Maintain reduce on TVS Motors, target price Rs 501

TVSL’s EBITDA margins at 7.4% missed the estimates (consensus 7.6%/Nomura 7.9%). There was sharp raw material cost inflation, which the company was unable to pass on during the quarter (RM/sales up 240 bps q-o-q). Also, there was an accounting change in Q1, because of which Rs 0.9 billion of freight recovery was netted off from revenues and other costs. This did not affect Ebitda, but improved margins optically by 20bps. Management guided that while they have taken price hikes of 0.5% and 0.3% in Q1 FY19 and Q2 FY19 respectively, they could not take price hikes in entry segment due to competitive pressures. They also noted that there is some more cost pressure expected in Q2 FY19F.

On competition, TVSL mentioned that it plans to build brands and will not engage in a price war in the entry segment. In FY19F, TVSL expects 10- 12% volume growth for two-wheeler Industry and it plans to grow ahead of that. The company has seen good response for the ‘NTorq’ scooter. While management tries to achieve double-digit margins, we see risks to reaching this goal. We lower our FY19/20F Ebitda margin estimates further to 8%/8.4% from 8.2%/8.5%, leading to a 4%/3% Ebitda cut and a 7.2%/6.5% EPS cut, which is higher as we also factor in a higher tax rate. Our estimates are 7-10% below consensus.

The stock is trading at 23.3x FY20F EPS adjusted for subsidiaries. We lower the valuation multiple to 20x (22x earlier) to factor in rising headwinds to earnings growth due to competition in domestic two-wheeler industry. We value other investments at Rs 56/share to arrive at a TP of Rs 501 (Rs 568 earlier) and maintain reduce. In the two-wheelers space, we prefer HMCL IN.

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The 2W industry growth momentum remains healthy at ~16% y-o-y in Q1 FY19, benefiting from rural demand. As highlighted in our note on 25 February, we expect a ~8% volume CAGR over FY18-21F, due to the reasonably high penetration of two-wheelers in top states (in terms of per capita income levels). In FY19F, we see upside risks to our ~10% y-o-y industry growth expectation. Rural areas remain an important demand contributor, with ~50% of motorcycle volumes coming from this segment.