead of street over CY14, CY15e, and our PO (price objective) of Rs 6,000 (earlier Rs 2,845) offers 43% potential upside.
Motorcycles: structural demand drives sharp revision: Our demand model suggests
India’s leisure motorcycle market could register 38% CAGR (compound annual growth rate) over the next five years, nearly 2x (times) earlier expectations. Eicher Motors will be key beneficiary as it readies to scale its operations with an expanded facility (end-Q1CY14), portfolio (Continental GT end-Nov) and network (five-six distributors per month). We therefore revise our volume-led profit forecasts by 36%-65% over CY14-15e (estimates).
Commercial vehicles: new products to drive advantage: Although early revival seems unlikely, Eicher Motors’ operating subsidiary is well positioned to gain market share, aided by new launches starting Dec ’13. We also expect the company to be advantaged with leaner cost structure and pricing discipline into the next economic cycle, and thereby register healthier profits. Cut forecasts to reflect the slowdown, but contribution is less significant at 24% of Eicher Motors’ consolidated profit.
Engines: larger potential, better profitability: VECV’s (VE Commercial Vehicles Limited) outsourcing initiative to Volvo is larger and also includes engine supplies towards (i) select off-road applications in Europe, and (ii) specific 9L products for emerging markets. Also, we expect profits to be higher due to upfront recognition of product development expenses. Our estimates are raised by 30% in CY15e.
Polaris JV: Not in our forecasts: Eicher Motors and Polaris Industries (PI) operate a 50:50 joint venture, which is setting up a green field project aimed at design and manufacturing of passenger vehicles for India and other emerging markets. The joint investment is estimated at R2.5 bn.
First product in CY15: The JV is expected to roll out its first customised product in CY15. Although our cash flows build in EML’s share of the investment, we have not factored in contribution from the new launch due to lack of visibility at this stage. Given PI’s historic track record and strong execution capabilities across markets, we expect this JV to also be value accretive.
Upgrade to Buy: What has changed? Contrary to our expectations of overall growth being restricted by cyclical downturn in commercial vehicles, we note the following: Motorcycle demand continues to stay ahead of supply; commercial vehicles performing better than the competition with higher profitability despite worse than anticipated demand slowdown; engine business has wider scope and is likely to be more profitable than estimated earlier.
Raising forecasts: We raise Eicher Motors’ EPS forecasts by 25% in CY14e and 46% in CY15e. Much of this is driven by the motorcycle business, both on revised volume and margin assumptions, and to a limited extent on VECV’s engine business. We largely retain forecasts for the CV business, with lower volumes offsetting increased assumptions on margins.