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WE ARE downgrading Hero (target price R1,730), Bajaj (TP R1,670) and TVS (TP R70) to Sell. Our ratings reflect the concern that Honda’s sustained market share gains will impact the margins of the Indian two-wheeler companies. Honda has gained 890 bps (basis points) market share over the last 24 months, aided by an aggressive launch pipeline and stronger demand for scooters. Hero, Bajaj and TVS have been unsuccessfully trying to staunch their market share losses through more frequent product launches as well as higher brand spends. We believe such competitive activity will continue, resulting in lower margins due to loss of pricing power and higher selling costs.
Hero: Our negative stance on Hero stems from our concerns about market share losses, a deterioration in pricing power and higher marketing costs. We also highlight the market risk for Hero, as it will now be developing products on its own. We also believe that the cost reduction efforts of the management will not yield significant gains and these will be competed away in the market. Investors are positive on Hero on FY15e as the fixed royalty payable to Honda would end by then, leading to a one-time gain. However, we believe that profit growth from FY16e would taper to lower levels.
Bajaj: We downgrade Bajaj to Sell as we believe that current valuations (15.5xFY15e EPS) do not factor in the sustained market share losses in the domestic market as well as the uncertainties emanating in its exports. Bajaj’s margins have remained higher than peers’, due to richer product mix and currency benefits on its exports. However, we expect Honda’s aggression to hurt Bajaj’s margins going forward. While exports (40% of revenues) have provided a cushion, we highlight that near-term growth may remain below trend level. We understand that demand in Bajaj’s major export destinations (Africa, South Asia, Latin America) continue to be affected by changes in regulations and an increase in import barriers.
TVS: TVS is also likely to be affected by the increase in competitive intensity which would constrain its margin expansion efforts. The pressure could be offset to an extent by its recent product launches and a revival in its higher margin three-wheeler business. However, TVS’s current valuations at 15.7xFY15e EPS (adjusting for Indonesian business) are at a premium to Hero and Bajaj. We believe this is unsustainable as the profitability gap with peers continues to be significantly high.
Our revised forecasts and