Auto Sector Intiation Sep2010

India | Automobiles & Parts
EQUITY RESEARCH 2 September 2010
India Auto Sector

Foot off the accelerator? Not yet
Amit Kasat
amit.kasat@sc.com +91 22 6751 5816
All rights reserved. Standard Chartered Bank 2010 IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX. http://research.standardchartered.com THIS REPORT MAY NOT BE DISTRIBUTED INTO THE UNITED STATES
India | Automobiles & Parts
EQUITY RESEARCH
2 September 2010
India Auto Sector

Foot off the accelerator? Not yet
Top picks: Maruti Suzuki Bajaj Auto M&M Tata Motors We are upbeat on Indias auto sector given strong macro drivers, healthy margins and still reasonable valuations relative to growth. Though all stocks could be swept up in the surge, we prefer companies with likely market share gains, good return ratios and strong cash flows. We have a contrarian view on Maruti Suzuki (where we think the worst is behind and in the price) and expect Bajaj Auto to command a premium over Hero Honda. We also initiate on Mahindra & Mahindra and Tata Motors with Outperform, Ashok Leyland with In-Line, and Hero Honda and TVS Motor with Underperform. Strong macro drivers to boost volume growth We expect the sector to report ~20% volume CAGR over FY10-12 given Indias strong macro drivers fast-growing per capita income, favourable demographics, shifting consumption patterns and easier credit availability. Our analysis also shows that monetary tightening would only have a limited impact on growth. Margins to stabilise lower, but be healthy relative to history From the FY10 peak, we expect margins to decline by 120-130bps after factoring in a 200bps increase in raw material costs. This builds in a cushion against any commodity price fluctuation. Notwithstanding this, the sectors FY11 EBITDA margin is likely to be a healthy 12-13%, aided by productivity improvements and operational leverage, and still be respectable vs historical performance. Sector valuation to catch up with broader market Given the auto sectors superior earnings growth compared with the Sensex (43% vs 20%), we expect the sectors current ~16% discount to Sensex multiples to narrow significantly. We, in fact, expect sector valuations to do much better than the historical average discount of 10-12%. Top picks Maruti Suzuki (our contrarian call; valuations depressed beyond realistic levels), Bajaj Auto (gaining market share, most profitable two-wheeler company), M&M (strong core business outlook), and Tata Motors (riding the commercial vehicle cycle, recovery at JLR). Risks Competition is intensifying given the entry of more global majors across all segments, which could lead to aggressive price wars to gain market share. Other risks: higher-thanexpected monetary tightening/interest rates/commodity prices.
India Auto Sector Valuation Matrix

BB code AL IN BJAUT IN HH IN MM IN MSIL IN TTMT IN TVSL IN Mkt cap Rec (US$bn) I/L 2.1 O/P 8.9 U/P 7.9 O/P 7.7 O/P 7.8 O/P 12.6 U/P 0.8 Price (Rs) 72 2,780 1,785 611 1,218 991 143 FV (Rs) 79 3,260 1,901 762 1,478 1,452 146 EPS (Rs) EPS CAGR FY11e FY12e FY10-12e (%) 4.4 5.7 40.4 175.4 203.2 27.2 116.4 134.3 9.6 40.8 45.6 16.8 90.3 113.7 14.2 28.9 38.7 28.9 8.0 10.9 42.3 PE (x) FY11e FY12e 16.3 12.6 15.8 13.7 15.3 13.3 15.0 13.4 13.5 10.7 34.3 25.6 17.8 13.1 EV/EBITDA (x) FY11e FY12e 10.4 8.3 11.2 9.4 11.2 9.1 8.9 8.0 6.4 4.8 9.8 8.2 7.9 6.2
Ashok Leyland Bajaj Auto Hero Honda M&M (SA) Maruti Suzuki Tata Motors (SA) TVS Motors
Note:O/P=OUTPERFORM,U/P=UNDERPERFORM,IL=IN-LINE; SA: Standalone; Stock prices as at 26 Aug 2010; For Tata Motors and M&M consolidated numbers please see pg 8 Source: Company, Bloomberg, Standard Chartered Research estimates
Amit Kasat
All rights reserved. Standard Chartered Bank 2010 IMPORTANT DISCLOSURES CAN BE FOUND IN THE DISCLOSURES APPENDIX. http://research.standardchartered.com
Sector research India Auto | 2 September 2010
Contents
Investment argument and valuation
Sector valuation Company valuation Top picks
3
4 9 12
Strong macro drivers to boost volume growth

Macro drivers favour the sector Macro factors impacting the various segments A rewind of FY10 Sector volume assumptions FY11-13e Segment-wise volume growth assumptions Monetary tightening would push up ownership costs Scenario analysis Impact of higher interest rates
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13 15 16 16 17 19 20
Margins to stabilise lower, yet remain healthy

Raw material costs to increase 200bps Assumptions for our forecast period Flexible strategies that auto OEMs can adopt Industry utilisation to improve to 88.7% in FY11e
21
21 21 22 23
Fundamentals intact, competition intensifies

Cash generation likely to improve Competition intensifies across segments
24
24 25
Company section
Ashok Leyland Bajaj Auto Hero Honda Mahindra & Mahindra Maruti Suzuki Tata Motors TVS Motor
27
28 40 57 69 84 96 113

We are upbeat on Indias auto sector given strong macro drivers, healthy margins and still reasonable valuations relative to growth. Though all stocks could be swept up in the surge, we prefer companies with likely market share gains, good return ratios and strong cash flows. We have a contrarian view on Maruti Suzuki (where we think the worst is behind and in the price) and expect Bajaj Auto to command a premium over Hero Honda. We also initiate on M&M and Tata Motors with Outperform, Ashok Leyland with In-Line, and Hero Honda and TVS Motor with Underperform.

We expect 19.8% CAGR in sector volume over FY1012e Indias strong macroeconomic fundamentals driving growth FY10 was a landmark year for Indias auto companies (excluding Ashok Leyland). They reported all-time high unit sales, strong volume growth and record profits. The performance came on the heels of an economic downturn in FY09, making it more remarkable. Going forward, we expect the sector to report volume CAGR of 19.8% over FY10-12e, compared with 25.6% in FY10. We believe that fundamental factors Indias high per capita income growth, recovering urban demand, aggressive vehicle financing, among others are intact and favour the sector, though monetary tightening could raise the cost of ownership in the short term. Furthermore, recent monsoon rainfall data suggest a normal to above-normal monsoon with good spatial distribution, that augurs well for agri-GDP growth in FY11. Fig 1 Industry volume growth (FY02-13e) (000s) FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e PV 722 779 1,027 1,229 1,319 1,578 1,766 1,872 2,423 3,143 3,674 4,183 LCV 64 82 108 136 171 223 253 227 308 362 413 455 M&HCV 95 121 169 211 221 295 294 199 265 320 361 398 2W 4,306 5,060 5,622 6,573 7,571 8,492 8,069 8,442 10,511 13,105 15,060 16,789 3W 216 275 336 374 436 548 506 497 613 706 767 810 Total 5,402 6,317 7,262 8,524 9,718 11,136 10,888 11,238 14,120 17,637 20,275 22,635 % Growth 16.9 15.0 17.4 14.0 14.6 -2.2 3.2 25.6 24.9 15.0 11.6
Source: Society of Indian Automobile Manufacturers (SIAM), Standard Chartered Research estimates
Sector margins to stabilize at 12-13%

At 12-13%, sector margins 140bps lower yoy but still healthy We expect commodity price risk to be offset by productivity improvements and operational leverage. This will enable auto companies to maintain EBITDA margins of around 12-13% over FY11 and FY12, 140bps lower yoy, but still healthy. The auto sectors raw material to sales ratio rose from 69.6% in 1Q FY10 to 72.5% in 1Q FY11. The main reasons: key input prices around 50% higher; rise in excise duty; and cost of implementing new emission norms. Given these, most OEMs raised prices in the past 12 months. Nevertheless, demand has continued to be strong.
Fig 2 Trend in industry EBITDA margins (FY99-13e)

16 12 8 4.7 4 0 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e 14.7 11.7 9.6 8.3 % 13.6 12.9 13.2 14.1 12.3 11.6 9.6 12.9 12.7 13.3
Source: Companies, Standard Chartered Research estimates
We believe that companies would not run the risk of increasing their channel inventories as we expect moderate demand growth over FY11-12 (compared with growth seen in FY10) and a high premium credit environment over the medium term.
Fundamentals intact, competition intensifying

We expect Indian auto companies to continue to report strong cash flows and good return ratios, even though competition is intensifying given the entry of more global majors. Competition from global majors, especially in the small-mid-size car segment We believe competition is set to rise over FY10-12, driven by the entry of Toyota and Nissan into the small/mid car segment and with the current success of GMs Beat, VWs Polo, Fords Figo, M&Ms entry into commercial vehicles (CVs), and Yamaha and HMSIL becoming more aggressive in two-wheelers following M&Ms entry through Kinetic. Yet, we believe that the incumbents have built multiple competitive advantages that will enable them to maintain their dominance.
Sector valuation
Sector trading at 18.2% discount to Sensex on FY12e earnings Sector to catch up with the Sensex multiple We expect earnings upgrades to continue and believe the sector valuation is still reasonable relative to growth. The sector is trading at 12.2x FY11e consolidated earnings, which is a 15.6% discount to the Sensex PE of 14.4x and at 10.4x FY12e consolidated earnings, an 18.2% discount to the Sensex PE of 12.7x. Fig 3 Sensex valuation Earnings (Rs) PE (x) EV/EBITDA (x) EV/S (x)
Source: Bloomberg
FY09 840 21.4
FY10 1,027 17.6 12.2 2.2
FY11e 1,260 14.4 9.4 1.8
FY12e 1,468 12.7 8.4 1.6
Strong auto sector earnings growth to narrow discount
Despite the sharp rise in stock prices in FY10, the sector is still trading at a reasonable PE relative to growth. The auto universes EPS CAGR of 43.2% over FY10-12e (consolidated) and 19.6% (standalone) against consensus Sensex earnings growth of 20% over the same period, strengthens the likelihood that the discount to the broad market would narrow. Within the auto sector, we expect two-wheeler companies to report earnings CAGR of 19% over the period and four-wheelers at 58%.
Fig 4 Auto sector valuation Aggregates Market capitalisation (Rsm) Adj. net profit (Standalone) (Rsm) PE (x) Adj. net profit (Consolidated) (Rsm) PE (x) EV (standalone) (Rsm) EBITDA (standalone) (Rsm) EBITDA (consolidated) (Rsm) EV/E (x) EV/E (consolidated) (x) Sales (standalone) (Rsm) Sales (consolidated) (Rsm) EV/S (x) EV/S (consolidated) (x) FY09 2,150,516 52,988 40.6 18,452 116.4 1,985,738 87,283 93,620 22.8 21.2 901,638 1,356,314 2.20 1.46 FY10 2,150,516 105,200 20.4 101,163 21.3 1,983,365 175,353 219,711 11.3 9.0 1,230,256 1,799,519 1.61 1.10 FY11e 2,150,516 124,778 17.2 176,759 12.2 1,952,413 200,936 304,664 9.7 6.4 1,544,309 2,247,496 1.28 0.87 FY12e 2,150,516 150,512 14.3 207,566 10.4 1,880,772 233,849 345,095 8.0 5.5 1,826,093 2,648,194 1.03 0.71
Historically, the auto sector has traded at a 10-12% discount to the Sensex, while currently it is trading at discounts of 16% and 18% for FY11e and FY12e, respectively. We expect the sectors current discount to the Sensex multiple to narrow significantly and, in fact, expect the sector valuation to do much better than the historical average discount. PEG supports our view For our PEG valuation, we have excluded FY10 earnings and looked at PE valuations for coverage companies on FY11e earning basis against earnings CAGR over FY11-13e. This is to remove the impact of low commodity prices in FY10, which created a temporary peak in margins that year. With commodity prices having recovered from the lows, we believe FY11 is more indicative of the sustainable margins going forward. Valuations relative to growth is one of the key determining factors for our recommendation spread. As per the figure below, Tata Motors, Maruti and M&M are cheap relative to earnings growth. Two-wheeler stocks are relatively more expensive due to relatively less volatile earnings profile, higher return ratios and balance sheet strength. However, we prefer Bajaj Auto over Hero Honda given higher earnings growth in Bajaj at similar valuations. Ashok Leyland and TVS appear to have priced in the positives. Fig 5 PE to earnings growth
20 16 PE FY11e (x) 12 M&M (Consol) 8 T M (Consol) 4 0 0 5 10 15 20 EPS CAGR FY11-13e (%) 25 30 35 HH BA
AL MSL
TVS
Source: Standard Chartered Research estimates
Fig 6 Auto sector PE vs EPS CAGR EPS (Rs) FY10 FY11e FY12e Ashok Leyland 2.9 4.4 5.7 Bajaj Auto 125.5 175.4 203.2 Hero Honda 111.8 116.4 134.3 M&M (Standalone) 33.4 40.8 45.6 M&M (Consolidated) 41.6 48.5 53.7 Maruti Suzuki 87.1 90.3 113.7 Tata Motors (Standalone) 23.3 28.9 38.7 Tata Motors (Consolidated) 18.9 115.2 134.3 TVS Motor 5.4 7.9 10.6
CAGR FY13e (FY11e-13e) 6.2 19.1 235.3 15.8 149.7 13.4 48.0 8.4 63.8 14.6 141.0 24.5 47.6 28.4 158.5 17.3 13.8 32.8
Price (Rs) 72 2,780 1,785 611 611 1,218 991 991 143
PE (x) FY11e 16.3 15.8 15.3 15.0 12.6 13.5 34.3 8.6 17.8
PEG (x) 0.9 1.0 1.1 1.8 0.9 0.5 1.2 0.5 0.6
On a Price/Book basis, the sector seems to be sticking to a trend, the exception being Tata Motors, which also has the highest target price upside in our universe. M&M is also attractive on P/B basis relative to the return on equity. Fig 7 Price/Book vs RoE
10 8 PBR FY11e (x) 6 4 2 0 0 10 20 30 RoE FY11e (%) 40 50 60 T VS MSL AL TM (Consol) M & M (Consol) HH BA
Sensitivity analysis We have undertaken a sensitivity analysis based on volume and margins, the latter partly dependent on the former, for all the stocks in our coverage universe. Ashok Leyland, TVS and Tata Motors are the most sensitive given higher operating/financial leverage. Bajaj and Hero Honda are the most stable, which also justifies their premium valuations relative to the sector. Fig 8 Earnings sensitivity to Key Assumptions ALs earnings will change by 21.8% and -20.4% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Ashok Leyland FY11 EPS sensitivity

Volume -10% 9.6% Operating margin 10.1% 11.1% 12.1% 12.6% 2.9 3.2 3.7 4.3 4.5 -5% 3.2 3.5 4.1 4.6 4.9 Volume -10% 18.0% Operating margin 18.5% 19.5% 20.5% 21.0% 146.2 150.2 158.1 165.9 169.9 6 -5% 154.1 158.3 166.6 174.9 179.1 0% 162.0 166.4 175.1 183.9 188.3 5% 169.9 174.5 183.7 192.9 197.5 10% 177.8 182.6 192.2 201.8 206.7 0% 3.5 3.8 4.4 5.0 5.3 5% 3.8 4.1 4.7 5.3 5.7 10% 4.1 4.4 5.0 5.7 6.0
Bajaj's earnings will change by 10.1% and -9.6% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Bajaj Auto FY11 EPS sensitivity
Operating margin
Hero Honda's earnings will change by 11.9% and -10.6% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Hero Honda FY11 EPS sensitivity

Volume -10% 13.4% 13.9% 14.9% 15.9% 16.4% 95.5 98.9 105.3 112.3 115.7 -5% 100.5 104.1 110.8 118.3 121.9 0% 105.5 109.3 116.4 124.3 128.0 Volume -10% 13.5% Operating margin 14.0% 15.0% 16.0% 16.5% 32.7 34.0 36.5 39.2 40.5 -5% 34.6 36.0 38.6 41.5 42.9 Volume -10% 10.1% Operating margin 10.6% 11.6% 12.1% 12.6% 67.5 71.6 79.8 83.9 88.0 -5% 72.1 76.4 85.0 89.4 93.7 Volume -10% 6.5% Operating margin 7.0% 8.0% 9.0% 9.5% 3.8 4.7 6.4 8.3 9.2 -5% 4.4 5.4 7.2 9.2 10.2 Volume -10% Operating margin 10.1% 10.6% 11.1% 12.1% 12.6% 18.0 20.5 22.8 27.8 30.3 -5% 20.8 23.4 25.8 31.2 33.7 0% 23.5 26.3 28.9 34.5 37.2 5% 26.3 29.2 31.9 37.8 40.6 10% 29.0 32.1 34.9 41.1 44.1 0% 5.1 6.1 8.0 10.1 11.1 5% 5.7 6.8 8.8 11.0 12.1 10% 6.4 7.5 9.6 11.9 13.0 0% 76.7 81.2 90.3 94.8 99.4 5% 81.3 86.0 95.6 100.3 105.1 10% 85.9 90.9 100.8 105.8 110.8 0% 36.6 38.0 40.8 43.9 45.3 5% 38.5 40.1 43.0 46.2 47.7 10% 40.5 42.1 45.2 48.5 50.1 5% 110.5 114.5 122.0 130.2 134.1 10% 115.6 119.7 127.5 136.2 140.3
M&M's earnings will change by 13% and 12% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Mahindra & Mahindra (standalone) FY11 EPS sensitivity
Maruti's earnings will change by 11% and 15% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Maruti Suzuki FY11 EPS sensitivity
TVS' earnings will change by 37% and -33% if volume exceeds/declines by+/- 5% and margins by +/-100bps
TVS Motor FY11 EPS sensitivity
Tata Motor's earnings will change by 31% and -19% if volume exceeds/declines by+/- 5% and margins by +/-100bps
Tata Motors (standalone) FY11 EPS sensitivity
Fig 9 India auto sector valuation matrix BB code AL IN BJAUT IN HH IN MM IN MM IN MSIL IN TTMT IN TTMT IN TVSL IN Rec I/L O/P U/P O/P O/P O/P O/P O/P U/P Mkt cap (US$bn) 2.1 8.9 7.9 7.7 7.7 7.8 12.6 12.6 0.8 PE (x) FY11e 16.3 15.8 15.3 15.0 12.6 13.5 34.3 8.6 17.8 ROE (%) FY11e 22.4 52.6 42.6 25.7 18.1 11.5 49.7 18.6 Price (Rs) 72 2,780 1,785 611 611 1,218 991 991 143 FV (Rs) 79 3,260 1,901 762 773 1,478 1,452 1,452 146 Up/ Down 10.8 17.3 6.0 26.6 26.6 21.3 46.6 46.6 2.6 EPS (Rs) CAGR (%) FY10 FY11e FY12e FY10-12e 2.9 4.4 5.7 40.4 125.5 175.4 203.2 27.2 111.8 116.4 134.3 9.6 33.4 40.8 45.6 16.8 41.6 48.5 53.7 13.6 87.1 90.3 113.7 14.2 23.3 28.9 38.7 28.9 18.9 115.2 134.3 166.6 5.4 8.0 10.9 42.3 EV/Sales (x) FY10 FY11e FY12e 1.5 1.2 1.0 3.1 2.2 1.7 2.0 1.7 1.3 1.6 1.3 1.1 1.0 0.7 0.6 1.4 1.1 0.9 0.9 0.7 0.5 0.9 0.6 0.5 Div Yield (%) FY10 FY11e FY12e 2.1 2.8 2.8 1.4 1.6 1.7 6.2 2.0 2.2 1.6 2.0 2.1 0.5 0.6 0.7 1.5 1.8 2.0 1.5 1.8 2.0 0.8 1.1 1.4
Ashok Leyland Bajaj Auto Hero Honda M&M* M&M** Maruti Suzuki Tata Motors* Tata Motors** TVS Motor
FY10 24.9 22.2 16.0 18.3 14.7 14.0 42.5 52.4 26.5
FY12e 12.6 13.7 13.3 13.4 11.4 10.7 25.6 7.4 13.1
EV/EBITDA (x) FY10 FY11e FY12e 14.3 10.4 8.3 14.4 11.2 9.4 11.8 11.2 9.1 10.1 8.9 8.0 7.3 6.4 4.8 11.5 9.8 8.2 9.3 5.0 4.0 10.9 7.9 6.2 RoCE (%) FY11e 14.6 56.1 50.3 24.3 24.2 12.0 22.3 17.3
FY10 16.4 62.0 58.2 25.4 21.1 9.7 30.7 14.7
FY12e 24.7 41.5 36.5 24.0 18.8 14.4 38.8 21.0
FY10 12.0 60.4 69.1 25.0 28.6 10.5 10.9 12.8
FY12e 16.9 46.6 43.4 23.1 25.3 13.9 22.7 19.5
* Standalone ** Consolidated Source: Companies, Bloomberg, Standard Chartered Research estimates
Company valuation
Hero Honda Fair value at 14.0x FY12e core earnings Two-wheeler companies Hero Honda We value Hero Honda at 14x FY12e core earnings, in line with its long-term average PE of 13.7x. We believe such a valuation is justified given expected market share loss and slower earnings growth over FY10-12e. We thus expect the premium to the sector it attracted during the years of strong profitability growth and market share gains to decrease. Our fair value for HH is Rs1,901 (6% upside). Fig 10 Hero Honda: 12-month forward PE band
3,000 2,500 2,000 Rs 1,500 1,000 500 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10
14x 11x 9x 7x 5x 3x
21x 18x 15x 12x 9x 6x
Source: Bloomberg, Standard Chartered Research estimates
Bajaj Auto Fair value at 16x FY12e core earnings
Bajaj Auto We value Bajaj Auto at 16x FY12e core earnings, which is a15% premium to Hero Honda. We believe our PE rating for Bajaj Auto is justified considering its robust balance sheet, improvement in market share over FY10-12e and profit profile. We set a value of Rs58 on its investments in its Indonesian venture and in KTM Sports AG, the Austrian company, and give a 20% discount to cash in the balance sheet. Our fair value for Bajaj Auto is Rs3,260 (17% upside). Fig 11 Bajaj Auto: 12-month forward PE band
3,000 2,500 2,000 Rs 1,500 1,000 500 0 Aug-08 Nov-08 Aug-09 Feb-09 Nov-09 May-08 May-09 Feb-10 May-10
TVS Motor Fair value at 12x FY12e core earnings
TVS Motor We value TVS at 12x FY12e core earnings, which is a 15% discount to Hero Honda. We give it a discount given its low profitability margins (compared with those of Hero Honda and Bajaj Auto) and market share in the two-wheeler space (though market share could improve over FY10-12e). We give a 20% discount to the cash on its balance sheet to arrive at our fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside).
Fig 12 TVS Motor: 12-month forward PE band

200 160 120 Rs 80 40 0 Apr-05 Aug-05 Apr-06 Aug-06 Apr-07 Aug-07 Apr-08 Aug-08 Apr-09 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 21x 18x 15x 12x 9x 6x
Maruti Suzuki Fair value at 13x FY12e earnings
Four-wheeler companies Maruti Suzuki Our target multiple for Maruti Suzuki is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently, valuation is weighed down on account of intense competition in the passenger car (PC) segment and the negative surprise of higher royalty costs. Our earnings forecast does capture the worst-case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside). While Maruti is in a temporary slack earnings growth phase due to the royalty issue, we expect it to return to growth in FY12 (26% over FY11e) as royalty outflow eases over a period of time and product development in India attains critical mass. The recent correction in the stock price offers an attractive entry point into the stock. Fig 13 Maruti Suzuki: 12-month forward PE band
2,000 1,600 1,200 Rs 800 400 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Apr-10 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Jul-10 21x 18x 15x 12x 9x 6x
M&M Fair value using SOTP methodology
Mahindra & Mahindra (M&M) At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-parts method to arrive at our fair value of Rs762 (26% upside). To arrive at fair values for M&Ms listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&Ms other investments. We apply a PE multiple of 13x to M&Ms core business, comprising tractors and other farm equipment, utility vehicles and three-wheelers. We have not assigned any value to Satyam Computers (acquired by Tech Mahindra) due to non-availability of financials. But the cost of acquiring Satyam Computers is factored in the consolidated financials. Any positive surprise from Satyam Computers would provide upside potential to our current fair value. 10
Fig 14 Mahindra & Mahindra: 12-month forward PE band

1,200 1,000 800 Rs 600 400 200 0 Apr-10 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 19x 16x 13x 10x 7x 4x
Ashok Leyland Fair value at 14x FY12e earnings
Ashok Leyland (AL) The stock trades at a PE of 12.6x and an EV/EBITDA of 8.3x FY12e. In our view, ALs current stock price factors in the CV cycle uptrend, market share gains and improved profitability. We assign a 14x PE multiple on FY12e, which is in line with its long-term PE multiple of 13.3x. At 14x FY12e EPS, we arrive at a fair value of Rs79 (11% upside). Fig 15 Ashok Leyland: 12-month forward PE band
120 100 80 60 40 20 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10
57x 1,500 44x 31x 18x 5x Jul-09 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Jul-05 Jul-06 Jul-07 Jul-08 Apr-06 Apr-07 Apr-08 Apr-09 Apr-05 Jan-06 Jan-07 Jan-08 Jan-09 Apr-10 Jan-10 Jul-10
21x 18x 15x 12x 9x 6x
Tata Motors Fair value using SOTP methodology
Tata Motors Tata Motors currently trades at the sector average valuation, and is attractive given the CV cycle uptrend, Nano ramp-up and re-rating of Jaguar Land Rover (JLR). Our fair value for Tata Motors is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (after 20% discount), holding in Tata Sons at Rs60, and the value of investment in JLR at Rs717 (6x EBITDA). Our fair value for Tata Motors is Rs1,452 (47% upside). Fig 16 Tata Motors: 12-month forward PE band
2,000
Rs
Rs
1,000 500
11
Fig 17 Target valuation multiples Fair value FV P/E FV EV/ Companies (Rs) (x) EBITDA (x) Ashok Leyland Bajaj Auto Hero Honda Mahindra & Mahindra Maruti Suzuki Tata Motors TVS Motor 79 3,260 1,901 762 1,478 1,452 146 14.0 16.0 14.0 17.0 13.0 37.5 12.0 9.1 11.3 10.2 10.7 6.3 12.6 6.3
View Assigned a PE of 14 against the long-term avg. of 13.3, but on our fair value EV/EBITDA will be 7% higher than the long-term average 15% premium to Hero Honda justified on account of market share improvement and profit profile In-line with it's long-term PE average of 13.7 justified given the expected market share losses and slow earnings growth SOTP basis. Core earnings at 13x; listed subsidiaries at 20% discount to current price and other investments at 50% discount to market/book values 13x FY12e earnings, 5% discount to its six-year forward average PE. Our target EV/EBITDA will be 12% lower than the aforesaid average. SOTP basis. Core earnings at 15x; Investment in key subsidiaries at Rs97 (20% discount); JLR at 6x EBITDA (50% discount to standalone EBITDA multiple) 15% discount to HH target PE multiple. Discount is justified given its low profitability margins and market share in 2W space
Top picks
Bajaj Auto Rating: Outperform Fair value: Rs3,260 Bajaj Auto Bajaj Auto is our top pick in the two-wheeler segment; we initiate coverage on it with an Outperform rating and a fair value of Rs3,260. We estimate Bajaj Autos volume would grow at a CAGR of 28% over FY10-12, above the industry rate of 19.7%, leading to gains in market share. Based on these gains, we estimate earnings to grow at a CAGR of 27% over the same period. Hence, going forward, we expect Bajaj to trade at a premium to the two-wheeler industry leader Hero Honda. Mahindra & Mahindra We initiate coverage on Mahindra & Mahindra (M&M) with an Outperform rating and a fair value of Rs762. With its core segments growing at a good clip, foray into international markets with the Ssangyong acquisition raising its profile/ product offerings, and new businesses having value unlocking potential, we believe M&M should be a core holding for any investor in the sector. Maruti Suzuki We initiate coverage on Maruti Suzuki with a contrarian Outperform call and fair value of Rs1,478. We believe the negatives (rising competition, loss in market share, and increase in royalty payment) are priced in; we believe that the stock currently offers a good entry point, given its strong balance sheet, cash flows and expected 26% earnings growth in FY12. Tata Motors We initiate coverage on Tata Motors with an Outperform rating and fair value of Rs1,452. We believe the strong revival at JLR, increasing commercial vehicle (CV) demand in India, and improving operating leverage would lead to consolidated earnings growth of 167% over FY1012e, the highest in the sector. Tata Motors currently trades at the sector average and looks attractive for multiple reasons uptrend in the CV cycle, Nano production ramp-up, strong product pipeline and re-rating of JLR.
M&M Rating: Outperform Fair value: Rs762
Maruti Suzuki Rating: Outperform Fair value: Rs1,478
Tata Motors Rating: Outperform Fair value: Rs1,452
12

We expect the sector to report ~20% volume CAGR over FY10-12e given Indias strong macro drivers fast-growing per capita income, favourable demographics, shifting consumption patterns, and easier availability of credit. Our analysis also shows that monetary tightening would only have a limited impact on growth.
Macro drivers favour the sector

Strong structural support Our economist, Samiran Chakraborty, believes the auto sectors structural growth story is supported by many factors, such as a high rate of increase in per capita income, favourable demographics, shifting consumption patterns and urbanisation/infrastructure development. Per capita income rising fast Indias per capita income has doubled in the past five years to ~US$1,000, whereas it took 33 years to rise from US$100 to US$500. Even with such growth in incomes and car sales doubling from 2003 to 2009, India still stands near the bottom of the motor vehicle ownership charts, with just 12 vehicles per 1,000 persons compared with Chinas 128, Brazils 156, Russias 213 and South Koreas 293. As per capita income increases, driven by strong GDP growth, we expect the auto sector to benefit. Most developed countries experienced exponential growth in auto sales once their per capita income crossed the US$5,000 mark. In Indias case, however, the exponential growth could come even at a lower level of per capita income because of two reasons. First, the cost of a car is lower in India than in developed countries. Second, certain urban pockets in India could be much closer to the US$5,000 per capita income threshold. Fig 18 Motor vehicle ownership Motor vehicles per 1,000 persons Countries USA 765 Germany 558 Japan 543 UK 458 Greece 455 South Korea 293 Malaysia 273 Russia 213 Brazil 156 China 128 Indonesia 21 India 12
Source: US Department of Energy
Indias per capita income doubled in the past five years
Fig 19 India: Per capita income growth

12 10 US$ hundreds
.
Fig 20 India: Passenger car sales

1,500,000 1,200,000 900,000 600,000
8 6 4 2 0 FY81
300,000 0 2002 2003 2004 2005 2006 2007 2008
FY85
FY89
FY93
FY97
FY01
FY05
Source: RBI, Standard Chartered Research
FY09
Source: SIAM, Standard Chartered Research
13
2009
Labour markets, too, favour income growth, with salary increases back in vogue as employment outlook improves. Fig 21 India: Wage increases
18 16 14 12 % 10 8 6 4 2002 2003 2004 2005 2006 2007 2008 2009 2010F
%
Fig 22 India: Employment

100 80 60 40 20 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 T eamlease (index level) Change in RBI ind. survey (RHS)
Source: Hewitt Consulting, Teamlease Employ Outlook, RBI
25 20 15 10 5 0 -5 -10
Junior/superv./prof. Manual workforce
Source: Hewitt Consulting, Teamlease Employ Outlook, RBI
Demographics would help India sustain consumption growth
Indias demographics supportive Indias demographics map favours consumption growth, given that 28% of the increase in the global working age population is to come from India in the next decade. In addition, shifting consumption patterns show a steady rise in the share of transportation in total consumption. The proportion of income spent on transportation and communication has almost doubled in the past 20 years. Fig 23 Indias demographics better than Chinas (addition over the decade in millions)
130 75 20 -35 -90 2010-20 (Working age) 2020-30 (Working age) China
2010-20 (Senior citizens) India
2020-30 (Senior citizens)
Steady rise in the share of transportation in total consumption
Fig 24 Shifting consumption patterns Items (%) Food & beverages Transport & comm. Rent, fuel & power Medical Recreation, education Clothing & footwear Furniture, hotels Misc. (personal care, etc.) FY91 58 10 13 3 3 6 3 6 FY01 48 14 11 5 4 6 3 8 FY08 42 16 9 6 5 5 4 12 FY08* 36.8 18.7 11.4 4.4 3.5 8.5 4 12.8 FY10* 35.3 19.7 11 4.4 3.4 7.9 3.9 14.4
*Base is 2004. For years FY01 and FY08 the base is 2000 Source: NSSO, Economic Survey
14
Macro factors impacting the various segments

Farm income, finance, urban demand Agri income, consumer confidence Two-wheeler (2W) segment: The improvement in farm incomes, urban demand and availability of financing and consumer sentiment would have a positive impact on the segment. Passenger vehicle (PV) segment: Higher agricultural incomes and improved consumer confidence would impact auto demand positively in segments such as passenger cars and multiutility vehicles (MUVs). Commercial vehicle (CV) segment: Positive traction in industrial production (strong co-relation); government thrust on infrastructure investment; good agri-GDP growth and healthy freight rates. Rural demand Rural demand in India remains secular, driven by 1) the National Rural Employment Guarantee Act (NREGA), which is having a positive impact on rural consumption; 2) higher agricultural income arising from better minimum selling prices (MSP) for essential commodities, which have increased by a CAGR of 10% (on average) for key crops, leaving more disposable income for farmers; and 3) recent monsoon rainfall data suggesting a normal to above-normal monsoon with good spatial distribution that should augur well for agri-GDP growth in FY11. Urban demand We believe urban demand is recovering, driven by 1) rising wages; 2) renewed hiring by the IT/ITES sector; 3) improved availability of financing; and 4) still attractive interest rates (despite monetary tightening). Fig 25 India: Farm income
21 14 7 % 0 -7 -14 1QFY01 4QFY01 3QFY02 2QFY03 1QFY04 4QFY04 3QFY05 2QFY06 1QFY07 4QFY07 3QFY08 2QFY09 1QFY10 4QFY10
Rs bn
Industrial production, infra investment
Fig 26 India: Infra invest. as a % of GDP

8,000 6,000 4,000 2,000 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e Infra investment (LHS) Infra investment as a % of GDP (RHS)
10 9 8 7 6 5 4 %
15
A rewind of FY10
FY10 a landmark year for the Indian auto sector For Indian auto companies, with the exception of Ashok Leyland, FY10 was a landmark year, with unit sales at an all-time high and strong volume growth. Further, most OEMs set new records in terms of volume and profitability. This strong performance came on the heels of an economic downturn, making it more remarkable. Looking forward, we expect volume to grow at a CAGR of 17% for the industry over FY10-13, compared with the 25.6% reported in FY10. Fig 27 Segment-wise volume growth in FY10
40 30 20 10 0 PV LCV 2W M&HCV 3W Total 29.4 35.4 32.7 24.5 23.4 25.6
Source: Companies
Sector volume assumptions FY11-13e

Fig 28 Auto sector volume CAGR CAGR (%) FY02 onwards FY04 onwards FY06 onwards FY08 onwards FY10 onwards FY03 16.9 FY04 86.2 FY05 16.4 17.4 FY06 15.8 15.7 FY07 15.6 15.3 14.6 FY08 12.4 10.7 5.9 FY09 11.0 9.1 5 3.2 FY10 FY11e FY12e FY13e 12.8 14.0 14.1 13.8 11.7 13.5 13.7 13.4 9.8 12.7 13.0 12.8 13.9 17.4 16.8 15.7 24.9 19.8 16.7
Fig 29 Segment-wise volume CAGR (FY10-12e)

25 20 15 % 10 5 0 PV LCV 2W M&HCV 3W Total 23.2 19.7 15.9 16.8 11.8 19.8
16
Segment-wise volume growth assumptions

Two-wheelers to report 19.7% CAGR over FY10-12e Motorcycles to lead Fig 30 Two-wheelers
30 25 20 15 10 5 0 -5 -10 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e % 24.7 14.9 11.5
Fig 31 Motorcycles
35 30 25 20 15 % 10 5 0 -5 -10 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
FY12e
25.0 15.6 11.7
Passenger cars (including Nano) likely to grow at 28.7% and 23.8% in FY11e and FY12e
Fig 32 Passenger cars (excl. Nano)

40 35 30 25 20 15 10 5 0 FY11e FY12e FY13e FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 % 22.2 16.2 14.2
Fig 33 Passenger cars (incl. Nano)

40 35 30 25 20 15 10 5 0 FY11e FY12e FY13e
10.0 FY13e
28.7 23.8 21.7
FY03
FY04
FY05
FY06
FY07
FY08
FY09
Passenger vehicles likely to report 23.2% CAGR over FY10-12e
Fig 34 Passenger vehicles

35 30 25 20 % 15 10 5 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e 24.4 17.0 13.8
Fig 35 Utility vehicles

35 25 15 % 5 -5 -15 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e 14.4 13.0
17
FY10
FY13e
Commercial vehicles likely to grow at 19.3% and 13.4% in FY11e and FY12e; M&HCV to grow at 17%
Fig 36 Commercial vehicles

40 30 20 10 % 0 19.3 13.4 10.1
Fig 37 M&HCVs
45 35 25 15 % 5 -5 -15 -25 -35 21.0 12.6 10.2
-10 -20 -30 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
Fig 38 LCVs
40 30 20 10 0 -10 -20 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e % 17.9 14.0 10.0
18
FY13e
Monetary tightening would push up ownership costs

80% of passenger vehicles financed Financing plays an important role in Indian vehicle sales (40% for two-wheelers, 80% for passenger vehicles and 90% for commercial vehicles). The onset of monetary tightening is expected to push up interest rates and, thereby, the cost of ownership. Fig 39 Rates rising
16 14 12 10 8 6 4 2 0 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
Fig 40 Liquidity tightening

1,500 1,000 500 0 -500 -1,000 Apr-09 Jan-09 Jan-10 Apr-10 Jul-09 Oct-09 Jul-10 7 6 5 4 3
PLR
Repo rate
Reverse repo rate
Avg. LAF (INR bn, LHS) Call rates

Source: CEIC, Bloomberg, RBI
Repo rate Reverse repo
Source: CEIC, Bloomberg, RBI
IIP moderates
Industrial growth has moderated in May and June 2010, the latest data we have, and we believe it is just not the base effect catching up. Fig 41 Industrial production moderates
20 15 10 5 0 -5 Apr-09 Aug-07 Aug-08 Aug-09 Apr-08 Dec-07 Dec-08 Dec-09 Apr-10
Fig 42 Not just the base effect

3.0 2.0 1.0 0.0 -1.0 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Jun-10
Basic goods Intermediate goods
Capital goods Consumer goods
SA adjusted
Source: CEIC, RBI, Standard Chartered Research
Source: CEIC, RBI, Standard Chartered Research
But car sales buoyant
But car sales do not seem to have been affected, as clearly shown in the sales numbers. Fig 43 Passenger car sales rising
80 60 40 % yoy 20 0 -20 -40 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 May-02 May-03 May-04 May-05 May-06 May-07 May-08 May-09 Nov-09 May-10
Note: Monthly data, last data point: July-10 Source: SIAM, Standard Chartered Research
19
Scenario analysis Impact of higher interest rates

Our analysis (see below) reveals that the impact of hikes in prices and/or interest rates on equated monthly instalments (EMIs) would be marginal. Moreover, financing the key driver of automobile demand is more easily available now than during previous periods and at better rates across dealer locations. Assumptions Average cost of vehicles to increase 2%, 3% and 4% in Scenarios I, II and III, respectively Interest cost to increase 50bps, 100bps and 150bps in Scenarios I, II and III, respectively Monthly maintenance cost to increase 5%, 10% and 15% in Scenarios I, II and III, respectively Fig 44 Two wheelers (Rs) Average cost of a two-wheeler % Finance Loan Amount Interest rate (%) Duration (months) Monthly EMI Per day usage (km) Fuel efficiency (km/lt) Petrol price (per lt) Fuel cost per month Monthly maintenance cost 2W ownership cost (per month) % yoy increase Fig 45 Commercial vehicles (Rs) Average cost of a CV % Financed Loan Amount Interest rate (%) Duration (months) Monthly EMI Per day usage (km) Fuel efficiency (km/lt) Diesel price (per lt) Fuel cost per month Monthly maintenance cost CV ownership cost (per month) % yoy increase Fig 46 Passenger vehicles (Rs) Average cost of a PV % Financed Loan Amount Interest rate (%) Duration (months) Monthly EMI Per day usage (km) Fuel efficiency (km/lt) Petrol price (per lt) Fuel cost per month Monthly maintenance cost PV ownership cost (per month) % yoy increase FY06 300,000 80.0 240,000 11.0 60 5,218 30 12 46 3,450 750 9,418 FY07 300,000 80.0 240,000 13.0 60 5,461 30 12 51 3,825 788 10,073 7.0 FY08 309,000 80.0 247,200 14.0 60 5,752 30 12 50 3,750 827 10,329 2.5 20 FY09 324,450 80.0 259,560 15.0 60 6,175 30 12 51 3,825 910 10,909 5.6 FY10 324,450 80.0 259,560 12.0 60 5,774 30 12 55 4,125 955 10,854 -0.5 Scenario I 330,939 80.0 264,751 12.5 60 5,956 30 12 55 4,125 1,003 11,084 1.6 Scenario II Scenario III 340,867 354,502 80.0 80.0 272,694 283,601 13.0 13.5 60 60 6,205 6,526 30 30 12 12 55 55 4,125 4,125 1,053 1,106 11,383 11,756 4.3 7.8 FY06 FY07 FY08 FY09 FY10 960,000 1,000,000 1,040,000 1,102,400 1,124,448 90.0 90.0 90.0 90.0 90.0 864,000 900,000 936,000 992,160 1,012,003 10.0 13.0 14.0 15.0 13.5 60 60 60 60 60 18,357 20,478 21,779 23,603 23,286 280 280 280 280 280 4 4 4 4 4 32 35 34 35 40 67,830 72,660 71,400 73,500 84,000 1,200 1,250 1,500 2,000 2,000 87,387 94,388 94,679 99,103 109,286 8.0 0.3 4.7 10.3 Scenario I 1,146,937 90.0 1,032,243 14.0 60 24,018 280 4 40 84,000 2,000 110,018 0.7 Scenario II Scenario III 1,181,345 1,228,599 90.0 90.0 1,063,211 1,105,739 14.5 15.0 60 60 25,016 26,305 280 280 4 4 40 40 84,000 84,000 2,000 2,000 111,016 112,305 1.6 2.8 FY06 40,000 90.0 36,000 17.0 36 1,283 30 50 46 828 400 2,511 FY07 40,000 90.0 36,000 19.0 36 1,320 30 50 51 918 420 2,658 5.8 FY08 40,000 85.0 34,000 21.0 36 1,281 30 50 50 900 441 2,622 -1.3 FY09 41,000 70.0 28,700 23.0 36 1,111 30 50 51 918 452 2,481 -5.4 FY10 41,000 70.0 28,700 23.0 36 1,111 30 50 55 990 463 2,564 3.4 Scenario I 41,820 70.0 29,274 23.5 36 1,141 30 50 55 990 486 2,617 2.1 Scenario II Scenario III 43,075 44,798 70.0 70.0 30,152 31,358 24.0 24.5 36 36 1,183 1,239 30 30 50 50 55 55 990 990 511 536 2,684 2,765 4.7 7.8
Margins to stabilise lower, yet remain healthy

From the FY10 peak, we expect margins to decline by 120-130bps after factoring in a 200bps increase in raw material costs. This builds in a cushion against any commodity price fluctuation. Notwithstanding this, the sectors FY11 EBITDA margin is likely to be a healthy 12-13%, aided by productivity improvements and operational leverage, and still respectable vs historical performance.
Raw material costs to increase 200bps

RM to sales ratio climbs Key input prices for auto companies rose by ~50% in FY10. The raw material (RM) to sales ratio, which had edged down to ~69.6% in 1Q FY10, rose back to 72.5% in 1Q FY11. This coupled with the increase in excise duty and the cost of implementing new emission norms led to most auto OEMs raising prices over the past 12 months. The key positive is that even with the price increases, demand growth has continued unabated. We expect raw material costs as a percentage of sales to increase 200bps from 69.9% in FY10 to 71.9% in FY12, helping to stabilise auto sector EBITDA margins at around 12-13%, 140bps lower yoy, but still healthy compared with historical margins. Fig 47 RM trend, annual data
8,000 6,000 US$/t 4,000 2,000 0 FY07 FY08 FY09 FY10
Rs m
Sector EBITDA margin to stabilise at 12-13%
Fig 48 RM cost as % of sales

600 500 400 300 200 100 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
74 72 % 70 68 1QFY07 3QFY07 1QFY08 3QFY08 1QFY09 3QFY09 1QFY10 3QFY10 1QFY11 Quarterly RM cost as a % of sales (RHS)
74 72 70 68 66 64 % RM cost (LHS) RM cost as a % of sales (RHS)
Aluminium
Copper
Lead
Steel - CR
Source: LME, Standard Chartered Research estimates
Fig 49 RM trend, quarterly data

10,000 8,000
US$ / t
Fig 50 Quarterly RM cost as % of sales

300 240 Rs m 180 120 60
6,000 4,000 2,000 0 1QFY07 3QFY07 1QFY08 3QFY08 1QFY09 3QFY09 1QFY10 3QFY10 1QFY11
Aluminium
Copper
Lead
Steel-CR
RM cost (LHS)
Source: LME, Standard Chartered Research
Source: Companies, Standard Chartered Research
Assumptions for our forecast period

Discount to the spot rate for raw material purchases: 10% each in FY11e, FY12e and FY13e. INR/USD conversion at Rs45, Rs42 and Rs42 in FY11e, FY12e and FY13e, respectively. Productivity and cost cutting gains of 7% each in FY11e, FY12e and FY13e. 21
Fig 51 Auto sector Contribution and EBITDA margins

32 30 28 26 24 FY11e 1QFY08 2QFY08 3QFY08 4QFY08 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 FY12e % 16 14 12 10 8 %
Contribution (LHS)
EBITDA Margins (RHS)
Lower impact on fourwheeler companies
Two-wheeler companies, which procure raw materials on a spot basis, have already felt the impact of higher raw material costs in 1Q FY11, on a yoy basis. On the other hand, four-wheeler companies, which have long-term contracts, have seen a lesser decline in EBITDA margins than two-wheeler companies. We believe the auto industry can cope with rising raw material costs. Our analysis indicates that the cumulative price increase of 3-5% by passenger vehicle and two-wheeler manufacturers in a year and of 5-6% by CV makers offset almost 60-70% of the increase in raw material costs. In addition, higher operating leverage because of higher utilisation on account of volume growth (which we expect in FY11) and the ramping up of operations at tax- and excise-free facilities (for some players) would further arrest the decline in operating margins.
Price increases offset most cost increases
Flexible strategies that auto OEMs can adopt

Auto OEMs take regular price increases Given a stable to negative outlook for input costs, auto companies could choose one of two strategies: resort to price cuts to gain market share or maintain prices over the medium term to attain better per-unit profitability. Analysing data for the past 10 years, we expect auto companies to select the latter option. (In FY02, when commodity prices slid, only Maruti showed a sizeable reduction in per-unit net realisations in FY03.) Fig 52 Trend in realisation compared to raw material costs (indexed)
500 400 300 200 100 0 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Realisation per unit

RM trend
22
We acknowledge that this trend analysis does not completely capture any change in a companys product mix. However, it suffices to illustrate the change in weights of products on a per-company basis (such as Hero Honda displaying the highest volume growth in FY02 in the sector, contributing to the dip in industry realisations for the year). Since we are factoring in blended net realisations per vehicle, the question of price reduction due to excise duty cuts that we have seen over the past decade is not captured in the analysis. Despite competitive pressure, we expect the auto companies to follow a rational pricing strategy rather than a price-based strategy.
Industry utilisation to improve to 88.7% in FY11e

Since global companies entered India post-2003, competition has intensified and companies are in the process of completing, or have already completed, their capacity expansion projects. Fig 53 Higher utilisation provides operating leverage for the sector
160 140 120 100 80 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 100 90 80 70 60 %
Realisation per unit (indexed) (LHS)

Capacity utilisation (RHS)
We believe, however, that the precedent set in the past could come true once again we may see an extreme scenario where companies resort to selective price increases for premium products as the gap between capacity utilisation and realisation widens. Our analysis, however, leads us to believe that companies would prefer a qualitatively rather than quantitatively enhanced performance. We believe that the net result of either of these two strategies would be the same quantum of profitability as the benefits and drawbacks of opting for either the qualitative or quantitative strategies would balance out in the final analysis.
23
Fundamentals intact, competition intensifies

We believe Indian auto companies will continue to report strong cash flows and good return ratios, even though competition is intensifying given the entry of more global majors.
Cash generation likely to improve

Cash generation likely to improve on stable margins Rising competition and customer aspirations are driving auto companies to refresh their products more frequently thereby pushing up their capex. We expect capex to remain higher than historical levels over FY10-12, but do not see this as a source of concern as cash generation is likely to improve on a stable margin outlook (though margins may be lower on a yoy basis) and we expect strong volume growth in each segment. In addition, we think the majority of capacity expansion is well behind us. Fig 54 Auto companies free cash flow generation after investment income Rs/share Ashok Leyland Bajaj Auto Hero Honda M&M (Standalone) Maruti Suzuki Tata Motors (Standalone) Tata Motors (Consolidated) TVS Motor FY09 -12.0 40.1 69.2 33.2 4.0 -78.9 -49.0 2.5 FY10 3.0 210.0 129.7 46.4 13.4 74.8 8.0 7.3 FY11e 0.6 76.5 68.3 85.9 12.1 4.9 7.4 6.9 FY12e 3.7 184.8 139.9 63.9 19.2 18.7 17.8 12.5 FY13e 4.4 218.5 143.4 111.3 25.4 50.0 15.8
Fig 55 Sector operational snapshot Sector volume (Units) CAGR (FY10-12e) Sector revenue (Rsm) CAGR (FY10-12e) Sector revenue (cons)* (Rsm) CAGR (FY10-12e) Sector EBITDA (Rsm) CAGR (FY10-12e) Sector EBITDA (cons)* (Rsm) CAGR (FY10-12e) Sector net profit (Rsm) CAGR (FY10-12e) Sector net profit (cons)* (Rsm) CAGR (FY10-12e) Sector OPM (%) Sector OPM (%) (cons) FY07 9,194,131 827,780 874,502 102,163 106,959 70,889 71,521 12.3 12.2 FY08 8,790,251 887,471 955,635 103,388 115,529 67,467 68,423 11.6 12.1 FY09 8,933,266 901,638 1,356,314 87,283 93,620 52,988 18,781 9.7 6.9 FY10 11,166,669 1,230,256 1,799,518 175,352 219,711 105,200 102,236 14.3 12.2 FY11e 13,922,763 1,544,301 2,247,496 200,936 304,664 124,778 178,665 13.0 13.6 FY12e 16,076,178 20.0 1,826,093 21.8 2,648,194 21.3 233,849 15.5 345,095 25.3 150,512 19.6 210,159 43.2 12.8 13.0
*Only Tata Motors is considered in the sector consolidated calculation. M&M is not considered as its consolidated financial statements include many companies other than those in the auto sector; Bajaj Auto, Maruti Suzuki, Ashok Leyland and TVS Motor are not considered as the impact of consolidation is very marginal relative to a standalone basis. Source: Companies, Standard Chartered Research estimates
24
Fig 56 RoE of auto companies, FY11e (%)

Bajaj Auto Hero Honda M&M Ashok Leyland Maruti Suzuki T VS Motor Tata Motors 0 10 12.8 11.5 20 30 40 50 60 25.7 22.4 18.4 42.6 52.6
Fig 57 RoCE of auto comp., FY11e (%)

Bajaj Auto Hero Honda Maruti Suzuki M&M TVS Motor Ashok Leyland T ata Motors 0 10 17.1 14.6 12.0 20 30 40 50 60 24.7 24.3 50.3 56.1
Competition intensifies across segments

Competition has been steadily rising in recent years: incumbents continue to dominate each auto sub-segment. We believe competition is set to rise even more over FY10-12, driven by the entry of Toyota and Nissan into the small/mid-size car segment and also the current success of GMs Beat, VWs Polo, Fords Figo, M&Ms entry into CVs, and Yamaha and HMSIL becoming more aggressive in two-wheelers following M&Ms entry through Kinetic. Still, we believe that the incumbents have built multiple competitive advantages that will enable them to maintain their dominance. Bajaj Auto We expect market gain of 440bps over FY1012e in the motorcycle segment Hero Honda We expect market share loss of 450-500bps over FY10-12e in the motorcycle segment Fig 58 Bajaj Autos market share
35 34.0 30 % 29.7 27.4 25 23.9 27.6 34.1
Fig 59 Hero Hondas market share

60 45 30 15 0 16.0 % 51.9 43.8
48.2 40.9
47.5 40.7
14.3
14.9
20 FY07 FY08 FY09 FY10 FY11e FY12e
FY07
FY08
FY09
FY10
FY11e
Motorcycles
Overall - 2W
Motorcycles
Scooters
Overall
Source: Company, Standard Chartered Research estimates
25
FY12e
Maruti Suzuki We expect market share loss of 600bps over FY10-12e including the Nano impact Tata Motors PC market share to increase on account of Nano volume
Fig 60 Maruti Suzukis market share

55 51.5 50 %
Fig 61 Tata Motors PC market share
14
14.4
50.7
47.5 45.1
%
46.8 43.9
45
11 10.5
11.6
40 FY07 FY08 FY09 FY10 FY11e FY12e

8 FY07 FY08 FY09 FY10 FY11e FY12e 26.2 FY12e
Of total PCs
Of total PCs Incl. Nano
In the CV segment, recovery by industry players to normative levels as compared to FY10 will lead to the normalisation of market shares, in our view. Ashok Leyland Market share to normalise Fig 62 Tata Motors M&HCV mkt share
63.5 63.4
Fig 63 ALs M&HCV market share

30
63.1 62.7
% 28 26 24 23.7
62.5 %
26.0
61.5
60.5 FY07 FY08 FY09 FY10 FY11e FY12e
22 FY07 FY08 FY09 FY10 FY11e
26
Company section
27
Company updates
Ashok Leyland
Positives priced in, initiate with In-Line
In-Line (initiating coverage)

PRICE as at 26 Aug 2010
Rs72
We initiate coverage on Ashok Leyland (AL) with an In-Line rating and fair value of Rs79. We believe positives such as likely market share gains over FY10-12e, uptrend in commercial-vehicle cycle and improving profitability are in the price and recommend accumulating the stock on declines.
Bloomberg code Reuters code
AL IN
Market cap
ASOK.BO
12 month range
US$2.1bn
Rs39-73
Market share to improve We expect ALs market share to improve 250bps from a low 23.7% in FY10 to 26.2% by FY12e (management expects a gain of 300-400bps in FY11e). In our view, this improvement is mainly because production levels in the industry are recovering to normal levels post the FY09-10 crunch. Uttarakhand plant key to FY11/12e profits Vehicles manufactured at ALs Uttarakhand plant are exempted from excise duty and value-added tax, which at current rates would be around Rs60,000 per vehicle. In addition, being fully integrated, the plant has scope for margin improvement. ALs profitability would be sensitive to production from the Uttarakhand plant, in our view. Management guidance seems achievable Management expects the industry to register volume growth of 15-20% in FY11 and AL to outperform industry volume growth by a wide margin. We expect the company to register a volume CAGR of 22.5% over FY10-12e (FY11e 33% YoY) and an earnings CAGR of 40.4% over the same period. Valuation The stock trades at a PE of 12.6x and an EV/EBITDA of 8.3x FY12e. In our view, ALs current stock price has factored in the CV cycle uptrend, market share gains and improved profitability. We think it is expensive on an EV/EBITDA basis when compared with its long-term average of 6.5x. We assign it a fair value multiple of 14.0x FY12e earnings, which is in line with its long-term PE multiple of 13.3x, and arrive at a fair value of Rs79.
Year end: March Sales (Rs m) EBIT (Rs m) EBITDA (Rs m) Pretax profit (Rs m) Earnings (Rs m) adjusted Diluted EPS (Rs) adjusted Diluted EPS growth (%) adj. DPS (Rs) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Div payout (%) Book value/share (Rs) Net gearing (%) ROE (%) ROACE (%) FCF (INRm) EV/Sales (x) EV/EBITDA (x) PBR (x) PER (x) Dividend yield (%)
FY10 72,447 5,587 7,628 5,448 3,821 2.87 120.0 1.50 50.0 10.5 7.7 5.3 52.2 17.56 72.1 16.4 12.0 5,490.9 1.5 14.3 4.1 24.9 2.1
FY11e 96,496 8,088 10,711 7,116 5,835 4.39 52.7 2.00 33.3 11.1 8.4 6.0 45.6 19.61 92.7 22.4 14.6 1,788.7 1.2 10.4 3.6 16.3 2.8
FY12e 113,103 10,063 13,120 9,076 7,533 5.66 29.1 2.00 0.0 11.6 8.9 6.7 35.3 22.94 83.1 24.7 16.9 6,092.4 1.0 8.3 3.1 12.6 2.8
FY13e 129,901 10,855 14,159 9,969 8,274 6.22 9.8 2.00 0.0 10.9 8.4 6.4 32.2 26.83 68.9 23.2 17.0 7,072.1 0.8 7.5 2.7 11.5 2.8
Share price performance

75 70 65 60 55 50 45 40 35 Aug09 Nov09 AshokLeylandLtd Feb10 May10 Aug10
BSESENSEX30INDEX(rebased)
Share price (%) Ordinary shares Relative to Index Relative to Sector Major shareholder Free float Average daily vol
Source: Company, Bloomberg
-1 mth -4
-3 mth -12 mth 19 79 12 65 4 27 Promoter: 38.61% 47.96% US$7.6m
Amit Kasat
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Following a two-year downswing in FY08-09, we expect the commercial vehicle (M&HCV) segment to report a 16.8% volume CAGR over FY10-12. ALs current valuations, in our view, reflect expectations of strong gains in market share over FY10-12 and improved profitability as the company raises utilisation at its Uttarakhand plant. We, therefore, believe upside is limited and recommend accumulating the stock on declines. Since the new non-cyclical businesses that AL has ventured into are likely to be revenue and earnings accretive only from FY12-13, we have not factored them into our estimates.
Goods commercial vehicle segment in cyclical upswing

We expect the goods commercial vehicle segment to post 18% volume CAGR over FY10-12 We expect the goods commercial vehicle segment to post 18% volume CAGR over FY10-12, after registering a low base-driven 37% yoy growth in FY10. In FY08 and FY09, the segment was in a severe slump, registering -4.2% and -36% growth, respectively The segments demand drivers are growth in manufacturing, infrastructure and excavation and mining. All macroeconomic indicators show healthy signs of growth in India, supporting strong demand for goods commercial vehicles. Fig 1 CV sales and GDP growth (%)
300 250 '000 units 200 150 100 50 0 FY00 FY01 FY02 FY03 FY08 FY09 FY04 FY05 FY06 FY07 FY10 12 10 8 6 4 2 0
Fig 2 CV sales and IIP growth (%)

300 250 200 '000 units 150 100 50 0 FY00 FY01 FY02 FY03 FY08 FY09 FY04 FY05 FY06 FY07 FY10
%
14 12 10 8 6 4 2 0 %
CV sales (LHS)
Source: SIAM, GoI
GDP growth (RHS)
CV sales (LHS)
Source: SIAM, GoI
IIP growth (RHS)
Financing availability crucial as 90% of CV sales are financed
Availability of financing crucial for volume growth Financing is crucial to commercial vehicle sales 90% of sales are financed. We expect monetary tightening to push up interest rates and thereby the cost of owning commercial vehicles. Nevertheless, our analysis reveals that the impact of a hike in prices and/or interest rates on EMIs has been marginal. Fig 3 CV financing rates vs industry goods CV demand
45 30 % growth 15 0 -15 -30 -45 FY05 FY06 FY07 FY08 FY09 FY10 16 12 8 4 0 %
M&HCV growth (LHS)

Source: SIAM, RBI
Interest rates (RHS)
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Regulatory measures could support CV sales growth
In the short term, regulatory measures could have a positive impact We expect demand for commercial vehicles to improve in the remaining 9M of FY11, given the 50% accelerated depreciation on commercial vehicles the government has allowed for those vehicles purchased between January and March 2011. Change in emission norms to Euro IV for 16 cities and Euro III for the rest of the country should also help. The new norms and costs could prompt transporters to pre-purchase trucks given that they would need to pay around Rs40,000-50,000 more if they delay purchases beyond the deadline. AL key beneficiary of CV cycle uptrend AL, a core CV manufacturer, should benefit from the structural CV cycle upswing, in our view. Management has guided for an FY11 volume of 87,000-89,000 units. In our view, there is a strong possibility that AL will outperform the industry. We expect AL to post 22.5% volume CAGR over FY10-12 (FY11e growth 33% yoy), above our estimate of industry volume CAGR of 16.8%. For FY10-12, we peg domestic vehicle sales growth at 23.4% and export growth at 12.4%. For the same period, we expect goods commercial vehicles to grow at 27% (domestic -28%, exports - 13.5%), and the passenger bus segment to grow at 11.4%. ALs volume has shown very strong growth of 239% ytd on a very low base of FY10; we expect 9% residual growth in volume for the rest of FY11, driven by the high base in 2H FY10. We expect growth rates to normalize.
We expect AL to benefit from the structural CV cycle upswing
AL is likely to report 22.5% volume CAGR over FY10-12e
Fig 4 AL: Total volume growth

100 80 '000 units 60 40 20 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 40 30 20 10 0 -10 -20 -30 -40
Fig 5 AL: Breakup of M&HCVs

100 80 '000 units 60 40 20 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
.
Volume (units) (LHS)
Growth (RHS)
% growth
Trucks
Buses
Sri Lanka, Bangladesh and the Middle East (Saudi Arabia and Dubai) are ALs main export markets. We expect volume to Sri Lanka and Bangladesh to double in FY11 (the company recently received orders for 1,000 units from Sri Lanka the largest in ALs history from that country).
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Exports likely to grow at 12.4% over FY1012e
Fig 6 AL: Export growth

8,000 6,000 units 4,000 2,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
40.0 40.0 39.6 23.8 20.2 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 23.6 FY11e FY12e
One time Iraq order excluded 4,879 3,782 3,999
7,286 6,025
6,812 5,979
6,794
7,556
Fig 7 AL: Product mix: Domestic and export sales

100 90 80 70 60 50 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Trucks
Domestic
Exports
ALs market share to improve

We estimate ALs market share will improve 250bps from a low 23.7% in FY10 to 26.2% by FY12 given its low base. Management expects a gain of 300-400bps in FY11. In our view, this improvement would be mainly due to the normalization of industry production (especially at AL) compared with FY10. In our analysis, we have not factored in any price wars during the forecast period, as the industry is a virtual duopoly with the top two players enjoying above 90% market share. Although AL has a significant advantage with a new plant in a tax-free zone, we believe that the main focus of auto companies would be cash flow generation, and not gaining market share through price wars. ALs M&HCV market share to improve 250bps over FY1012e, driven by goods M&HCV segment Fig 8 AL: M&HCV market share
30 28 26 24 23.7 22 FY07 FY08 FY09 FY10 FY11e FY12e % 26.0 26.2
Fig 9 AL: Buses/truck market share

55 45 35 25 15
% market share
Buses
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Recovery in volumes is also helping AL to regain its lost market share (actual market-share loss was lower since retail sales were higher than dispatches, and AL cleared its accumulated channel inventory). The key to ALs expectation of outperforming the industry would be successful execution of its order book and a sustained commercial vehicle recovery, in our view.
Uttarakhand plant: strategic edge, key to FY11-12 profits

AL would benefit by around Rs60,00080,000 per vehicle The Uttarakhand plant provides AL the benefits from the exemption of excise-duty and valueadded tax. It gives AL a strategic edge over competitor Tata Motors. Considering 60% localization at a 10% excise duty rate, the company would benefit by around Rs60,000-80,000 per vehicle. As it is a fully integrated plant, there is higher scope to improve margin. In FY11, we expect the plant to have a capacity of 25,000-30,000 units, whereas by end-FY11 capacity should rise to 50,000pa. We expect incremental revenue from the plant to be 3.3% in FY11 and 4.4% in FY12 on our volume assumptions of 18,400 units and 27,600 units for FY11 and FY12, respectively. We expect profit to rise 9% and 11.2% in FY11 and FY12, respectively. Fig 10 AL: Benefits likely to accrue from the Uttarakhand plant Units manufactured YoY growth (%) At Uttarakhand At other plants Net sales (Rsm) % increase due to new plant Increase in net profit (%) FY08 83,307 0 83,307 70,484 0.0 0.0 FY09 54,431 -34.7 0 54,431 48,020 0.0 0.0 FY10 63,926 17.4 800 63,126 58,796 0.2 0.4 FY11e 84,769 32.6 18,400 66,369 83,560 3.3 9.1 FY12e 95,860 13.1 27,600 68,260 99,279 4.4 11.2 FY13e 105,395 9.9 34,500 70,895 114,162 5.0 13.5
ALs profitability is likely to be sensitive to production from its Uttarakhand plant. If it produces 3,000 more units than our volume assumptions for FY11 and FY12, our margin estimates would rise by 25-30bps and the tax rate estimate would fall by 120-150bps.
Steady non-cyclical revenue to support profitability

Non-core revenue now at 46% of total AL has diversified into areas such as buses, spare parts, exports, defense supplies and engine sales. These products constituted 46% of FY10 revenue (passenger HCVs and exports 28%; engines and defense 18%). We expect the steady growth in the non-cyclical segments to support overall profitability. Nevertheless, as the cyclical business picks up momentum, we expect the non-cyclical business to stabilise at around 35-39% of revenue over FY10-12. Fig 11 AL: Non-cyclical revenue, FY10
Sales to defense; sale of spare parts 27% Engine sales 12%
Fig 12 AL: Non-cyclical revenue, FY12e

Sales to defense; sale of spare parts 27% Engine sales 12%
Passenger buses 42%
Exports 19%
Exports 20%
Passenger buses 41%
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Valuation
Fair value of Rs79 at 14x FY12e earnings ALs current valuations, in our view, reflect expectations of strong gains in market share over FY10-12 and improved profitability as it raises utilization at its Uttarakhand plant. We, therefore, believe upside is limited and recommend accumulating on declines.
The stock trades at a PE of 12.7x and an EV/EBITDA of 8.4x FY12e. It is expensive on EV/EBITDA when compared with its long-term average of 6.5x. We assign it a fair value multiple of 14.0x FY12e earnings, which is in line with its long-term PE multiple of 13.3x, and arrive at a fair value of Rs79.
Fig 13 AL: 12-month forward PE band
120 100 80 60 40 20 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10
4x 30 20 10 0 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Rs 3x 2x 1x
21x 18x 15x 12x 9x 6x
Source: Company, Bloomberg, Standard Chartered Research estimates
Fig 14 AL: 12-month forward EV/EBITDA band

40
Risks
A double-dip recession would lead to a decline in global economy. A decline in Indias commercial vehicle volume FY11 on a slower-than-anticipated macroeconomic recovery.
Rs
33
New businesses
AL has ventured into a number of new non-cyclical businesses, which would provide revenue and earnings accretion from FY12-13; this upside has not yet been factored into our estimates. Hinduja Leyland Finance New finance company to support vehicle sales. Focus area would be those pockets not currently serviced by existing finance networks and would also address the need for promoting specific model/product segments. It has operations across 130 centres in 16 cities. AL would cap its equity injection to not more than Rs1.5bn; it also plans to induct strategic investors. JV with Nissan Motors Will roll out its first LCV product in April 2011. Will also manufacture and assemble engines and drivetrain components for LCVs. Develop LCV products/related powertrains and target emerging markets. JV with John Deere New company formed in June 2009 with 50-50 partnership with John Deere. Product rollout by October 2010, serial production by Feb 2011. Product plans in place, testing is underway, land has been identified, negotiation is underway. JV with Continental AG Focus on consolidating the execution plan for existing projects, which were aligned with a roadmap for stabilization and growth. Develop low-cost products for the company and Continental, and engage in engineering services to align with Continentals product development process. Avia Ashok Leyland Motors s.r.o. Acquired in 2006 through an SPV. Currently focused on restructuring operations, strengthening dealerships, and introducing products in new export markets; Operations cash broke even in FY10 Albonair GmbH Made an investment in this company to develop vehicle emission treatment/control systems and products. Will focus on development, production and sales of exhaust after treatment systems for environment friendly diesel engines. Over the long term, these engines are expected to find application in the US and Europe Venture has commenced operations and strengthened through recruitment of technical personnel; production to commence by 2010-11.
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Financials
We estimate AL to report 25% revenue CAGR over FY10-12 supported by strong volume growth of 22.5%. EBITDA and profitability growth, in our view, are likely to be higher at 31% and 40%, respectively, during the period on account of higher utilisation at its tax-free plant. Fig 15 AL: Sales and sales growth
120,000 100,000 80,000 Rsm 60,000 40,000 20,000 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 45 35 25
Rsm
Fig 16 AL: RM and RM as % of sales

100,000 80,000 76 74 72 % 70 68 66 64 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
15 5 -5
% growth
60,000 40,000 20,000 0
-15 -25
Net Sales (LHS)
Growth change (RHS)
RM (LHS)
% of Sales (RHS)
Fig 17 AL: EBITDA and EBITDA margins

15,000 12,000 Rsm 9,000 6,000 3,000 0 FY11e FY12e FY13e FY04 FY05 FY06 FY07 FY08 FY09 FY10 12 11 10
Fig 18 AL: Realization per vehicle

1,400,000 1,200,000 Rs 1,000,000 800,000 600,000 400,000 FY11e FY12e
FY12e
9 8 7 6
EBITDA (LHS)
EBIT DA Margins (RHS)
Fig 19 AL: Contribution per vehicle

400,000 350,000 300,000 Rs 250,000 200,000 150,000 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
Fig 20 AL: EBITDA per vehicle

140,000 120,000 100,000 80,000 60,000 40,000 FY11e FY13e FY04 FY05 FY06 FY07 FY08 FY09 FY10
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Rs
FY13e
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Capex at Rs20bn The company has maintained its capex plan at Rs20bn over the next two years, with Rs8bn being dedicated to its joint-venture companies. The bulk of its capex on the standalone entity would be on expanding production capacities. The Nissan JV to manufacture LCVs is expected to roll out its first vehicle by early 2011, while the John Deere JV is expected to start production in October 2010. Interest and depreciation costs to increase in FY11 The commissioning of the Pantnagar plant in March 2010 means that interest costs, which were being capitalised until now, would hit the P&L in FY11 (it capitalised Rs320m of interest costs in FY10). Similarly, depreciation would also increase next year as the Pantnagar plant ramps up its capacity. Return ratios to improve We expect the improvement in profitability over FY10-12 to impact ALs return ratios positively to an RoE of 24.7% and an RoCE of 16.9% in FY12 (from 16.4% and 12% respectively in FY10). Fig 21 Ashok Leyland: Quarterly Performance Rs m Total volume (nos) Realisation Net sales Total cost EBITDA EBITDA margin (%) Yoy growth (%) Non-operating income Net non-operating income Interest EBIT Less: depreciation PBT Tax Effective tax rate (%) Adj. PAT (before extraord) Extraordinary income Extraordinary loss PBT after EO Tax Effective tax rate (%) Rep. PAT yoy growth (%) Adj. PAT (after ext ord) yoy growth (%) FY10 1Q 2Q 3Q 4Q 7,698 14,301 16,129 25,798 1,185,310 1,103,199 1,125,634 1,139,251 9,125 15,777 18,155 29,390 9,003 14,116 16,093 25,606 122 1,660 2,062 3,784 1.3 10.5 11.4 12.9 -91.9 7.9 226.4 316.5 91 56 20 23 -167 -114 -143 -198 258 170 162 221 -45 1,546 1,920 3,586 435 506 513 588 -480 1,040 1,407 2,998 -53 146 351 768 11.1 14.0 24.9 25.6 -427 895 1,056 2,231 515 0 0 -20 10 9 10 4 25 1,032 1,397 2,974 -53 146 351 768 -217.0 14.1 25.1 25.8 78 886 1,046 2,207 -84.6 31.8 452.1 313.9 -376 894 1,055 2,228 -145.8 31.2 -1,708.0 641.3 FY11 1Q FY10 FY11e 21,402 63,930 84,769 1,097,083 1,133,151 1,138,332 23,480 72,442 96,496 21,126 64,819 85,785 2,354 7,624 10,711 10.0 10.5 11.1 1834.7 66.1 40.5 47 189 314 -269 -622 -972 316 811 1,286 2,085 7,002 9,739 615 2,041 2,623 1,470 4,961 7,116 244 1,211 1,281 16.6 24.4 18.0 1,226 3,750 5,835 0 515 0 0 33 0 1,470 5,443 7,116 244 1,211 1,281 16.6 22.2 18.0 1,226 4,232 5,835 1478.0 122.7 37.9 1,226 3,798 5,835 na 118.7 53.6
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Fig 22 Ashok Leyland: Income statement Year end March (Rs m) Volume (units) Volume growth (%) Net realisation (Rs) YoY growth (%) Net Sales Change (%) Total expenditure EBITDA Change (%) % of net sales Depreciation EBIT Interest & fin. charges Other income PBT before EO Non-recurring expense Non-recurring Income PBT Tax Effective rate (%) Rep. PAT (after. EO) Change (%) Adj. PAT Change (%) % of net sales FY09 54,431 -34.7 1,098,836 18.4 59,811 -22.6 55,221 4,590 -42.1 7.7 1,784 2,805 1,603 696 1,898 617 804 2,084 185 8.9 1,900 -59.5 1,737 -60.3 2.9 FY10 63,926 17.4 1,133,296 3.1 72,447 21.1 64,819 7,628 66.2 10.5 2,041 5,587 1,019 417 4,985 33 495 5,448 1,211 22.2 4,237 123.0 3,821 120.0 5.3 FY11e 84,769 32.6 1,138,332 0.4 96,496 33.2 85,785 10,711 40.4 11.1 2,623 8,088 1,452 480 7,116 7,116 1,281 18.0 5,835 37.7 5,835 52.7 6.0 FY12e 95,860 13.1 1,179,879 3.6 113,103 17.2 99,983 13,120 22.5 11.6 3,057 10,063 1,626 640 9,076 9,076 1,543 17.0 7,533 29.1 7,533 29.1 6.7 FY13e 105,395 9.9 1,232,519 4.5 129,901 14.9 115,742 14,159 7.9 10.9 3,304 10,855 1,626 740 9,969 9,969 1,695 17.0 8,274 9.8 8,274 9.8 6.4
Fig 23 Ashok Leyland: Balance sheet As at end March (Rs m) Share capital Reserves Net worth Loans Deferred tax liability Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr.assets, L & adv. Inventory Sundry debtors Cash & bank balances Loans & advances Current liab. & prov. Sundry creditors Other liabilities Provisions Net current assets Application of funds FY09 1,330 19,760 21,090 19,581 2,634 43,306 35,884 15,542 20,343 9,983 2,636 31,656 13,300 9,580 881 7,895 21,369 17,713 976 2,681 10,287 43,306 FY10 1,330 22,025 23,356 22,039 4,611 50,006 46,855 17,691 29,164 5,615 3,262 41,397 16,382 10,221 5,189 9,605 29,608 23,317 2,604 3,687 11,789 50,006 FY11e 1,330 24,758 26,088 28,039 4,611 58,738 59,469 20,314 39,156 8,262 43,872 19,828 10,575 3,865 9,605 32,728 26,437 2,604 3,687 11,144 58,738 FY12e 1,330 29,188 30,519 28,039 4,611 63,168 64,469 23,371 41,098 11,262 47,910 23,240 12,395 2,670 9,605 37,278 30,987 2,604 3,687 10,632 63,168 FY13e 1,330 34,360 35,690 28,039 4,611 68,340 69,469 26,675 42,794 13,262 53,988 26,692 14,236 3,456 9,605 41,880 35,589 2,604 3,687 12,108 68,340
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Fig 24 Ashok Leyland: Ratios Year end March Basic (Rs) EPS Fully Diluted Cash EPS EPS growth (%) Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) Profitability ratios (%) RoE RoCE Turnover ratios Debtors (days) Inventory (days) Creditors (days) Core working capital (days) Asset turnover (x) Leverage ratio Debt/equity (x) FY09 1.3 2.6 -60.3 15.9 1.0 76.6 54.8 27.0 24.2 1.9 4.5 1.4 8.2 8.1 58 81 108 32 1.4 0.9 FY10 2.9 4.4 120.0 17.6 1.5 52.2 24.9 16.2 14.3 1.5 4.1 2.1 16.4 12.0 51 83 117 17 1.4 0.9 FY11e 4.4 6.4 52.7 19.6 2.0 45.6 16.3 11.3 10.4 1.2 3.6 2.8 22.4 14.6 40 75 100 15 1.6 1.1 FY12e 5.7 8.0 29.1 22.9 2.0 35.3 12.6 9.0 8.3 1.0 3.1 2.8 24.7 16.9 40 75 100 15 1.8 0.9 FY13e 6.2 8.7 9.8 26.8 2.0 32.2 11.5 8.2 7.5 0.8 2.7 2.8 23.2 17.0 40 75 100 15 1.9 0.8
Fig 25 Ashok Leyland: Cash slow statement Year end March (Rs m) OP/(Loss) before tax Interest/dividends received Depreciation & amortisation Direct taxes paid (Inc)/dec in working capital Other items CF from oper. activity Extra-ordinary items CF after EO items (Inc)/dec in FA+CWIP (Pur)/sale of invest. CF from inv. activity Inc/(Dec) in debt Interest rec./(paid) Dividends paid CF from fin. activity Inc/(dec) in cash Add: beginning balance Closing balance FY09 2,805 696 1,784 -88 -7,722 -745 -3,270 187 -3,084 -11,785 3,463 -8,322 10,706 -1,603 -1,330 7,773 -3,633 4,514 881 FY10 5,587 417 2,041 765 2,688 24 11,523 462 11,985 -6,494 -626 -7,120 2,457 -1,019 -1,996 -557 4,308 881 5,189 FY11e 8,088 480 2,623 -1,281 -679 -442 8,789 0 8,789 -7,000 -5,000 -12,000 6,000 -1,452 -2,661 1,887 -1,324 5,189 3,865 FY12e 10,063 640 3,057 -1,543 -682 -442 11,092 0 11,092 -5,000 -3,000 -8,000 0 -1,626 -2,661 -4,287 -1,195 3,865 2,670 FY13e 10,855 740 3,304 -1,695 -690 -442 12,072 0 12,072 -5,000 -2,000 -7,000 0 -1,626 -2,661 -4,287 785 2,670 3,456
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Company profile
Ashok Leyland is Indias second-largest commercial vehicle manufacturer The second-largest commercial vehicle manufacturer in India, Ashok Leyland has a wide range of passenger/goods carriers across all tonnages. Formerly regionally concentrated, it has been successful in the past three to four years in widening its markets both in terms of product range and geographic reach. The flagship company of the Hinduja group, Ashok Leyland is Indias second-largest commercial vehicle manufacturer. The Hinduja group has been in existence for over 90 years and operates in over 32 countries with more than 35,000 employees in nine business sectors. Expanding its reach Ashok Leyland operates in the >7.5-ton gross vehicle weight (GVW) truck and bus segment. An erstwhile southern and regional player, it has instituted measures to widen its geographic reach to other parts of the country. Other measures to diversify its truck and bus range are also in place. These include various JVs (with Nissan for LCVs, with Alteams for a foray into high-pressure die casting, with Continental AG for infotronics products, with John Deere for excavators, etc). Stable management team ALs management team comprises chairman R. J. Shahney, co-chairman D. G. Hinduja, managing director R. Seshasayee, chief financial officer K. Sridharan and full-time director Vinod Dasari, among others. ALs fresh initiatives have been undertaken during the stewardship of the current managing director R. Seshasayee. Under this management team, revenue over FY04-10 has grown at a CAGR of 13.5%, and profitability at a 13.9% CAGR. Fig 26 AL: Shareholding pattern
Promoter 39% FII 14%
DII 19% Others 28%
Source: BSE
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Bajaj Auto
Top two-wheeler pick; initiate with Outperform
Outperform (initiating coverage)

Rs2,780
Bajaj Auto is our top pick in the two-wheeler segment; we initiate coverage on it with an Outperform rating and fair value of Rs3,260. We estimate Bajaj Auto would post 29% volume CAGR over FY10-12e, above the industrys 19.7%, likely resulting in market share gains. Given such growth, we estimate it would post an earnings CAGR of 27% over the same period. We thus expect it to trade at a premium to the two-wheeler industry leader Hero Honda going forward.
BJAUT IN
Market cap
BAJA.BO
12 month range
US$8.9bn
Rs1,176-2,848
Focused strategy bearing fruit Leaving behind its unsuccessful earlier strategies, Bajaj Auto is now focused on its core segments. No more does it dilute brand equity by spreading itself thin with many brands. It also exited the scooter segment to refocus resources. Improvement in market share over FY10-12e Our estimate for Bajaj Autos sales are in line with managements, i.e., 4m vehicles in FY11e (200,000 domestic motorcycles/month, 100,000 exports/month plus 34,000 units/month of 3Ws). We believe they are achievable given the companys current monthly run rate. We estimate that such growth would translate into a 440bps improvement in market share. Advantage of a diversified business model Bajaj Autos diversified business model gives it an advantage over competition in key segments. The company has a dominant market share in the 125+cc motorcycle category (high-margin segment) and in passenger three-wheelers. Exports also provide a huge cushion to revenue and profitability (margins similar to the domestic business). This enables the company to maintain the highest profitability profile in the sector. Valuation We value Bajaj Auto at 16x FY12e core earnings, which is a 15% premium to Hero Honda. We believe this PE multiple is justified given its strong balance sheet, market share improvement over FY10-12e and profit profile. We value its investments in its Indonesian venture and in KTM Sports AG, the Austrian company, at Rs58, and give a 20% discount to cash on the balance sheet. Our fair value for Bajaj Auto is Rs3,260.
Year end: March Sales (Rs m) EBIT (Rs m) EBITDA (Rs m) Pretax profit (Rs m) Earnings (Rs m) adjusted Diluted EPS (Rs) adjusted Diluted EPS growth (%) adj. DPS (Rs) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Div payout (%) Book value/share (Rs) Net gearing (%) ROE (%) ROACE (%) FCF (Rs m) EV/Sales (x) EV/EBITDA (x) PBR (x) PER (x) Dividend yield (%)
FY10 FY11e FY12e FY13e 119,210 168,489 202,772 234,418 24,561 31,564 35,524 39,822 25,926 32,914 37,067 41,642 24,076 34,534 39,195 44,802 18,156 25,383 29,396 34,049 125.49 175.44 203.18 235.34 127.1 39.8 15.8 15.8 40.00 44.00 48.00 50.00 81.8 10.0 9.1 4.2 21.7 19.5 18.3 17.8 21.3 19.3 18.0 17.4 15.2 15.1 14.5 14.5 39.1 28.8 27.2 24.4 202.40 333.84 489.02 674.36 76.7 42.2 16.0 -17.0 62.0 52.6 41.5 34.9 60.4 56.1 46.6 40.4 30,564.2 11,068.3 26,731.0 31,608.7 3.3 2.3 1.8 1.4 14.4 11.2 9.4 7.8 13.7 8.3 5.7 4.1 22.2 15.8 13.7 11.8 1.4 1.6 1.7 1.8

3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 Aug09 Nov09 Feb10 May10 Aug10
BajajAutoLtd
-1 mth 5 5 0
Amit Kasat
40

The two-wheeler industry is in a secular growth phase, driven by improving farm incomes, urban demand and availability of financing. We estimate the industry will post volume growth of 25% and 15% in FY11 and FY12, respectively. We expect Bajaj Auto to outperform the industry by a wide margin by registering 27.5% volume and 27% earnings CAGR over FY10-12, thereby increasing its market share. Bajaj Auto, thus, is our preferred pick in the two-wheeler space and we expect it to trade at a premium to the two-wheeler industry leader, Hero Honda, going forward.
Focused strategy bearing fruit

Current strategy is to focus on its three motorcycle segments economy, executive and premium Bajaj Auto has moved beyond the period when it kept tweaking its strategy unsuccessfully. Its current successful strategy is to focus on its three motorcycle segments economy (with Platina), executive (with Discover) and premium (with Pulsar). Going forward, we expect the company to leverage its existing products brand equity. Bajaj Auto recently exited the scooter segment. By doing this, management has ensured that resources would be focused on its core, profitable businesses. Going forward, management expects to focus more on its profitable executive and premium segments, and less on the entry level segment. Looking at industry volume over FY06-10, we believe Bajaj Autos strategy is falling in line with industry reality. Fig 1 Entry-levels share of industry vol.
60 50 40 30 20 10 0 FY06 FY07 FY08 FY09 FY10 % 43 54 47 38 31
%
Fig 2 Executive segments share

70 57 62 64 45 32 25 35 30
41 24
43 24
60 50 40 30 20 10 0
48
52
19
FY06
FY07
FY08
FY09
Entry level as % of industry volumes Entry level as % of Bajaj's total volume

Source: SIAM, Companies
Exec as % industry volume Exec segment as % of Bajaj's total volume

Fig 3 Premium segments share

35 30 25 20 % 15 10 5 0 FY06 FY07 FY08 FY09 FY10 9 10 12 21 21 24 14 27 17 31
Prem as % of industry volume Prem as % of Bajaj's volume

41
FY10
Bajajs entry-level segment market share falling
Entry level (commuter) segment Bajaj is decreasing focus in this segment The main brands in the entry level segment are Bajaj Autos Platina, Hero Hondas CD series and TVS Star. In FY06, the segment accounted for a good 43% of industry motorcycle volume. By FY10, however, the segments share had fallen to just 19%. Bajaj Auto had dominated the segment, with 54% of its total motorcycles sales in FY06 coming from this segment. Currently, however, only 24% of Bajaj Autos overall sales come from the entry level segment. Bajaj Auto has decided not to invest in this low-margin segment, and will concentrate just on its Platina brand. Executive (mass volume) segment Bajaj is increasing penetration The executive segment comprises Bajajs Discover, Hero Hondas Splendor, Passion and Glamour, HMSIs Shine and TVS Fiero. This is a fast-growing segment and accounted for 64% of industry volume in FY10, compared with 48% in FY06. Bajaj had earlier made many unsuccessful attempts to penetrate the segment, where Hero Honda is dominant. But its current focused strategy with Discover DTSI has enabled it to increase sales of the brand from 25% of total motorcycles sold in FY06 to 45% in FY10. Premium segment Bajaj is the market leader This segment comprises Bajaj Autos Pulsar, Hero Hondas CBZ, Hunk and Karizma, HMSIs Unicorn and Stunner, TVS Apache and Yamahas R15 and FZ16. This segments share of industry volume has risen to 17% in FY10 from 9% in FY06. During the same period, Bajaj Autos share in this segment to its total volume grew from 21% in FY06 to 31% in FY10. Bajaj remains the market leader in the segment. Bajaj Autos motorcycle segment to outperform industry growth over FY10-12 Given its focused strategy, we expect Bajaj Autos motorcycle segment to register volume growth of 28.8% over FY10-12 against industry volume growth of 19.7%. Bajaj Autos growth is likely to be driven by 31% growth in the domestic market and 23% in its export markets. Fig 4 Bajaj Auto: Domestic volume and growth
3,500 3,000 2,500 '000 units 2,000 1,500 1,000 500 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY05-10 CAGR 6.1% FY10-12e CAGR 31.1% 39.6 50 40 30 20 10 0 -10 -20 -30
Segment where Bajaj is increasing penetration
Leader in the premium segment
We expect Bajajs motorcycle volume CAGR over FY10-12 at 28.8% vs industrys 19.7%
48.2
16.0
Domestic motorcycles (LHS)

Growth (RHS)
Domestic volume to remain strong Bajaj Auto currently has a stable product portfolio in the motorcycle segment compared with its past. Management is currently focusing on creating a strong brand franchise for its well-accepted products such as Discover and Pulsar, which will likely boost volume, going forward. Pulsar and Discover to drive growth Going forward, we believe that Discover and Pulsar would contribute the most to volume growth. Discover is doing extremely well post the Discover100 launch; it is positioned in the mass market segment where its competing with Hero Hondas best-selling brand Splendor. We expect Discover to sell, on average, 100,000 units per month in FY11 (Bajaj Auto now sells 80,000-90,000 units per month). The recent addition of Pulsar135 to the Pulsar family is likely to incrementally improve Pulsars volume. Moreover, 42
whatever gaps the company had in its product portfolio have been filled. Thus, we expect Bajaj Auto to outperform industry volume growth over FY10-12 by posting 31% growth in domestic sales. Given its focus on core brands, we expect executive and premium products to account for 79% of Bajaj Autos product mix in FY11 compared with 76% in FY10. Fig 5 Bajaj Auto: Improvement in product mix
60 50 40 64 63 48 31 18 18 18 19 21 20 50 30
FY11e
FY12e
FY11e
Industry Entry
Bajaj Auto Executive Premium
Motorcycle exports to grow at 23% over FY10-12 Bajaj Auto has created an identity for Indian motorcycles in the global market. Its exports constituted 26.3% of volume and 28% of its revenue in FY10. Bajaj Auto is Indias largest exporter of two-wheelers and three-wheelers and one of the first to tap fast-growing African, Latin America and Asian (ex-China and India) markets. Fig 6 Bajaj Auto: Export volume and growth
1,200 1,000
'000 units
FY12e
We expect Bajaj Autos product mix to have a high portion of executive and premium products
30 20 10 0
FY05-10 CAGR 42.4% FY10-12e CAGR 23.0%

.
85 70 55 30.2 14.8 16.1 40 25 10 %
800 600 400 200 0
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
Export motorcycles (LHS)

Growth (RHS)
43
FY12e
Fig 7 Bajaj Auto: Export and geographical spread (FY10)

South Asia (excl. India) 25% Latin America 15% South East Asia 9%
Africa & the Middle east 51%

Source: Company
We expect a strong 23% CAGR in motorcycle exports despite the high base of a 42% CAGR in export volume over FY05-10. We expect export volume to constitute 26.3% of overall volume in FY12 despite strong growth in its domestic sales. Strategy for global market penetration Bajaj Auto is preparing to penetrate the top-end and the bottom-end of the global motorcycle market, where it does not yet have a presence. It aims to do this by developing new brands, and retain the Bajaj Auto brand for the middle value segment. The aim is to have at least 80% of revenue from overseas in five years, compared with 30% currently. Low value segment The global low-value segment is dominated by Chinese-made bikes. This segment totals 21m two-wheelers, of which 14m are motorcycles. The Chinese market alone accounts for 6-7m bikes annually. Africa accounts for 4m units, of which Nigerias share is 1.5m units. Currently, Bajaj Auto has a 15% share of the Nigerian market. The low-end bikes are priced at less than US$1,000 per unit, but they are often shipped for US$300-400 each. Bajaj Auto is targeting 5.5m units in this segment for a market share of 39.3% by FY15. Bajaj is to develop a new brand to take on Chinese competition at the low-end Bajaj Autos strategy for the low-end segment Bajaj Autos strategy is to develop a new brand to take on Chinese competition. It will launch a new bike in Nigeria (the largest market for sub-US$1,000 bikes outside China) that would be cost-competitive with Chinese bikes. The new bike has been designed in India, with development and manufacturing done in China. The bike is likely to be priced at US$600 compared with the cheapest bikes, which are priced around ~US$300. Mid-segment The mid segment is dominated by Japanese brands. It constitutes 22m twowheelers, of which 11m are motorcycles. Bajaj Auto sells the 220cc Pulsar in this segment for around US$2,000 per unit. Bajaj Auto is targeting 2-2.5m units, or a 20% market share. Bajaj Autos strategy for the mid segment Bajaj Auto intends to maintain its modest target of 20% market share; the key markets would be India, South America, Indonesia and Nigeria. The company intends to increase its market share in India to over 25-27% from 17% in FY10. It intends to follow a platform-sharing strategy for the mid and low segments as done by international passenger car manufacturers and price it at two separate price points. Currently, the basic platform for the low and mid segments is the same and, hence, the company is benefiting by targeting economies of scale in manufacturing, suppliers and R&D. Top-end segment This segment is dominated by American and European bikes. Japanese players have a presence in this 600cc and above segment, but American and European bikes command pricing power due to higher brand awareness among consumers. The segment constitutes 4m motorcycles. The top three players are Harley Davidson, BMW and KTM. Ducati and Piaggio are also among the top five companies. Bajaj Auto is targeting 0.2m units, which is a market share of 5%. 44
Bajaj Autos aim is earn at least 80% of revenue from overseas markets in five years
Bajajs strategy is to develop bikes of 400500cc and above using KTM brand
Bajaj Autos strategy for the top-end segment It may increase its stake in KTM (31.7% currently), which sells 90,000 bikes annually and is at the top end of the motorcycle market. Its strategy is to develop bikes of 400-500cc and above using KTM; currently KTM focuses on 800cc and 1,000cc bikes. Bajaj Autos three-wheelers likely to post 18.4% volume CAGR over FY10-12e Bajaj Auto commands a stranglehold in the domestic three-wheeler market and is Indias largest exporter of three-wheelers. While passenger 3Ws would be its key growth driver, it is also building a range of light goods vehicles.
Transition to alternative fuel vehicles to be a growth driver
Traditionally, the passenger three-wheeler market has been permit-driven, with sales depending on permits issued. However, we believe that the transition to alternative fuel vehicles (owing to the implementation of fuel-emission norms) would be the growth driver over the next two to three years. Older petrol vehicles are being phased out in favour of LPG/CNG powered vehicles. Also, some states have done away with permits for passenger three-wheeler vehicles and they can now be bought freely in those states. We anticipate, going forward, that more and more states will follow the same policy, which is expected to be positive for the segments growth. On the back of the global recovery in 2HFY10, the company has seen a pick-up in its three-wheeler exports. Bajaj Auto has recently become very aggressive in its three-wheeler business: it launched two new products in the passenger carrier segment and is expected to launch a few more in the goods commercial vehicle segment. We expect Bajajs three-wheeler business to report 17.4% (domestic) and 19.6% (exports) volume CAGR over FY10-12. Three-wheeler volume accounts for 10-12% of the companys total volume. Fig 8 Bajaj Auto: Domestic 3W volume and growth
300 250 200 '000 units 150 100 50 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
FY05-10 CAGR 2.4% FY10-12e CAGR 17.4%
40 30 20 10 0 -10 -20 %
%
Domestic 3Ws (LHS)

Growth (RHS)
Fig 9 Bajaj Auto: Export 3W volume and growth

250 200 '000 units 150 100 50 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 18.6 10.0
.
FY05-10 CAGR 20.2% FY10-12e CAGR 19.6%
100 80 60 30.0 40 20 0 -20
Exports 3Ws (LHS)

Growth (RHS)
45
Fig 10 Bajaj Auto: Total 3W volume and growth

600 500 '000 units
.
FY05-10 CAGR 9.0% FY10-12e CAGR 18.4%
24.2
22.0
30 20 15.0 10 0 -10 -20 %
400 300 200 100 0
FY11e
T otal 3Ws (LHS)

Growth (RHS)
Sustainable improvement in market share over FY10-12e

440bps improvement in market share Our sales estimates for Bajaj Auto are in line with those of management, ie, 4m vehicles in FY11 (200,000 domestic motorcycles per month, 100,000 export units per month plus 34,000 threewheeler units per month). In our view, this is an achievable target, given its current monthly run rate. We estimate that this growth would translate into a 440bps improvement in market share. Fig 11 BA: Motorcycle market share
36 34 32 % 30 28 26 FY07 FY08 FY09 FY10 FY11e FY12e 28.0
22 FY07 FY08
Fig 12 BA: Overall 2W market share

30
610bps improvement in market share 34.0
34.1
28
490bps improvement in market share 27.6 27.4
29.7
24 22.7 FY09 FY10 FY11e FY12e 23.9
26
Motorcycle market share

Bajaj's overall 2W market share

driven by rising market share in the executive and premium segments
Domestic market share driven by executive and premium segments We expect Bajaj Auto to improve its domestic market share for motorcycles to 29% in FY12 from 24.3% in FY10. We expect this to be driven by rising market share in the executive segment from 17% in FY10 to 23% in FY12 and in the premium segment from 44.3% in FY10 to 45.8% in FY12. Fig 13 Bajaj Auto: Domestic market share in different segments
80 60 40 20 0
FY06 FY07 FY08 FY09 FY10 FY11e FY12e %
49.6 33.6 28.8 21.6 29 32.2
FY12e
FY05
FY06
FY07
FY08
FY09
FY10
45.8 23.0
Domestic motorcycle market share Executive market share

Entry level market share Premium market share
46
Diversified business model an advantage

Bajaj Auto has a diversified business model that acts as an advantage for the companys performance when an entire segment or geography is underperforming. The company has a healthy mix of domestic and export revenues (in the ratio 75:25). It derives close to 20-25% revenue from the three-wheeler segment (19% in FY10). In the motorcycle segment, executive and premium segments (which are high-margin and high-profit segments) constitute 76% of overall sales. Given this, the company's revenue may not face a major risk in the event of a slowdown in demand in a particular geography or segment. The three-wheeler and premium segment exports to different markets in Africa, Middle East, Latin America and South East Asia help Bajaj Auto generate volume and simultaneously maintain a healthy margin; this helps the company in mitigating the impact of higher input costs in a way far better than its peers. Fig 14 Bajaj Auto: Product mix: 2W & 3W
100
Fig 15 Bajaj: Product mix: Dom and Exp

100 80
90 %
60 % 40 20
80
70 FY10 FY11e FY12e FY06* FY07* FY08* FY09*
0 FY06 FY07 FY08 FY09 FY10 FY11e

FY11e
2Ws
3Ws
Domestic volume
Export volume
*Scooter volume not included Source: Company, Standard Chartered Research estimates
Fig 16 Bajaj: Rev break-up: 2W & 3W

100
Fig 17 Bajaj: Rev break-up: Dom vs Exp

90
80 60 % % 40 20 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
75 60 45 30 15 0 FY06 FY07 FY08 FY09 FY10 FY12e
Domestic Revenue
Export Revenue
2W revenue
3W revenue
Note: Spare parts revenue not included Source: Company, Standard Chartered Research estimates
47
FY12e
Fig 18 Bajaj Auto: Motorcycle product mix

100 80 60 % 40 20 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 54 47 41 43 21 25 21 32 24 35 27 30 45 48 50 31 31 30
24
21
20
Entry-Level
Executive segment
Premium segment
Valuation
Fair value of Rs3,260 at 16x FY12e core earnings We value Bajaj Auto at 16x FY12e core earnings, which is at a 10% premium to our value for Hero Honda. We believe our PE rating for Bajaj Auto is justified considering its strong balance sheet, improvement in market share over FY10-12e and profit profile. We set a value of Rs58 for investments in the Indonesian venture and KTM Sports AG, the Austrian company, and give a 20% discount to cash in the balance sheet. Our fair value for Bajaj Auto comes to Rs3,260, which presents an upside of 24%. Fig 19 Bajaj Auto: SOTP valuation Core EPS (Rs) Multiple (x) Value (Rs) Cash per share (Rs) Price (Rs) Inv in KTM Power Sports AG and PT BAI at 20% discount (Rs m) Fair value (Rs)
FY09 49.1 16.0 785.2 107.6 892.7 58.5 951.2
FY10 120.4 16.0 1,927.2 228.0 2,155.2 58.5 2,213.7
FY11e 154.5 16.0 2,472.5 253.7 2,726.1 58.5 2,784.6
FY12e 177.4 16.0 2,838.8 362.8 3,201.6 58.5 3,260.1
Fig 20 Bajaj Auto: 12-month forward PE band

3,000 2,500 2,000 Rs 1,500 1,000 500 0 Aug-08 Nov-08 Aug-09 Feb-09 Nov-09 May-08 May-09 Feb-10 May-10 14x 11x 9x 7x 5x 3x
Source: Bloomberg, Company, Standard Chartered Research estimates
48
Fig 21 Bajaj Auto: 12-month forward EV/EBITDA chart

3,000 2,500 2,000 Rs 1,500 1,000 500 0 Nov-08 Nov-09 Aug-08 Aug-09 Feb-09 May-08 May-09 Feb-10 May-10 Aug-10 15x 12x 9x 7x 5x 3x
Source: Bloomberg, Company, Standard Chartered Research estimates
Risks
Lower-than-expected demand for new launches by Bajaj Auto could hamper its market share gains. Regulatory or bureaucratic issues in overseas markets may potentially hamper export growth (as seen previously in the context of Sri Lanka).
Subsidiaries
Bajaj Auto International Holdings BV (BAIH BV) It is a Netherlands-based 100% subsidiary of Bajaj Auto Ltd. and was formed to focus on international ventures, including possible acquisitions. In FY08, it acquired a 24.45% equity stake in KTM Power Sport AG of Austria, Europes second-largest sports motorcycle manufacturer. Recently, it increased its stake to 31.92%. PT Bajaj Indonesia (PT BAI) It was incorporated in FY07 as a subsidiary in Indonesia with an issue and subscribed capital of US$12.5m. In FY10, Bajaj increased its stake to 98.9% with a further addition of US$ 17m in capital. The subsidiary assembles and markets Pulsars in Indonesia. In 2H FY11, it is expected to assemble complete knock down parts, which attract lower custom duties in Indonesia. The subsidiary has not yet broken even but losses have decreased. Losses for FY10 were Rs159m at the PBT level compared with a loss of Rs615m in FY09.
49
Financials
We expect Bajaj Auto to register strong 29% CAGR in volume and 27% in earnings The strong volume growth we expect in FY10-12 along with a negative working capital cycle, strong cash flows and good return ratios, points to its strong financials. Over FY10-12, we expect Bajaj Auto to register strong 29% CAGR in volume and 27% in earnings. EBITDA is likely to grow at a CAGR of 20% over the same period. Furthermore, a ramp up of production at the Pantnagar plant from 80,000 units currently to 120,000 units in 3Q FY11 will help improve profitability and counter the impact of any further increase in raw material costs. Return ratios to remain healthy We expect that an improvement in profitability over FY10-12 would help maintain the companys RoE at 52.6% and RoCE at 56.1% in FY11. Fig 22 Bajaj: Revenue and growth
250,000 200,000 Rsm 150,000 100,000 50,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 50 40 % growth
Rsm
Fig 23 Bajaj: RM and RM % of sales

150,000 120,000 90,000 60,000 30,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY11e 75 74 73 72 71 70 69 68 67 66
30 20 10 0
-10
Revenue (LHS)
Growth (RHS)
Raw Material (LHS)
RM % of sales (RHS)
Fig 24 Bajaj: EBITDA and margins

45,000 37,000 Rsm 29,000 21,000 13,000 5,000 FY11e FY12e FY06 FY07 FY08 FY09 FY10 25 22
Fig 25 Bajaj: Realization per vehicle

45,000 40,000 Rs 35,000 30,000 25,000 FY06 FY07 FY08 FY09 FY10 FY12e
19 16 13 10 %
EBIT DA (LHS)
EBIT DA margins (RHS)
Fig 26 Bajaj: Contribution per vehicle

14,000 12,500 Rs 11,000 9,500 8,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Fig 27 Bajaj: EBITDA per vehicle

10,000 8,500 Rs 7,000 5,500 4,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
50
Quarterly Performance
Fig 28 Bajaj Auto: Standalone quarterly performance 1Q 547,662 -11.7 42,699 14.6 23,385 1.2 18,831 -12.9 4,554 19.5 70.7 231 458 218 60 331 4,155 1,220 29.4 2,935 67.6 3,103 77.2 13.3 FY10 2Q 686,823 7.3 42,042 5.6 28,875 13.3 22,510 -33.8 6,365 22.0 85.1 217 458 0 0 336 5,788 1,760 30.4 4,028 117.9 4,349 91.0 15.1 3Q 809,218 63.9 40,725 -4.4 32,956 56.7 25,720 -51.2 7,235 22.0 136.6 351 458 0 0 357 6,771 2,020 29.8 4,751 189.2 5,072 143.4 15.4 4Q 808,929 83.8 42,024 -1.8 33,995 80.5 26,224 -58.8 7,771 22.9 149.9 425 493 0 0 341 7,362 2,075 28.2 5,287 240.4 5,632 163.9 16.6 FY11 1Q 928,336 69.5 41,904 -1.9 38,901 66.4 31,131 -9.0 7,769 20.0 70.6 817 0 0 6 318 8,262 2,360 28.6 5,902 101.1 5,902 90.2 15.2 FY10 2,852,632 30.0 41,789 4.0 119,210 35.1 93,284 -156.7 25,926 21.7 115.6 1,225 1,868 218 60 1,365 24,076 7,075 29.4 17,001 159.8 18,156 127.1 15.2 FY11e 4,000,730 40.2 42,115 0.8 168,489 41.3 135,575 -156.7 32,914 19.5 27.0 3,025 0 0 55 1,351 34,534 9,152 26.5 25,383 49.3 25,383 39.8 15.1
Total volumes (nos) Yoy change (%) Realisation Yoy change (%) Total income Yoy change (%) Total cost Expenses capitalised EBITDA EBITDA margin (%) Yoy change (%) Other income Extraordinary expenses Extraordinary income Interest Depreciation PBT Tax Effective tax rate (%) Rep. PAT Yoy change (%) Adj. PAT Yoy change (%) PAT margin (%)
51
Fig 29 Bajaj Auto: Income statement (Standalone) Year end March (Rs m) Volume (units) YoY growth (%) Net realisation (Rs) YoY growth (%) Operating other income Total Income Change (%) Total expenditure EBITDA Change (%) % of net sales Depreciation EBIT Interest & finance charges Other income PBT Tax Effective rate (%) PAT Adj. PAT Change (%) PAT margin (%) FY09 2,194,108 -10.5 40,019 8.4 3,437 87,807 -2.9 76,183 11,624 -11.2 13.2 1,298 10,326 210 1,516 9,561 3,016 31.5 6,545 7,995 -4.3 9.1 FY10 2,852,632 30.0 41,789 4.4 4,125 119,210 35.8 93,284 25,926 123.0 21.7 1,365 24,561 60 1,225 24,076 7,075 29.4 17,001 18,156 127.1 15.2 FY11e 4,000,730 40.2 42,115 0.8 4,744 168,489 41.3 135,575 32,914 27.0 19.5 1,351 31,564 55 3,025 34,534 9,152 26.5 25,383 25,383 39.8 15.1 FY12e 4,637,188 15.9 43,727 3.8 5,455 202,772 20.3 165,705 37,067 12.6 18.3 1,543 35,524 55 3,726 39,195 9,799 25.0 29,396 29,396 15.8 14.5 FY13e 5,178,957 11.7 45,264 3.5 6,001 234,418 15.6 192,776 41,642 12.3 17.8 1,821 39,822 55 5,035 44,802 10,752 24.0 34,049 34,049 15.8 14.5
Fig 30 Bajaj Auto: Balance sheet (Standalone) As at end March (Rs m) Share capital Reserves Net worth Deferred tax Loans Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Technical know how Investments Net current assets Inventory Sundry debtors Cash & bank balances Loans & advances Others Current Liab. & Prov. Sundry creditors Other liabilities Provisions Net current assets Miscellaneous expenditures Application of funds FY09 1,447 17,250 18,697 42 15,700 34,439 33,339 18,079 15,260 221 163 18,085 23,253 3,388 3,587 1,369 13,652 1,257 24,376 8,000 4,134 12,242 -1,123 1,833 34,439 FY10 1,447 27,837 29,283 17 13,386 42,686 33,793 18,997 14,796 415 0 40,215 30,010 4,462 2,728 1,014 20,745 1,060 42,750 15,712 4,551 22,487 -12,740 0 42,686 FY11e 1,447 46,853 48,300 17 13,386 61,703 39,208 20,347 18,861 0 0 40,215 40,925 8,075 5,383 5,661 20,745 1,060 38,298 17,047 4,551 16,700 2,627 0 61,703 FY12e 1,447 69,305 70,751 17 13,386 84,154 44,208 21,890 22,317 0 0 40,215 62,333 8,650 6,487 25,392 20,745 1,060 40,712 19,461 4,551 16,700 21,621 0 84,154 FY13e 1,447 96,120 97,567 17 13,386 110,969 49,208 23,711 25,497 0 0 40,215 89,037 10,013 7,510 49,709 20,745 1,060 43,779 22,529 4,551 16,700 45,257 0 110,969
52
Fig 31 Bajaj Auto: Ratios (Standalone) Year end March Basic (Rs) EPS EPS growth (%) Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) Profitability ratios (%) RoE RoCE Turnover ratio Asset turnover (x) Leverage ratio Debt/equity (x) FY09 55.3 -4.3 64.2 129.2 22.0 55.9 50.3 43.3 34.3 4.7 21.5 0.8 42.8 34.4 2.4 0.8 FY10 125.5 127.1 134.9 202.4 40.0 39.1 22.2 20.6 14.4 3.3 13.7 1.4 62.0 60.4 2.7 0.5 FY11e 175.4 39.8 184.8 333.8 44.0 28.8 15.8 15.0 11.2 2.3 8.3 1.6 52.6 56.1 2.7 0.3 FY12e 203.2 15.8 213.8 489.0 48.0 27.2 13.7 13.0 9.4 1.8 5.7 1.7 41.5 46.6 2.3 0.2 FY13e 235.3 15.8 247.9 674.4 50.0 24.4 11.8 11.2 7.8 1.4 4.1 1.8 34.9 40.4 2.1 0.1
Fig 32 Bajaj Auto: Cash flow statement (Standalone) Year end March (Rs m) OP/(loss) before tax Interest/Div. received Depreciation & amort. Direct taxes paid (Inc)/Dec in working capital CF from oper. activity Extra-ordinary items CF after EO items (Inc)/dec in FA+CWIP (Pur)/sale of invest. CF from inv. activity Inc. / dec.in net worth Inc/(dec) in debt Interest paid Dividends paid CF from fin. activity Inc/(dec) in cash Add: beginning balance Closing balance FY09 10,326 1,516 1,298 -3,084 -345 9,711 -3,904 5,807 -3,908 486 -3,422 -64 2,357 -210 -3,660 -1,577 808 561 1,369 FY10 24,561 1,225 1,365 -7,100 11,263 31,314 183 31,496 -932 -22,130 -23,062 241 -2,314 -60 -6,655 -8,789 -355 1,369 1,014 FY11e 31,564 3,025 1,351 -9,152 -10,720 16,068 0 16,068 -5,000 0 -5,000 955 0 -55 -7,321 -6,421 4,647 1,014 5,661 FY12e 35,524 3,726 1,543 -9,799 736 31,731 0 31,731 -5,000 0 -5,000 1042 0 -55 -7,986 -7,000 19,731 5,661 25,393 FY13e 39,822 5,035 1,821 -10,752 682 36,609 0 36,609 -5,000 0 -5,000 1085 0 -55 -8,319 -7,289 24,320 25,392 49,711
53
Fig 33 Bajaj Auto: Income statement (Consolidated) Year end: Mar (Rs m) Sales Gross profit SG&A Other income Operating expenses EBIT Depreciation & amortization EBITDA Net interest Associates Exceptional items Pretax profit Taxation Minority interests Net profit Net profit (adjusted) Basic EPS (Rs) EPS (adjusted) (Rs) DPS (Rs) FY08 90,488 24,295 9,337 1,152 2,185 11,027 1,746 12,773 52 231 1,185 10,942 3,684 231 7,496 8,290 51.81 57.30 20.00 FY09 88,297 23,681 10,305 1,070 1,985 10,086 1,306 11,392 219 -622 2,072 8,865 2,889 -622 5,358 6,746 37.03 46.63 22.00 FY10 119,556 38,518 10,491 1,410 2,340 24,313 1,374 25,687 68 -1,028 1,624 24,032 7,035 -1,028 15,972 17,060 110.40 117.92 40.00 FY11e 171,631 50,472 15,104 3,125 4,134 29,869 1,366 31,234 65 -771 0 32,929 9,418 -771 22,743 25,270 157.20 174.66 44.00 FY12e 208,304 58,739 18,956 3,826 5,051 33,174 1,558 34,732 65 -385 0 36,935 10,527 -385 26,264 29,182 181.53 201.70 48.00
Fig 34 Bajaj Auto: Balance sheet (Consolidated) Year end: March Cash Accounts receivables Inventory Other current assets Total current assets PP&E Investment Intangible Assets Total long term assets Total assets Accounts payables Other current liabilities Total current liabilities Long term debt Deferred tax Total long term liabilities Total liabilities Shareholders funds Minority Interests Total liab and equity FY08 712 2,529 3,661 9,778 16,681 12,975 15,633 3,223 31,830 48,511 8,852 9,986 18,838 13,464 -31 13,433 32,271 16,236 4 48,511 FY09 1,426 2,809 3,718 16,899 24,852 15,522 14,232 3,835 33,589 58,441 8,203 16,378 24,581 15,954 -222 15,732 40,313 18,128 0 58,441 FY10 1,073 2,719 4,584 21,908 30,284 15,249 34,452 3,290 52,991 83,275 15,763 27,050 42,813 13,610 -321 13,289 56,102 27,169 4 83,275 FY11e 17,047 3,931 6,627 21,908 49,514 18,468 34,452 3,290 56,210 105,724 22,790 27,050 49,840 13,610 -321 13,289 63,129 42,592 4 105,724 FY12e 35,519 4,778 8,055 21,908 70,260 20,910 34,452 3,290 58,652 128,912 27,701 27,050 54,751 13,610 -321 13,289 68,040 60,869 4 128,912
54
Fig 35 Bajaj Auto: Ratio (Consolidated)

Year end: March Gross margin (%) EBIT margin (%) Effective tax rate (%) Interest cover (x) Op cash/EBIT (x) Depn/capex (x) Quick ratio (x) ROE (%) ROCE (%) Net gearing (%) Inventory days Accounts receivable days Accounts payable days Total asset turonver (x) PBR (x) EV/Sales (x) EV/EBITDA (x) PER (x) Dividend yield (%) No of shares, fully diluted (m)
FY08
26.85 12.19 33.7 214 0.7 0.2 51.1 41.0 78.5 17 10 49 2.9 24.8 4.5 30.2 48.5 0.7 145
FY09
26.82 11.42 32.6 46 2.9 0.7 0.2 37.2 32.9 80.1 18 11 46 2.5 22.2 4.6 33.9 59.6 0.8 145
FY10
32.22 20.34 29.3 360 1.2 0.1 0.1 62.8 63.6 46.1 18 8 71 2.9 14.8 3.2 14.3 23.6 0.9 145
FY11e
29.41 17.40 28.6 459 1.0 0.4 0.4 59.3 59.0 -8.1 17 8 69 3.0 9.4 2.1 11.2 15.9 0.9 145
FY12e
28.20 15.93 28.5 510 0.0 0.6 0.7 47.9 49.9 -36.0 17 8 68 2.7 6.6 1.6 9.6 13.8 0.9 145
Fig 36 Bajaj Auto: Cash flow statement (Consolidated)

Year end: Mar (Rs m) Pretax profit Interest/dividend paid Depreciation & Amortization Taxes paid (Inc)/Dec in Working Capital Others Cash flow from operations Capex Disposals Cash flow from investing Dividends Change in debt Interest Paid Cash flow from financing Change in cash Free cash flow
FY09 10,086 1,070 1,306 -3,079 116 -2,128 7,371 -3,853 1,401 -2,452 -3,183 -70 -219 -3,471 2,160 11,224
FY10 24,313 1,410 1,374 -7,134 10,614 -1,459 29,117 -1,101 -20,220 -21,321 -6,749 130 -68 -6,686 2,536 30,218
FY11e 29,869 3,125 1,366 -9,418 3,771 2 28,715 -4,585 0 -4,585 -7,321 0 -65 -7,386 17,818 33,300
FY12e 33,174 3,826 1,558 -10,527 2,636 2 30,670 -4,000 0 -4,000 -7,986 0 -65 -8,051 35,666 34,670
55
Company profile
Bajaj Auto is India second-largest twowheeler manufacturer The second largest two-wheeler manufacturer in India, the erstwhile scooter company has reinvented itself by re-innovating its product range to turn into the second-largest motorcycle manufacturer in India. Apart from its two-wheeler business, Bajaj has, through Bajaj Auto Financing, diversified into twowheeler financing. With the opening up of the insurance sector, it has entered into a joint-venture with Allianz AG, Germany. In May 07, to establish clear defining lines between the responsibilities among the Chairman, Mr. Rahul Bajajs sons, the company split up Bajaj Auto. This was completed in May 08, and culminated in the listing of the three hived off entities: Bajaj Auto the automobile company headed by Rajiv Bajaj; Bajaj Finserv the financial services company, with stakes in insurance ventures, consumer finance and wind power, headed by Sanjiv Bajaj, and Bajaj Holding & Investments the holding company, with a 30% stake each in the auto and financial services companies, and cash and investments on the books of the consolidated entity.
Fig 37 Bajaj Auto: Shareholding pattern

FII 19% Promoter 49%
DII 6%
Others 26%
Source: BSE
56
Hero Honda
Dominance peaked; valuation premium unsustainable; initiate with Underperform
We initiate coverage on Hero Honda (HH) with an Underperform rating and fair value of Rs1,901. We expect HH to maintain its market dominance in the 2W segment given its brand image, distribution strengths, and successful product/variant launches. Nevertheless, we expect HH to lose the premium at which it had traded over the sector given earnings growth 50% below the 2W sector average and market share losses. Earnings growth likely 50% lower than 2W sector We estimate HH would report 17.1%, 8.6% and 9.6% CAGRs in revenue, EBITDA and earnings, respectively, over FY10-12e compared with its past eight-year CAGRs of 17.1%, 18.8% and 21.7%. Over the same period, we expect it to underperform the 2W industry earnings CAGR of 18.6%. Market leadership, but may cede 450-500bps market share
Underperform (initiating coverage)

Rs1,785
HH IN
Market cap
HROH.BO
12 month range
US$7.9bn
Rs1,497-2,086
Given the lacklustre performance on the volume front, we

expect HH to lose market share of 450-500bps. In the motorcycle segment, market share could drop from 51.9% in FY10 to 47.5% in FY12e, and in the 2W industry it could fall to 40.7% in FY12e from 43.8% in FY10. The bright spot is the scooter segment, which could contribute to 5.7% of its overall volume, up from 4.7% in FY10. Haridwar ramp-up positive, but insignificant to profit The increase in production at its Haridwar plant in Uttarakhand to 1.8m units in FY11 (from 500,000600,000 units in FY09) and increased localization from ancillary units there helped profit growth over FY08-10 (51.9% CAGR), while the tax rate dropped from 31.4% in FY08 to 21.2% in FY10. Nevertheless, we do not expect the incremental benefits from this plant to drive profits. Best in industry operating performance With RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e, HHs operating performance is likely to remain one of the best in the sector. We expect it to generate strong free-cash-flow (postinvestment income) of Rs68/share. Valuation We value HH at 14.0x FY12e core earnings, in line with its long-term average of 13.7x. We believe such a valuation is justified given expected market share loss and slower earnings growth over FY10-12e. We thus expect the premium to the sector it attracted during the years of strong profitability growth and market share gains to decrease. Our fair value for HH is Rs1,901 (6% upside).
Year end: March Sales (Rs m) EBIT (Rs m) EBITDA (Rs m) Pretax profit (Rs m) Earnings (Rs m) adjusted Diluted EPS (Rs ) adjusted Diluted EPS growth (%) adj. DPS (Rs ) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Div payout (%) Book value/share (Rs ) Net gearing (%) ROE (%) ROACE (%) FCF (Rs m) EV/Sales (x) EV/EBITDA (x) PBR (x) PER (x) Dividend yield (%)
FY10 FY11e FY12e FY13e 157,582 185,845 216,221 244,571 25,024 25,432 29,362 32,835 26,939 27,598 31,785 35,463 28,317 28,874 33,104 36,906 22,318 23,243 26,814 29,894 111.76 116.39 134.27 149.70 74.12 4.14 15.36 11.49 110.00 35.00 40.00 45.00 450.0 -68.2 14.3 12.5 17.1 14.9 14.7 14.5 15.9 13.7 13.6 13.4 14.2 12.5 12.4 12.2 115.2 35.2 34.9 35.2 192.08 273.47 367.74 472.44 -14.5 -22.7 -44.4 -55.6 58.2 42.6 36.5 31.7 69.1 50.3 43.4 37.9 25,904.9 13,630.6 27,931.7 28,644.6 2.0 1.7 1.3 1.1 11.8 11.2 9.1 7.6 9.3 6.5 4.9 3.8 16.0 15.3 13.3 11.9 6.2 2.0 2.2 2.5

2,100 2,000 1,900 1,800 1,700 1,600 1,500 1,400 Aug09 Nov09 Feb10 May10 Aug10 HeroHondaMotorsLtd BSESENSEX30INDEX(rebased)
-1 mth -4 -4 -9
-3 mth -12 mth -7 21 -14 7 -22 -30 Promoters: 52% 47.79% US$21.1m
Amit Kasat
57

Hero Honda (HH) is Indias leading two-wheeler manufacturer. It has strong brand value, distribution strengths (widest reach across the country) and has been successful at product and variant launches. Given this dominance, its valuation commands a premium over the sector. We, however, believe this is not sustainable given our expectation it is likely to lose market share and report earnings growth 50% lower than the sector average over FY10-12. While we expect HH to remain the market leader in two-wheelers, we do not see a case for PE-multiple expansion beyond the long-term historical average.
Earnings growth likely 50% below two-wheeler sector average

Volume growth to underperform industry Between FY02 and FY10, HH outperformed the two-wheeler and motorcycle segments on volume 15.8% growth in two-wheeler volume vs industrys 11.8% and 15.1% in motorcycle volume vs industrys 14.1%. This outperformance was driven by its strong brand value, distribution strengths (widest reach among two-wheeler companies), and successful launches of products/ variants. HHs total 2W volume FY02-10 CAGR 15.8%... Motorcycle volume CAGR 15.1% Fig 1 HH: Total 2W and motorcycle vol.
5,000 4,000
Fig 2 Industry: Total and motorcycle vol.

13,000 10,000 '000 units 7,000 4,000 1,000 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY12e
Industrys 2W volume CAGR FY02-10 11.8%... Motorcycles volume CAGR 14.1%
'000 units
3,000 2,000 1,000 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
HH's total 2W volume HH's motorcycle volume

Source: Company
Industry's total 2W volume Industry's motorcycle volume

Going forward, we expect HH to report 15.5% total volume and 15% motorcycle volume CAGR against the industrys 19.7% and 20.2%, respectively. We believe higher competition would lead to its underperformance. Its closest competitors, Bajaj Auto and TVS Motor, have built up stable product portfolios in each segment, unlike in the past when they had volatile volumes as they tried out different strategies. In addition, the entry of HMSI, Suzuki, Yamaha and M&M has made the industry more competitive. HHs 2W volume FY10-12e CAGR likely to be 15.5%... Motorcycles FY1012e CAGR likely 15.0% Fig 3 HH: CAGR over FY10-12e
7,000 5,500 '000 units 4,000 2,500 1,000 FY10 FY11e FY12e '000 units
Fig 4 Industry CAGR over FY10-12e

16,000 12,000 8,000 4,000 0 FY10 FY11e
Industrys 2W volume FY10-12e CAGR likely to be 19.7%... Motorcycles FY1012e volume CAGR likely 20.2%
HH's total 2W volume HH's motorcycle volume
Industry's total 2W volume Industry's motorcycle volume
58
FY10
EBITDA and earnings growth to significantly decline compared with FY02-10 We estimate HH would report CAGRs of 17.1%, 8.6% and 9.6% in revenue, EBITDA and earnings, respectively, over FY10-12 compared with its past nine-year average CAGRs of 17.1%, 18.8% and 21.7%. HH significantly outperformed the industry during the economic crisis in FY08-09, when its volume registered growth of 11.5% against the industrys -5%. There are many reasons for this: competition was at its weakest ever, HH had a wide distribution network, it had the best ruralurban mix in volume, and it was less dependent on two-wheeler financing than the rest of the industry. Over FY08-09, HH reported revenue, EBITDA and profit growth of 19.2%, 26.7% and 32.4%, respectively, outperforming the industry by a wide margin. At the same time, higher production at its Haridwar plant also helped profitability. Industry dynamics, however, have changed since FY10, with financing returning and competition intensifying. HHs FY02-10 revenue CAGR was 17.1%; over FY1012e we expect the same Fig 5 HH: FY02-12e revenue
250,000 200,000 Rsm 150,000 100,000
Fig 6 HH: FY02-12e EBITDA

35,000 28,000 Rsm 21,000 14,000 7,000 0
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
FY12e
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
HH's revenue
HH's EBITDA
HHs profit CAGR of 21.7% over FY02-10 is likely to drop to 9.6% over FY10-12e
Fig 7 HH: FY02-12e net profit

30,000 25,000 20,000 Rsm 15,000 10,000 5,000 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
HH's net profit

59
FY12e
Whereas EBITDA CAGR is falling from 18.8% over FY02-10 to 8.6% over FY1012e
50,000 0
Industrys profit CAGR over FY10-12e likely 18.6% vs HHs 9.6%
Fig 8 HH: Profit CAGR over FY10-12e

30,000 24,000 Rsm
Fig 9 2W ind profit CAGR over FY10-12e

60,000 45,000 Rsm 30,000 15,000 0
18,000 12,000 6,000 0 FY10 FY11e FY12e
FY10
FY11e
HH's profit
2W industry's profits
Dominates the two-wheeler sector

HH had a commanding 43.8% two-wheeler market share in FY10 Hero Honda dominates the Indian two-wheeler sector, commanding a 43.8% market share in FY10 compared to 39.3% in FY07. In the past four years, it has consistently gained market share driven by the spectacular success of its long-running Splendor range, the Passion family, and its scooter models. There has also been an enthusiastic response to its +150cc bikes. However, with Bajaj Auto and TVS Motor revving up their offensives in the executive segment, we expect HH to lose market share in this segment over FY10-12. Key contributing factors to its dominant market share Among two-wheeler manufacturers, HH has the most widespread network. Bajaj Auto is more urban-centric and does not have the formers rural reach; TVS Motor is South-based and focused on urban in other regions. HH has built up the largest dealer network in India over the past decade. This gives it access to a larger customer base and a higher proportion of rural population. It is now focusing on deeper penetration into the north east. Greater exposure to the rural sector also insulates it from the lack of availability of financing seen by its competitors, since rural purchases are mainly on a cash basis. Since its rural exposure is high, the companys volume is less cyclical to the slowdown in urban and semi urban areas. We are optimistic on two-wheelers mainly because we expect strong rural demand on account of rising agri incomes, the suitability of rural roads for two wheelers, and lesser dependence on financing. But is likely to cede 450-500bps in market share given rising competition but may cede 450-500bps market share Given the lackluster performance on the volume front, we expect HH to lose 450-500bps in market share. In the motorcycle segment, it could drop from 51.9% in FY10 to 47.5% in FY12, and in the two-wheeler industry, it could fall to 40.7% in FY12 from 43.8% in FY10. The bright spot is the scooter segment, which could contribute to 5.4% of its overall volume, up from 4.7% in FY10.
Supported by large dealer network, rural exposure
60
FY12e
Fig 10 HH: Market share

60 50 40 30 20 10 0 FY07 FY08 FY09 FY10 FY11e FY12e 14.3 14.9 16.0 % 51.9 48.2 47.5
Fig 11 HH: Total market share

46 44 42 % 40 38 36 FY07 FY08 FY09 FY10 FY11e FY12e 43.8 40.9
40.7
HH's motorcycle market share HH's scooter market share

HH's overall 2W market share
Production ramp-up at Uttarakhand positive

Incremental benefits from Uttarakhand plant diminishing The increase in production at its Haridwar plant in Uttarakhand from nil in FY08 to 1.4m units in FY10 and increased localization from the ancillary units there has helped HH improve profits by 51.9% over FY08-10. The Uttarakhand plant contributed 30.4% of total sales in FY10. The company is further expanding the capacity at a CAGR of 22.5% over FY10-12 to 2.1m units. We expect contribution of this plant to overall sales to improve to 34.2% over FY10-12 and expect localization to be stabilized at 65-70%, going forward. Fig 12 HH: Haridwar plant ramp-up ('000 units) Capacity % increase Production* % increase % of total volumes FY09 700 627 16.8 FY10 1,400 100.0 1,400 123.3 30.4 FY11e 1,800 28.6 1,800 28.6 33.5 FY12e 2,100 16.7 2,100 16.7 34.2
* We have assumed capacity and production to be the same in FY11e and FY12e Source: Company, Standard Chartered Research estimates;
Fig 13 Hero Honda: Haridwars impact on profitability diminishing

40,000 31.4 30,000 Rsm 20,000 21.2 10,000 0 FY08 FY09 FY10 FY11e FY12e 19.5 19.0 23 19 15 28.1 35 31 % 27
PBT (LHS)
Profits (LHS)
Tax rate (RHS)
But insignificant impact on profits, going forward Most of the benefits from the Haridwar plant have already been accrued over FY08-10. The percentage increase in volume over FY10-12 is expected to be 23% compared with 123% growth in FY10. The companys tax rate declined from 31.4% in FY08 to 21.2% in FY10. Nevertheless, we do not expect the incremental benefits to significantly drive profits for the company. We have factored in 19.5% and 19% tax rates for FY11 and FY12 and localization at 70% over the same period. HH is planning to build a fourth plant with a planned outlay of Rs20b to meet increasing demand in the future. 61
One of the best operating performances in the industry

HH likely to report RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e With RoE and RoCE of 42.6% and 50.3%, respectively, in FY11e, HHs operating performance is likely to be one of the best in the sector. We expect it to generate strong free cash flow (postinvestment income) of Rs68/share. Fig 14 Hero Honda: RoE & ROCE
80 70 60 50 40 30 20 FY07 FY08 FY09 FY10e FY11e FY12e % 38.3 48.5 35.5 45.7 37.8 48.1 58.2 50.3 42.6 43.4 36.5 69.1
RoE
ROCE
Valuation
Fair value of Rs1,901 at 14x FY12e core earnings We value Hero Honda at 14 x FY12e core earnings, in line with its long-term average of 13.7x. We believe such a valuation is justified given our expectation of a loss in market share and slower earnings growth over FY10-12. We thus expect that the premium that it enjoyed over the sector during the years of strong profitability growth and market share gains would decrease. Our fair value for HH is Rs1,901 (6% upside). Fig 15 Hero Honda: SOTP valuation Core EPS (Rs) Multiple (x) Value (Rs) Cash per share (Rs) Fair value (Rs)
FY09 56.2 14.0 765 143.7 909
FY10 99.6 14.0 1,354 160.3 1,515
FY11e 103.4 14.0 1,406 187.8 1,594
FY12e 120.0 14.0 1,632 268.6 1,901
Fig 16 Hero Honda: 12-month forward PE band

3,000 2,500 2,000 Rs 1,500 1,000 500 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 21x 18x 15x 12x 9x 6x
Source: Bloomberg, Standard Chartered Research
62
Fig 17 Hero Honda: 12-month forward EV/EBITDA band

2,400 2,000 1,600 Rs 1,200 800 400 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-07 Aug-08 Aug-09 Apr-10 Aug-05 Dec-05 Aug-06 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 7x 20x 16x 12x
Risk
A faster-than-anticipated ramp-up at the Haridwar plant may result in more-than-anticipated earnings growth in FY11. Upturn in demand for its products. Honda exiting from the joint venture
63
Financials
CAGRs of 15.5% in volume and 9.6%% in earnings likely over FY10-12, the lowest in the two-wheeler universe We expect HH to register, over FY10-12, CAGRs of 15.5% in volume and 9.6%% in earnings, the lowest in the two-wheeler universe. We expect revenue and EBITDA to register growth of 17.1% and 8.6%, respectively, over FY10-12. Fig 18 HH: Revenue and revenue growth
250,000 200,000 Rsm 150,000 100,000 50,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 30 25 20 15 10 5 0
Rsm
Fig 19 HH: RM and RM as % of sales

160,000 132,000 104,000 76,000 48,000 20,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 74 72 70 68 66 64 % Raw material (LHS) % of sales (RHS) 36,000 34,000 32,000 30,000 28,000 26,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Revenues (LHS)
Growth (RHS)
Fig 20 HH: EBITDA and margins (%)

35,000 28,000 Rsm 21,000 14,000 7,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 12 10 % 14 18 16
Fig 21 HH: Realization per vehicle
EBIT DA (LHS)
EBITDA margins (RHS)
Fig 22 HH: Contribution per vehicle

11,000 10,000 9,000 8,000 7,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e Rs
Fig 23 HH: EBITDA per vehicle

11,000 10,000 9,000 8,000 7,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
64
Rs
Rs
Fig 24 Hero Honda: Quarterly performance Year end March (Rs m) Total volumes (nos) Change (%) Realization Chg in realisation (%) Net sales Change (%) Total cost (Inc) / dec in SIT Raw material RM/sales (%) Staff cost % sales Other expenditure Other exp. as a % of sales EBITDA As % of sales Change (%) Other income Interest Depreciation PBT Tax Effective tax rate (%) PAT Adj. PAT Change (%) FY10 FY11 1Q 2Q 3Q 4Q 1Q FY10 FY11e 1,118,987 1,183,235 1,111,372 1,186,536 1,234,039 4,600,130 5,366,149 25.1 21.7 29.6 18.9 10.3 23.6 16.7 34,160 34,308 34,435 34,742 34,817 34,256 34,633 7.4 4.6 2.8 1.6 1.9 3.5 1.1 38,224 40,594 38,270 41,223 42,966 157,582 185,845 34.4 27.3 33.2 20.8 12.4 27.9 17.9 31,723 33,153 31,661 34,106 36,941 130,643 158,247 124 -50 95 -110 -255 0 0 25,773 27,686 26,051 27,794 30,848 107,364 131,950 67.7 68.1 68.3 67.2 71.2 68.1 71.0 1,385 1,387 1,371 1,460 1,450 5,603 6,040 3.6 3.4 3.6 3.5 3.4 3.6 3.3 4,441 4,130 4,144 4,962 4,897 17,676 20,257 11.6 10.2 10.8 12.0 11.4 11.2 10.9 6,501 7,442 6,609 7,117 6,025 26,939 27,598 17.0 18.3 17.3 17.3 14.0 17.1 14.9 90.6 76.1 61.3 32.2 -7.3 57.4 2.4 425 687 550 695 534 3,087 3,224 -55 -61 -46 -45 -27 -206 -217 456 503 469 487 483 1,915 2,166 6,525 7,686 6,736 7,370 6,103 28,317 28,874 1,524 1,715 1,378 1,382 1,187 5,999 5,630 23.4 22.3 20.5 18.8 19.4 21.2 19.5 5,001 5,971 5,358 5,988 4,917 22,318 23,243 5,001 5,971 5,358 5,988 4,917 22,318 23,243 83.3 95.0 78.3 48.9 -1.7 74.1 4.1
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Fig 25 Hero Honda: Income statement Year end March (Rs m) Volume (units) YoY growth (%) Realisation (Rs) YoY growth (%) Net sales Change (%) Total income EBITDA Change (%) % of net sales Depreciation EBIT Interest & finance charges Other income Non-recurring expense PBT Tax Effective rate (%) PAT % of net sales Adj. PAT Change (%) PAT margin (%) FY08 3,337,142 0.0 30,960 4.3 103,318 4.4 103,318 13,494 14.3 13.1 1,603 11,891 -358 1,854 0 14,103 4,424 31.4 9,679 9.4 9,679 11.8 9.4 FY09 3,722,000 11.5 33,098 6.9 123,191 19.2 123,191 17,097 26.7 13.9 1,807 15,291 -317 2,207 0 17,815 4,997 28.1 12,818 10.4 12,818 32.4 10.4 FY10 4,600,130 23.6 34,256 3.5 157,582 27.9 157,582 26,939 57.6 17.1 1,915 25,024 -206 3,087 0 28,317 5,999 21.2 22,318 14.2 22,318 74.1 14.2 FY11e 5,366,149 16.7 34,633 1.1 185,845 17.9 185,845 27,598 2.4 14.9 2,166 25,432 -217 3,224 0 28,874 5,630 19.5 23,243 12.5 23,243 4.1 12.5 FY12e 6,134,123 14.3 35,249 1.8 216,221 16.3 216,221 31,785 15.2 14.7 2,423 29,362 -229 3,513 0 33,104 6,290 19.0 26,814 12.4 26,814 15.4 12.4 FY13e 6,805,534 10.9 35,937 2.0 244,571 13.1 244,571 35,463 11.6 14.5 2,628 32,835 -241 3,831 0 36,906 7,012 19.0 29,894 12.2 29,894 11.5 12.2
Fig 26 Hero Honda: Balance sheet As at end March (Rs m) Share capital Reserves Net worth Deferred tax Loans Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry debtors Cash & bank balances Loans & advances Others Current liab. & prov. Sundry creditors Other liabilities Provisions Net current assets Miscellaneous expenditures Application of funds FY08 399 29,463 29,862 1,306 1,320 32,488 19,548 7,825 11,723 3,924 25,668 9,368 3,171 2,974 1,311 1,855 57 18,247 7,561 5,689 4,998 -8,880 52 32,488 66 FY09 399 37,608 38,008 1,531 785 40,323 25,163 9,426 15,737 1,205 33,688 10,135 3,268 1,499 2,196 3,113 59 20,528 7,030 8,228 5,270 -10,393 87 40,323 FY10e 399 37,959 38,359 1,531 785 40,674 29,368 11,340 18,028 0 33,688 15,161 4,749 2,159 6,340 1,855 59 26,288 10,793 8,228 7,267 -11,127 87 40,674 FY11e 399 54,213 54,612 1,531 785 56,928 33,868 13,506 20,362 0 33,688 25,025 6,110 2,546 13,198 3,113 59 22,233 12,729 8,228 1,276 2,792 87 56,928 FY12e 399 73,039 73,439 1,531 785 75,754 36,868 15,929 20,939 0 33,688 45,355 7,109 2,962 33,371 1,855 59 24,314 14,810 8,228 1,276 21,041 87 75,754 FY13e 399 93,947 94,346 1,531 785 96,662 39,868 18,557 21,311 0 33,688 67,832 8,041 3,350 53,270 3,113 59 26,256 16,751 8,228 1,276 41,577 87 96,662
Fig 27 Hero Honda: Ratios Year end March Basic (Rs) EPS EPS growth (%) Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) Profitability ratios (%) RoE RoCE Turnover ratios Debtors (days) Inventory (days) Creditors (days) Working capital (days) Asset turnover (x) Fixed asset turnover Leverage ratio Debt/equity (x) FY08 48.5 11.8 56.5 149.5 19.0 45.9 36.8 31.6 24.5 3.2 11.9 1.1 35.5 45.7 11 11 27 -5 3.2 8.8 0.0 FY09 64.2 32.4 73.2 190.3 20.0 36.5 27.8 24.4 18.8 2.6 9.4 1.1 37.8 48.1 4 10 21 -7 3.1 9.0 0.0 FY10 111.8 74.1 121.3 192.1 110.0 115.2 16.0 14.7 11.8 2.0 9.3 6.2 58.2 69.1 5 11 25 -9 3.9 9.3 0.0 FY11e 116.4 4.1 127.2 273.5 35.0 35.2 15.3 14.0 11.2 1.7 6.5 2.0 42.6 50.3 5 12 25 -8 3.3 9.7 0.0 FY12e 134.3 15.4 146.4 367.7 40.0 34.9 13.3 12.2 9.1 1.3 4.9 2.2 36.5 43.4 5 12 25 -8 2.9 10.5 0.0 FY13e 149.7 11.5 162.9 472.4 45.0 35.2 11.9 11.0 7.6 1.1 3.8 2.5 31.7 37.9 5 12 25 -8 2.5 11.6 0.0
Fig 28 Hero Honda: Cash flow statement Year end March (Rs m) OP/(loss) before tax Interest/div. received Depreciation & amort. Direct taxes paid (Inc)/Dec in working capital Other items CF from oper. activity Extra-ordinary items Other items CF after EO items (Inc)/dec in FA+CWIP (Pur)/sale of invest. CF from inv. activity Changes in reserves Inc/(dec) in debt Interest paid Dividends paid CF from fin. activity Inc/(Dec) in cash Add: beginning balance Closing balance FY08 11,891 1,854 1,603 -4,414 4,174 -38 15,069 0 0 15,069 -3,696 -5,930 -9,626 -723 -332 358 -3,794 -4,491 953 358 1,311 FY09 15,291 2,207 1,807 -4,772 2,399 -34 16,897 0 0 16,897 -3,102 -8,019 -11,121 -679 -535 317 -3,994 -4,891 885 1,311 2,196 FY10e 25,024 3,087 1,915 -5,999 4,878 0 28,905 0 0 28,905 -3,000 0 -3,000 0 0 206 -21,967 -21,761 4,144 2,196 6,340 FY11e 25,432 3,224 2,166 -5,630 -7,061 0 18,131 0 0 18,131 -4,500 0 -4,500 0 0 217 -6,990 -6,772 6,858 6,340 13,198 FY12e 29,362 3,513 2,423 -6,290 1,924 0 30,932 0 0 30,932 -3,000 0 -3,000 0 0 229 -7,988 -7,759 20,173 13,198 33,371 FY13e 32,835 3,831 2,628 -7,012 -637 0 31,645 0 0 31,645 -3,000 0 -3,000 0 0 241 -8,987 -8,745 19,899 33,371 53,270
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Company profile
Hero Honda is Indias largest two-wheeler manufacturer Hero Honda is a joint venture between Honda Corp, Japan, and the Munjal family (each party owns 26%). It has a large dealer network with excellent penetration in rural areas. HH commissioned its third plant at Haridwar in FY08 (initial installed capacity: 500,000 units and raised to 1.5m in FY10). It has overall annual capacity of 5.5m two-wheelers. In FY11, it has also decided to set up a fourth plant. The management team is led by chairman Brijmohan Munjal, managing director and chief executive officer Pawan Munjal and joint managing director Toshiaki Nagakawa. Fig 29 Hero Honda: Shareholding pattern
Promoter 52% FII 31%
DII 6% Others 11%

Source: BSE
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Company updates
M&M
Core holding; initiate with Outperform

Rs611
We initiate coverage on Mahindra & Mahindra (M&M) with an Outperform rating and fair value of Rs762. With its core growing at a good clip, foray into international markets (Ssangyong acquisition) raising its profile and product offerings, and new businesses providing value unlocking potential, we believe M&M should be a core holding for any investor in the sector.
MM IN
Market cap
MAHM.BO
12 month range
US$7.7bn
Rs407-663
Core growing strong We estimate M&Ms core segments, utility vehicles and farm equipment, would report volume, sales and profit CAGRs of 14%, 16%, and 17%, respectively, over FY10-12, driven mainly by rising demand and low competitive intensity. In utility vehicles, we expect M&M to improve its market share in FY11e, with new launches driving growth. In farm equipment, M&Ms most profitable segment post the Punjab Tractors acquisition, we expect it to capitalize on its leadership position. Foray into international markets raising profile M&Ms aim to become an international player in tractors and SUVs is reflected in its acquisition of Chinese tractor companies and Korean SUV manufacturer Ssangyong. We believe M&M has a sound balance sheet and enough cash flow for its acquisitions despite high capex in coming years. New business ventures to add value Over the past 3-4 years, M&M has increased its business portfolio by venturing into two-wheelers (acquired Kinetic), commercial vehicles (JV with Navistar), electric car (Reva) and auto components (Mahindra Systec). It has also carved out separate subsidiaries (defense and logistic) from existing operations. Over the medium to long term, we feel there is substantial value unlocking potential in these businesses. Valuation At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-the-parts method to arrive at our fair value of Rs762 (26% upside). To arrive at fair values for M&Ms listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&Ms other investments.
FY10 FY11e FY12e FY13e 185,296 216,641 248,430 281,087 25,409 28,014 30,101 31,659 29,117 32,395 35,562 37,777 28,468 30,375 33,109 34,830 19,893 24,300 27,149 28,560 33.41 40.81 45.60 47.97 115.84 22.15 11.73 5.20 9.71 12.00 13.00 14.00 -5.1 23.6 8.3 7.7 15.7 15.0 14.3 13.4 13.7 12.9 12.1 11.3 10.7 11.2 10.9 10.2 31.9 32.7 32.4 33.1 138.31 162.12 190.00 222.07 14.5 -6.2 -14.3 -30.1 25.4 25.7 24.0 21.6 25.0 24.3 23.1 21.5 15,039.0 25,307.4 19,256.3 33,368.8 1.6 1.4 1.2 0.9 10.1 8.9 8.0 6.9 4.4 3.8 3.2 2.7 18.3 15.0 13.4 12.7 1.6 2.0 2.1 2.3

700 650 600 550 500 450 400 Aug09 Nov09 Feb10 May10 Aug10 MahindraandMahindraLtd BSESENSEX30INDEX(rebased)
-1 mth -4 -4 -9
-3 mth -12 mth 12 49 5 35 -3 -3 Promoter: 23.88% 68.51% US$27.6m
Amit Kasat
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Mahindra & Mahindra (M&M), a conglomerate, dominates Indias tractor and utility vehicle segments. Its interests span over IT services, automobiles and components, financial services, infrastructure and real estate. M&M has a history of creating good businesses and then unlocking value for investors. We believe many of its current ventures, such as defense and logistics, have value unlocking potential. The recent acquisitions of Kinetic (two-wheeler), Reva (electric car), and Ssangyong gels well with M&Ms strategy to become an auto major in India and internationally.
Core growing strong

Likely to increase its dominance in its core segments M&Ms core businesses comprise utility vehicles, three-wheelers/mini vans and farm equipment tractors and implants. These segments are witnessing a demand upswing, and we expect M&M to increase its dominance in these low competition segments. We estimate core volume, sales and profit to register 14%, 16%, and 17% CAGRs, respectively, over FY10-12. M&M plans to launch a completely new SUV (priced higher than the Scorpio) in 3Q FY11. A further 6-7 new products built on existing platforms are likely to be launched to target niche markets in which the company does not have a presence three variants of Maxximo, a variant of Xylo, and a passenger variant of the Gio. Automotive segment Utility vehicle & three-wheelers/minivans In FY11, we expect M&M to improve its market share in both the utility vehicle and the three-wheeler segments, driven by new launches. We expect the utility vehicle and three-wheeler segments to report CAGRs of 14% and 22.3%, respectively, over FY10-12. M&M has had a dominant presence in UVs. Utility vehicle segment M&M has above 50% market share M&M has had a dominant presence in UVs. It has a wide product range in the utility vehicle segment Bolero, Xylo and Scorpio. Also, the Maxx range has done well in the pick-up segment, where M&M has a near monopoly (85% of the domestic market share). Low industry volume (compared with developed countries) and the fact that most sales occur outside the top 10 cities (requires large service and distribution networks) makes this segment unattractive to global players. We, therefore, do not expect new entrants to enter this space and expect competitive intensity to remain low. The main competition in this space is from Tata Motors Sumo and Safari brands. We expect M&Ms utility vehicle market share to improve 200bps over FY10-12 The success of the revamped Bolero and the launch of Scorpio variants (including those fitted with the new mHawk engine) helped M&M regain market share and register a 900bps improvement over FY08-10. The launch of Xylo was to compete with Toyotas Innova. We expect M&Ms utility vehicle market share to improve 200bps over FY10-12. Fig 1 M&M: UV volume and growth
350 300 '000 units 250 200 150 100 50 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 50 40 % growth 30 20 10 0 -10
Fig 2 M&M: UV market share

60 56 % 52 48 44 40 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 54.7 55.8 56.7
M&M's utlity vehicle volume (LHS)
Growth (RHS)
M&M's UV market share

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Competitive segment
Three-wheeler/minivan segment The three-wheeler and minivan segment is very competitive. Currently, the dominant players are Bajaj Auto (in both passenger and goods carriers and which plans to launch a small four-wheeler minivan in the goods segment), Tata Motors with its highly successful Ace and variants, and Piaggio. Going forward, as Hub and Spoke model is developed in India, we expect the segment to become more prominent than at present. M&M has a decent three-wheeler portfolio. The success of its recently launched new products Gio and Maxximo has strengthened its product portfolio. We expect M&M to report 22.3% volume CAGR over FY10-12. Its recently-launched products will be key volume drivers, helping it regain market share. Fig 3 M&M: Three-wheeler/minivan volume and growth
75,000 60,000 55 45 30.0 35 25 30,000 15,000 0 1.2 15.0 15 5 -5
Nos
45,000
FY11e
M&M's three-wheleer/minivan volume (LHS)

Growth (RHS)
The segment could grow at 8-10% annually
Farm-equipment segment The farm-equipment segment (FES) directly benefits from the governments support for agricultural, which has grown substantially over the past 4-5 years. Minimum support prices for various crops have also seen strong growth over the past two years. Apart from that, the rise in non-agri sales has made the segment less dependent on agriculture. We believe the segment could grow at 8-10% annually, above its long-term historical average of 5%, driven by increased mechanisation in farming and increased usage in non-agri segments. M&M dominates the industry with 41% market share We expect M&M to report an 11% CAGR in tractor volume over FY10-12. Post the acquisition of Punjab Tractors, M&M has become the dominant player in the tractor segment, commanding 41% market share. It is well-entrenched in most regions, with above 40% market share in the South, West and East. Even in the North, where the companys presence is relatively weak, it remains the market leader with 35% market share. Moreover, the companys portfolio caters to all segments. M&M is well positioned to capitalize on its leadership in the segment. Post the acquisition with Punjab Tractors, M&M revamped its tractor operations; tractors from Punjab Tractors constitute the lower end of the groups combined product range, while those from M&M are at the higher end. This segment is M&Ms most profitable division. The other sub-segment sales of DG sets, engines, forklifts and harvester combines is doing well.
where M&M commands ~41% market share
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FY12e
FY05
FY06
FY07
FY08
FY09
FY10
Fig 4 M&M: Tractor volume and growth

250,000 200,000 Nos 150,000 100,000 50,000 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 55 45 35 25 15 5 -5 %
Fig 5 M&M: Tractor market share

45 41.4 40 % 35 30 25 20 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 40.7 41.8
T ractor (units) (LHS)
Growth (RHS)
M&M's tractor market share

Foray into international markets solid foundation in place

M&M aims to become a global player in tractors and SUVs M&Ms aim to become an international player in tractors and SUVs is reflected in its acquisition of Chinese tractor companies and Korean SUV manufacturer Ssangyong. We believe M&M has a sound balance sheet and enough cash flow for its acquisitions despite high capex in coming years. M&Ms main markets for tractors and utility vehicle segments are Africa (mainly Nigeria, Mali, Chad, Gambia, Angola, Sudan, Ghana, and Morocco), Latin America (Chile and Brazil), South Asian countries (Sri Lanka, Bangladesh and Nepal), Middle East (Iran and Syria) and East Europe (Serbia and Macedonia; FES entered Turkey in 2008). Total exports were only 4.4% of total sales in FY10 (7.2% in FY08). Exports of utility vehicles were 4.6% of total vehicles sold in FY10 (7.7% in FY08) whereas tractor exports constituted 5.3% of total tractor sales in FY10 (8.8% in FY08). Fig 6 M&M: Total exports to total volume
30,000 25,000 20,000 9.0 7.5 6.0 4.5 3.0 1.5 0.0
Nos
15,000 10,000 5,000 0
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11e
M&M's total exports (LHS)

Exports as % of total volume (RHS)
72
FY12e
Fig 7 M&M: Tractor exp. to tractor vol.

12,000 9,000 Nos 6,000 3,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 12 10 % 8 6 4
Fig 8 M&M: UV exports and to UV vol.

16,000 12,000 Nos 8,000 4,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 9.0 7.0 5.0 3.0 1.0 %
Tractor exports (units) (LHS)
% of total volumes (RHS)
UV exports (units) (LHS)
Farm equipment segment: International aspiration to take off M&M has a presence in all large tractor markets, either with own assembly plants or through acquisitions or JVs. We expect the steps it has taken to move into international markets to bear fruit over the next five years. Mahindra USA (MUSA): Mahindra USA is a wholly-owned subsidiary of M&M. Over the years, Mahindra USA has reinforced its position in the compact and utility tractor segments. It has a wide network of tractor dealers that provides customers product support and after sales service. The company has three assembly plants in the US in Houston (Texas), Calhoun (Georgia) and Redbluff (California). Mahindra Australia: Brisbane-based, it offers a range of 2WD and 4WD compact tractors (20-30 HP range) and utility tractor models (45-80 HP range) along with attachments like loaders, backhoes and mowers. Mahindra China Tractor Company Ltd. (MCTCL): A joint venture between Jiangling Motors Company Group and Mahindra & Mahindra FES. It is increasingly becoming a centre for M&M to expand its product range and develop tractors for China and other overseas markets. JV with Jiangsu Yueda Yancheng Tractor Manufacturing Co: It is a joint venture with Jiangsu Yueda Yancheng Tractor Manufacturing Co. Ltd. (Yancheng Tractor), a leading Chinese tractor manufacturer. M&M is to hold 51 per cent in the JV. Yancheng Tractors Huanghai Jinma brand is the No 3 tractor brand in China (in terms of tractor volume in 2007). With a global footprint in the farm equipment segment in place, M&M intends to increase its international volume from 5.3% of total volume in FY10 to 15% by FY15. Exports of utility vehicles Utility vehicle exports form a mere 4.6% of the total volume at present. These vehicles are currently sold in Chile, Africa and Australia. We believe M&M can create a market for its vehicles internationally based on the price points at which it would launch in the global markets. Some 250,000 compact UVs are already being sold in the US every year. The Scorpio launch in the US is planned for after the completion of its homologation process there. At present, M&M has a very small presence in Europe. However, it plans to continue selling in the European market; the company may see rapid expansion in the European market now with Ssangyong in its stable. Acquisition of Ssangyong an important step We see M&Ms successful bid for the Korean SUV manufacturer as an important leap into the international market. The media and management conference call suggests the deal is in the range of US$450-500m. The key rationale for the move is M&Ms aspiration to become a global player in the SUV market. 73
Ssangyong acquisition
Our view: Ssangyong has 138 dealers in Korea and another 1,300 dealers across 98 nations worldwide. Thus, the acquisition gives M&M access to the Korean and European markets. Access to Ssangyongs large assembly capacity of 120,000 units per annum on single shift and engine capacity of 150,000 units (both petrol and diesel). M&M has strengthened the UV/SUV product portfolio by acquiring products like Rexton, Kyron, Actyon and other sedan models. Though it will have to refresh these models as the last new model was launched in 2002 (Rexton) and refreshed in 2007. The acquisition will add very little to M&Ms technical capability (R&D spend has been much lower in the last eight years) but will bring some synergies, going forward, to R&D spends. With a sound balance sheet and debt-equity ratio of less than 0.5, M&M is comfortably placed to fund the acquisition. The acquisition helps M&M garner an SUV market share of 14% in Korea. Overall, we view this acquisition as a win-win for M&M. Highlights of the deal from the conference call by M&M management The acquisition is a debt-free one with likely to M&M infuse US$450-500m (according to media reports) into the company to acquire a controlling stake. The infused money would be used to repay all long-term debts (US$320m as on March 2010 post restructuring). M&M will also provide an additional pre-determined debt to Ssangyong for it to continue operations. Ssangyong is also launching a new product, Korando C200, in 2010; according to management, no further launches are planned for two years following this launch. The fixed costs at Ssangyong have been reduced 37% by downsizing; the current operations, on a quarterly basis, are very close to break even levels and, hence, according to management, it will not be too difficult to get the company back in the black. According to management, there are no immediate labour issues either. The company sold 35,000 units in FY09 and the current monthly run-rate is +7,000 units; with a new product offering lined up this year, we believe there will be an improvement from this level.
New business ventures to add value

Over the past 3-4 years, M&M has increased its business portfolio by venturing into two-wheelers (acquired Kinetic), commercial vehicles (JV with Navistar), electric car (Reva) and auto components (Mahindra Systec). It has also carved out separate subsidiaries (defense and logistic) from existing operations. Over the medium to long term, we feel there is substantial value unlocking potential in these businesses. M&HCV joint venture with Navistar The joint venture will start production at its Chakan facility with capacity of 250,000 units for UVs/LCVs and 50,000 units for M&HCVs. The commercial vehicle industry is a virtual duopoly with enough for a third player. We believe that M&Ms JV with Navistar would enable it to become a major player in the segment over the next five years given its market knowledge and Navistars products and technology. Most other new players are unlikely to succeed to this extent given that they have either partnered with weak domestic players or are going it alone. The JV targets to produce a range of trucks from 9T onwards. 74
The JV is ready to launch a 25T truck followed by a 31T truck in FY11. The JV may use the existing dealer network in rural/semi urban areas for servicing and is also creating an alternate dealership network for the truck venture. Two wheelers: May remain a niche player M&M has acquired an 80% stake in Kinetic Motor Company (KMC), which has three production plants and a capacity to produce 400,000 two wheelers in a year. The company has also acquired Engines Engineering, Italy, which specialises in designing two wheelers. Kinetics market share has improved significantly from 0.5% at the time of the takeover to 6% post the takeover. The company has big plans for both the scooter and motorcycle segments, but the twowheeler industry is very crowded with the top three players enjoying over 90+ market share. Hence, we believe M&M may remain a niche player in the industry.
Value unlocking potential in new subsidiaries

Defense subsidiary Historically, the defense business had been an integral part of M&M. Seeing the opportunities available in the sector given the government increased spending on defense, the company created a separate subsidiary to cater to defense. In addition, in 2009, it set up a dedicated plant in Haryana to cater to defense requirements. Strong outlook for defense business India is one of the worlds largest importers of arms and defense equipment, with nearly 70% of the requirement being met by foreign companies. The government has announced its intent to decrease the import content in military hardware to ~30% over the next seven years. In addition, it announced an offset clause (whereby 30% of the overall expenditure from a foreign company will have to be sourced from Indian companies). Mahindra Defence Systems (MDS) has traditionally provided the entire range of light combat/armoured vehicles for defence/security forces. However, there are clear indications that the company seems to be attaching greater importance to the segment. Mahindra Logistics Mahindra Logistics, which began as a division supporting M&Ms transportation needs (called transport solutions group), was eventually hived off as a 100% subsidiary in 2008. The company provides inbound and outbound solutions to nearly 200 clients across various verticals, apart from automobiles. It manages more than 35 automotive plants with a warehousing capacity of more than 3m sq ft. In Indias growing logistics sector, with very few organized players, M&M has the potential to grow both organically as well as inorganically. The company has vast experience in inbound and outbound logistics. Mahindra Systec Mahindra Systec, a division of M&M, has interests in forgings, castings, engineering services (both for autos and airplane manufacturing), gear manufacturing and component sourcing. The company has expanded by acquiring companies in India and Europe. The company today has revenue close to US$1bn.
Valuation
At the current price, M&M is trading at 11.4x FY12e consolidated earnings on fully-diluted equity. We utilize a sum-of-parts method to arrive at our fair value of Rs762 (25% upside). To arrive at fair values for M&Ms listed subsidiaries (Tech Mahindra, M&M Financial, Mahindra Life Spaces, Mahindra Holidays, and Mahindra Forgings), we apply a 20% discount to their current market price. We assign a multiple of 8x to Mahindra Systech. We value investments in Mahindra Navistar at a 50% discount to its book value, and apply a 50% discount to book/market value of M&Ms other investments.
75
Fig 9 M&M: SOTP valuation Rs Core EPS PE attributable (x) Fair value Value of listed subsidiaries & associates 1. Tech Mahindra No. of shares held by M&M (m) Current price Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. 2. M&M Financial Services No. of shares held by M&M (m) Current price Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. 3. Mahindra Lifespaces No. of shares held by M&M (m) Current price Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. 4. Mahindra Holidays No. of shares held by M&M (m) Current price Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. Total value of listed subsidiaries Value considering 20% discount Value of Systech Division 1. Mahindra Forgings No. of shares held by M&M (m) Current price Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. 2. Other Systech PAT excluding MUSCO and MF PE attributable (x) Value of holding (Rs m) Value per share of M&M Value p.s. of M&M after 20% disc. Total value of Systech Value considering 20% discount Mahindra Holdings & Finance @ 50% disc Mahindra Renault (at 50% disc to BV) Mahindra Navistar (at 50% disc to BV) Other investments in books at 50% disc Total for others Fair value Fair value (after 20% discount) FY08 13.6 13 177 FY09 13.3 13 172 FY10 32.0 13 416 FY11e 39.3 13 511 FY12e 43.8 13 569
54 651 35,011 59 47 58 576 33,546 56 45 21 457 9,527 16 13 70 484 33,873 57 46 188 150
54 651 35,011 59 47 58 576 33,546 56 45 21 457 9,527 16 13 70 484 33,873 57 46 188 150
54 651 35,011 59 47 58 576 33,546 56 45 21 457 9,527 16 13 70 484 33,873 57 46 188 150
54 651 35,011 59 47 58 576 33,546 56 45 21 457 9,527 16 13 70 484 33,873 57 46 188 150
54 651 35,011 59 47 58 576 33,546 56 45 21 457 9,527 16 13 70 484 33,873 57 46 188 150
45 101 4,484 15 12 1,223 8 9,785 17 13 32 25 5 6 4 9 24 420 376
45 101 4,484 15 12 463 8 3,706 6 5 21 17 5 6 4 9 24 406 364
45 101 4,484 15 12 -262 8 -2,093 -4 -3 11 9 5 6 4 9 24 639 599
45 101 4,484 15 12 -26 8 -212 0 0 15 12 5 6 4 9 24 737 697
45 101 4,484 15 12 660 8 5,279 9 7 24 19 5 6 4 9 24 805 762
76
Fig 10 M&M: 12-month forward PE band

1,200 1,000 800 Rs 600 400 200 0 Apr-10 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10
20x 15x 12x 8x 4x Aug-10
19x 16x 13x 10x 7x 4x
Fig 11 M&M: 12-month forward EV/EBITDA band

1,200 1,000 800
Rs
600 400 200 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Dec-05 Dec-06 Dec-07 Dec-08 Aug-09 Dec-09 Apr-10
Risks
A slowdown in the Indian economy as both the automotive as well as the farm equipment segments are linked to the India growth story. Consolidated entity is very complex Recently, the company ventured into areas such as commercial vehicles, passenger cars, two wheelers and auto components, which will demand a significant part of managements time. M&M, as a consolidated entity, has made a number of acquisitions in the recent past. Integration as well as future financial commitment to the newly-acquired business may bring the consolidated balance sheet under pressure.
Apr-05
Apr-06
77
Apr-07
Apr-08
Apr-09
Financials (Standalone)
We expect M&M to register, over FY10-12, CAGR of 14% in volume, 16% in revenue, 11% in EBITDA and 17% in profit. Fig 12 M&M: Revenue and rev growth
300,000 250,000 200,000 Rsm 150,000 100,000 50,000 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 20 10 0 50 40
Fig 13 M&M: Adj. net profit and growth

30,000 25,000 20,000 Rsm 15,000 10,000 5,000 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
%
120 100 80 60 40 20 0 -20 %
30
M&M's revenue (LHS)
Growth (RHS)
Adj. Profit (LHS)
Growth (RHS)
Fig 14 M&M: RM and RM as % of sales

200,000 160,000 Rsm 120,000 80,000 40,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 72 70
Fig 15 M&M: EBITDA and margins

40,000 35,000 30,000 25,000 Rsm 15 12 9 6 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e % 18
68 66 64 62 %
20,000 15,000 10,000 5,000 0
Raw Material (LHS)
RM as % of sales (RHS)
EBITDA (LHS)
EBITDA magins (RHS)
Fig 16 M&M: Realization per vehicle

600,000 500,000 400,000 Rs
Fig 17 M&M: EBITDA per vehicle

64,000 53,000 Rs 42,000 31,000 20,000 FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09 FY10
300,000 200,000 100,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Realization per vehicle - Tractor Realization per vehicle - Utility vehicle

EBITDA per vehicle

78
Fig 18 M&M: Standalone quarterly segmental performance Rs m Revenue from operations Automotive segment Farm equipment segment Other segments Total Profit/loss before interest and tax Automotive segment Farm equipment segment Other segments Total EBIT margins (%) Automotive segment Farm equipment segment Other segments Less: interest Less: other un-allocable expenditure Total PBT 1QFY09 18,732 13,245 2,016 33,993 1,501 1,561 34 3,096 8.0 11.8 1.7 97 865 2,134 2QFY09 19,208 13,952 203 33,363 1,057 1,480 35 2,572 5.5 10.6 17.3 122 259 2,192 3QFY09 13,702 15,018 169 28,889 -104 1,628 25 1,549 -0.8 10.8 14.5 141 964 444 4QFY09 21,717 14,485 311 36,512 1,574 1,605 68 3,246 7.2 11.1 21.8 209 -1,869 4,906 1QFY10 22,575 19,750 198 42,524 2,302 3,344 27 5,673 10.2 16.9 13.8 60 233 5,381 2QFY10 26,145 18,556 230 44,930 3,429 3,784 52 7,264 13.1 20.4 22.6 128 -1,671 8,808 3QFY10 25,568 19,282 212 45,062 2,868 3,523 7 6,397 11.2 18.3 3.2 82 442 5,873 4QFY10 31,139 21,763 201 53,103 4,065 4,358 53 8,476 13.1 20.0 26.5 9 786 7,681 1QFY11 28,798 22,739 137 51,673 3,521 3,894 2 7,418 12.2 17.1 1.7 -227 433 7,211
Consolidated financial performance On consolidated basis, we expect revenue and profit to report CAGRs of 15% and 13.6% over FY10-12, respectively. Fig 19 M&M: Consolidated financials (Rsmn) Total revenue % growth PBT % growth PAT Reported consolidated PAT Adjusted consolidated PAT Diluted adjusted cons EPS FY06 125,881 18,025 13,996 12,697 9,842 16.5 FY07 178,418 41.7 22,024 22.2 16,067 14,972 14,091 23.7 FY08 242,676 36.0 25,040 13.7 18,468 15,711 16,321 27.4 FY09 267,670 10.3 22,541 -10.0 17,120 14,054 14,586 24.5 FY10 315,905 18.0 40,300 78.8 28,758 24,786 23,004 41.6 FY11E 365,219 15.6 43,569 8.1 33,330 28,905 28,905 48.5 FY12E 418,806 14.7 48,283 10.8 37,178 31,973 31,973 53.7
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Fig 20 M&M: Consolidated segmental revenue, profit, and margins FY09 FY10 Common Size (%) Revenue Profit Revenue Automotive 31.1 9.7 35.7 28.5 Farm equipment 25.1 25.1 Total core business (A) 56.2 34.8 64.2 Steel trading and processing 2.5 3.6 1.9 Financial services 5.2 12.5 5.0 Total trade & financial services (B) 7.7 16.1 6.8 Infrastructure 1.3 4.2 1.3 Hospitality 1.5 3.5 1.6 Total infrastructure development (C) 2.8 7.7 2.9 Total A + B + C 66.7 58.6 73.9 IT services 17.4 42.3 15.3 Systech 13.5 0.9 8.1 Others 2.4 -1.8 2.8 Margins (%) Automotive 3.1 Farm equipment 9.9 Total core business (A) 6.2 Steel trading and processing 14.2 Financial services 24.0 Total trade & financial services (B) 20.8 Infrastructure 33.0 Hospitality 23.1 Total infrastructure development (C) 27.6 Total A + B + C 8.7 IT services 24.2 Systech 0.7 Others -7.2 Grand total 10.0 Unallocable expenses (net of income) 0.3 Net unallocable interest income (net of exp) -0.9 Unallocable exceptional items -0.3 PBT 8.4 Tax 2.0 PAT 6.4 Prior period adjustments 0.0 Share of associates 0.0 Minority interest 1.2 Reported consolidated PAT 5.3 Adjusted consolidated PAT 5.4
Profit 28.9 32.2 61.1 1.9 12.0 13.9 2.8 3.6 6.4 81.4 23.5 -2.5 -2.5 11.2 15.6 13.2 14.0 33.4 28.1 29.3 31.6 30.6 15.2 21.3 -4.2 -12.3 13.8 0.5 -1.4 0.8 12.8 3.7 9.1 0.0 0.1 1.3 7.8 7.3
FY11e FY12e Revenue Profit Revenue Profit 37.2 28.0 38.6 25.7 27.1 27.9 25.8 25.7 64.3 55.9 64.4 51.3 1.7 1.7 1.6 1.7 5.2 12.4 5.3 13.5 6.9 14.2 6.9 15.1 1.5 3.6 1.6 4.1 1.7 3.9 1.8 4.2 3.2 7.5 3.4 8.4 74.3 77.6 74.7 74.8 14.7 23.2 14.1 23.4 8.4 1.3 8.8 2.8 2.6 -2.0 2.5 -1.0 10.0 13.7 11.6 13.5 32.0 27.4 32.5 30.0 31.2 13.9 21.0 2.0 -10.0 13.3 0.4 -1.0 0.0 11.9 2.8 9.1 0.0 0.1 1.3 7.9 7.9 8.4 12.6 10.1 13.5 32.0 27.8 32.5 30.0 31.2 12.7 21.0 4.0 -5.0 12.6 0.3 -0.8 0.0 11.5 2.7 8.9 0.0 0.1 1.3 7.6 7.6
80
Fig 21 M&M: Income statement (Standalone) Year end March (Rs m) Volume (units) YoY growth (%) Net realisation (Rs) YoY growth (%) Operating other income Total Income Change (%) Total EXPENDITURE EBITDA Change (%) % of net sales Depreciation EBIT Interest & finance charges Other income Profit before tax Tax Effective rate (%) Profit after tax Change (%) Adj. Profit after tax Change (%) FY09 325,946 11.0 400,142 3.0 3,997 130,425 14.3 117,961 12,464 0.2 9.6 2,915 9,549 453 2,703 10,672 1,997 18.7 8,675 -21.4 9,217 5.4 FY10 451,927 38.7 410,014 2.5 4,916 185,296 42.1 156,179 29,117 133.6 15.7 3,708 25,409 278 1,994 28,468 7,590 26.7 20,878 140.7 19,893 115.8 FY11e 521,274 15.3 415,598 1.4 5,309 216,641 16.9 184,245 32,395 11.3 15.0 4,381 28,014 231 2,592 30,375 6,075 20.0 24,300 16.4 24,300 22.2 FY12e 584,344 12.1 425,143 2.3 5,734 248,430 14.7 212,867 35,562 9.8 14.3 5,462 30,101 231 3,239 33,109 5,960 18.0 27,149 11.7 27,149 11.7 FY13e 646,526 10.6 434,765 2.3 6,020 281,087 13.1 243,310 37,777 6.2 13.4 6,118 31,659 231 3,401 34,830 6,269 18.0 28,560 5.2 28,560 5.2
Fig 22 M&M: Balance sheet (Standalone) As at end March (Rs m) Share capital Reserves Net worth Deferred tax Loans Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr. assets, L & Adv. Inventory Sundry debtors Cash & bank balances Loans & advances Others Current liab. & prov. Sundry creditors Other liabilities Provisions Net current assets Working capital Misc. Expenditures Application of funds FY09 2,726 49,895 52,621 -183 40,528 92,966 48,939 23,263 25,676 6,467 57,864 50,629 10,607 10,437 15,744 13,826 16 47,978 33,368 1,834 12,776 2,652 -13,093 307 92,966 FY10 2,830 75,438 78,268 2,403 28,802 109,473 52,763 25,378 27,385 9,642 63,980 60,424 11,888 12,581 17,432 18,014 509 51,965 32,601 1,399 17,965 8,458 -8,974 7 109,472 FY11e 2,921 91,782 94,703 2,403 28,802 125,907 67,405 29,759 37,646 0 63,980 81,834 13,927 14,740 34,644 18,014 509 57,559 38,195 1,399 17,965 24,274 -10,369 7 125,907 FY12e 2,977 110,146 113,123 2,403 28,802 144,328 82,405 35,220 47,184 0 63,980 96,385 15,994 16,927 44,940 18,014 509 63,228 43,863 1,399 17,965 33,157 -11,783 7 144,328 FY13e 2,977 129,246 132,223 2,403 28,802 163,427 85,405 41,338 44,067 0 63,980 124,453 18,128 19,185 68,617 18,014 509 69,078 49,714 1,399 17,965 55,374 -13,243 7 163,427
81
Fig 23 M&M: Ratios (Standalone) Year end March Basic (Rs) Adjusted EPS Consolidated EPS Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Consolidated P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) EBIDTA margins Net profit margins RoE RoCE Turnover ratios Debtors (days) Inventory (days) Creditors (days) Working capital (days) Asset turnover (x) Leverage ratio Debt/equity (x) FY09 15.5 24.5 20.4 96.5 10.2 33.9 39.4 24.9 30.0 24.1 2.4 6.3 1.7 9.9 6.9 17.5 13.2 30 31 96 -36 1.4 0.8 FY10 33.4 41.6 39.6 138.3 9.7 31.9 18.3 14.7 15.4 10.1 1.6 4.4 1.6 16.1 11.6 25.4 25.0 25 24 66 -16 1.6 0.4 FY11e 40.8 48.5 48.2 162.1 12.0 32.7 15.0 12.6 12.7 8.9 1.4 3.8 2.0 15.3 11.5 25.7 24.3 25 24 66 -16 1.7 0.3 FY12e 45.6 53.7 54.8 190.0 13.0 32.4 13.4 11.4 11.1 8.0 1.2 3.2 2.1 14.7 11.2 24.0 23.1 25 24 66 -16 1.7 0.3 FY13e 48.0 63.8 58.2 222.1 14.0 33.1 12.7 9.6 10.5 6.9 0.9 2.7 2.3 13.7 10.4 21.6 21.5 25 24 66 -16 1.7 0.2
Fig 24 M&M: Cash flow statement (Standalone) Year end March (Rs m) FY09 FY10 OP/(loss) before tax 9,549 25,409 Int./dividends received 2,703 1,994 Depreciation & amort. 2,915 3,708 Direct taxes paid -2,747 -5,004 (Inc)/dec in wkg. capital 8,524 -4,119 Other Items CF from oper. activity 20,944 21,988 Extra-ordinary items -1,127 1,343 Other items -171 300 CF after EO items 19,646 23,631 (Inc)/dec in FA+CWIP -11,449 -8,592 (Pur)/sale of invest. -15,714 -6,116 Cf from inv. activity -27,163 -14,708 Change in net worth 3,235 10,267 Inc/(dec) in debt 14,657 -11,726 Interest paid -453 -278 Dividends paid -2,788 -5,495 Cf from fin. activity 14,651 -7,233 Inc/(dec) in cash 7,134 1,690 Add: beginning balance 8,612 15,744 Closing balance 15,746 17,434
FY11e 28,014 2,592 4,381 -6,075 1,395 30,307 0 0 30,307 -5,000 0 -5,000 -853 0 -231 -7,010 -8,094 17,213 17,432 34,646
FY12e 30,101 3,239 5,462 -5,960 1,414 34,256 0 0 34,256 -15,000 0 -15,000 -987 0 -231 -7,740 -8,958 10,298 34,644 44,942
FY13e 31,659 3,401 6,118 -6,269 1,459 36,369 0 0 36,369 -3,000 0 -3,000 -1,123 0 -231 -8,336 -9,690 23,679 44,940 68,619
82
Company profile
Mahindra & Mahindra is Indias leading utility vehicle and tractor manufacturer Mahindra & Mahindra is Indias leading utility vehicle and tractor manufacturer. It has over the years diversified into sectors such as real estate, IT, financial services, logistics. M&M has generally followed an inorganic growth strategy to dominate its business. Recent acquisitions include Punjab Tractors, Satyam Computers, and Ssangyong. M&Ms auto products include Bolero, Xylo and Scorpio (utility), Alpha, Gio and Maximo (threewheelers), Logan (car), Kinetic (two-wheelers), Arjun and DI Super Turbo (farm equipment). It will manufacture LCVs in a JV with Navistar that would eventually also manufacture M&HCVs. Under the management team headed by chairman Keshub Mahindra and vice-chairman and managing director Anand Mahindra, M&M has expanded its business horizons to offer a whole range of products. Fig 25 Mahindra & Mahindra: Shareholding pattern
Others 26% Promoter 26%
DII 25%
Source: BSE
FII 23%
83
Maruti Suzuki
Time to be zen-like; initiate with Outperform

Rs1,218
We initiate coverage on Maruti Suzuki with a contrarian Outperform call and fair value of Rs1,478. We believe the negatives (rising competition, market share loss, and increase in royalty payments) are priced in and that the stock currently offers a good entry point considering its balance sheet strength, cash flow as well as 26% earnings growth in FY12e.
MSIL IN
Market cap
MRTI.BO
12 month range
US$7.8bn
Rs1,193-1,701
To lose less market share than most expect We estimate Maruti would lose 600bps in market share over FY10-12e (including the Nano impact). Our view: with industry capacity rising at a 16% CAGR (most added by Maruti and Tata Motors) and with industry volume CAGR of 23%, market share loss could be lower than our expectations. In addition, we have taken a worst-case volume CAGR estimate of 16.5% for Maruti over FY10-12e. The company could outperform our expectations given its established brand, strong dealer network, aggressive and innovative marketing strategies and largest and best-reach service network. Market leader on many fronts We expect Maruti to maintain its domestic market leadership in passenger cars, especially in small and compact cars. Export-oriented models could provide an added impetus going forward, subject to capacity expansion over the next two years. Export ramp-up Although suffering the hangover of the cash-for-clunkers scheme, we expect most European markets to report steady recovery in auto demand over the next three years. We expect Marutis exports to benefit from the European recovery and also from its efforts to tap new markets. We estimate Marutis exports to record an impressive 12% CAGR over FY10-12 (on base of FY10), raising exports share of volume to 13.5% by FY12e (from 6.9% in FY08). Valuation Our fair value multiple for Maruti is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently the valuation is weighed down on account of intense competition in the PC segment and the surprise higher royalty cost. Our earnings do capture the worst case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside).
Year end: March Sales (Rs m) EBIT (Rs m) EBITDA (Rs m) Pretax profit (Rs m) Earnings (Rs m) adjusted EPS (Rs) adjusted EPS growth (%) adj. DPS (Rs) DPS growth (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Div payout (%) Book value/share (Rs) Net gearing (%) ROE (%) ROACE (%) FCF (Rs m) EV/Sales (x) EV/EBITDA (x) PBR (x) PER (x) Dividend yield (%)
FY10 296,230 31,293 39,543 35,925 25,184 87.1 62.5 6.00 -30.0 13.3 10.6 8.5 6.9 409.5 6.1 21.1 28.6 20,809 1.0 7.3 3.0 14.0 0.5
FY11e 364,289 33,422 42,258 35,616 26,100 90.3 3.6 7.00 71.5 11.6 9.2 7.2 7.8 491.3 -5.5 18.1 24.2 17,431 0.8 6.4 2.5 13.5 0.6
FY12e 428,318 41,326 51,184 44,999 32,856 113.7 25.9 8.00 16.7 12.0 9.6 7.7 7.0 595.4 -18.8 18.8 25.3 27,301 0.6 4.8 2.0 10.7 0.7
FY13e 497,863 49,756 60,739 55,972 40,756 141.0 24.0 8.00 14.3 12.2 10.0 8.2 5.7 726.8 -31.4 19.2 26.0 36,298 0.4 3.5 1.7 8.6 0.7

1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 Aug09 Nov09 Feb10 May10 Aug10
MarutiSuzukiIndiaLtd
-1 mth 1 1 -4
-3 mth -12 mth -1 -14 -7 -28 -16 -66 Promoter: 54.21% 45.79% US$22.8m
Amit Kasat
84

We believe the negatives (rising competition, market share loss, and increase in royalty payments) are priced in and that the stock currently offers a good entry point considering its balance sheet strength, cash flow as well as 26% earnings growth in FY12e.
Maruti to underperform industry volume growth

Maruti likely to report domestic PC CAGR of 18.1% vs industrys 21.6% over FY10-12e We expect the passenger car industry to report 25.5% volume CAGR including Nano; excluding Nano, our growth estimate falls to 22.3%. Our estimates imply domestic growth of 21.6% and export growth of 24.9% over FY10-12. Compared with industry volume growth, we expect Maruti to register domestic passenger car CAGR of 18.1% and export CAGR of 12% over FY10-12, mainly driven by the A2 and A3 segments. We have factored in conservative volume growth assumptions for Maruti to assess the worstcase scenario of loss in market share due to the entry of new players. Fig 1 Maruti: Total volume and growth
1,500 1,200
'000 units
28.6
32 24 16 14.5 8 0
% growth
%
900 600 300 0

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e
18.6
Maruti's total volume (LHS)

Growth (RHS)
Fig 2 Maruti: Domestic vol and growth

1,400 1,100 30 24
Fig 3 Maruti: Export vol and growth

200 150 120 80 40 0 -40 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
'000 units
'000 units
18 12 6 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e % 800 500 200
100 50 0
Maruti's domestic volume (LHS)
Growth (RHS)
Maruti's export volume (LHS)
85
FY12e
Growth (RHS)
Fig 4 Maruti and industry: Comparison of volume CAGR Maruti Suzuki (%) Domestic PC sales A1 segment A2 segment A3 segment Domestic MPV sales Domestic UV sales Domestic PV sales PC exports PV exports Total PC sales Total PV sales Industry CAGR (FY04-09) CAGR (FY10-12e) CAGR (FY04-09) CAGR (FY10-12e) 12.2 18.1 11.9 21.6/25.5* -21.7 -27.6 23.8 19.9 40.5 15.9 5.5 11.4 13.3 11.0 16.1 4 7.8 13.7 11.4 17.3 11.3 22.8 6.6 11.5 21.5 24.9 6.6 12 21.1 24.8 11.6 17.1 13.6 22.3 10.9 16.5 12.8 23.2
* Including Nano volume Source: SIAM, Company, Standard Chartered Research estimates
Market share loss might be limited

Maruti could lose 600bps (our worstcase scenario) in market share over FY10-12 We estimate that Maruti could lose 600bps (our worst-case scenario) in market share over FY1012 (including the Nano impact). In reality, the loss in market share may be very limited. Our analysis is based on the assumption that all competitors new launches will be released on scheduled and that the new cars in each segment will be 100% successful (which is rare). In addition, we have assumed 75% utilisation (excluding Maruti) for the industry over FY10-12. Fig 5 Maruti: Market share excluding/including Nano
55 51.5 50 % 50.7 47.5 45.1
46.8
45
43.9 FY12e
40 FY07 FY08 FY09 FY10 FY11e
Maruti's total passenger car market share

Maruti's total passenger car market share (including Nano)
The company could outperform our expectations
Our view: With industry capacity rising at a CAGR of 16% over FY10-12e (49% added by Maruti and Tata Motors) and with industry volume growing at a CAGR of 23%, the loss in market share could be lower than our expectations. In addition, we have taken a worst-case volume CAGR estimate of 16.5% for Maruti over FY10-12. The company could outperform our expectations, given its established brand, strong dealer network, aggressive and innovative marketing strategies and largest and best-reaching service network.
86
Fig 6 Industry: Capacity from FY05-12e

5,000 4,000
Fig 7 Industry: Util with/without Maruti

160 140 120
%
'000 units
3,000 2,000 1,000 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
100 80 60 40 FY11e FY12e FY05 FY06 FY07 FY08 FY09 FY10
Industry capacity addition from FY05-12e

Note: Capacity also includes UV and SUV capacities Source: SIAM, Standard Chartered Research estimates
Industry capacity utilisation Industry capacity utilisation excluding Maruti Maruti's capacity utilisation
Note: Marutis utilisation is on nameplate capacity in BS for historical years Source: Companies, Standard Chartered Research estimates
Fig 8 Industry: Incremental capacity addition over FY10-12e

5,000 4,500 Others Nano Nano Maruti
49% of incremental industry capacity to be added by Tata Motors and Maruti over FY1012e
'000 units
4,000 3,500 3,000 2,500 2,000 FY10 FY12e
New entrants underestimating Indias demand growth over the next five years
New entrants underestimating India demand, which may help Maruti Indias consumption-led economy has prompted global majors to set up shop in India. They all plan to launch cars in the largest selling segment small/compact cars. But we believe they are underestimating Indias demand growth over the next five years, considering their slow pace of new product launches, investment in creating capacities and sales and distribution networks. Their capacity expansion plans are relatively small compared with those of Maruti, Tata Motors and Hyundai. Although capacity creation can take place in a relatively short time frame, developing India-specific models could be a longer process. Creation of distribution networks key challenge for new players In addition to creating capacities and aggressively developing new products, setting up a distribution network in India will be a key challenge for new players. Currently, the top 10 cities contribute 45-50% of overall passenger vehicle sales; in our view, these cities have become more or less saturated. Going forward, we see demand in these cities coming mainly from replacement demand. We expect demand from cities other than the top 10 will contribute a lions share of incremental demand and customer preferences would be for small and compact cars.
setting up a distribution network a key challenge for them
87
Fig 9 Industry: Sales by location

60 50 40 % 30 20 10 0 FY15e FY10 15 35 35 50
Fig 10 Maruti: Dealerships/locations

1,200 1,000 802 491 325 375 200 227 600 312 393 681 454 555
45
1,000 800 Nos 20 600 400 200 0 FY05
Top 10 cities
Next 40 cities
Others
Source: Company
Dealerships
Cities covered
We therefore believe that there is a strong possibility that Maruti could outperform our volume assumptions and, hence, the loss in market share may be limited.
Market leader on many fronts

Market leader in the small and compact car segment We expect Maruti to retain market leadership in the domestic passenger car market, especially in the small and compact car segment. Export-oriented models could provide added impetus going forward, subject to capacity expansion over the next two years. Operating performance is expected to improve in the next two years on account of lower royalty payout after two years. Maruti has displayed strength in its balance sheet, cash flows as well as earnings, even during the crisis. Domestic leadership expected to continue We expect Maruti to retain its dominant market share in the domestic passenger car segment (>45%), fending off local competitors such as Tata Motors and M&M, and overseas majors such as Hyundai, Honda, Ford, General Motors and Fiat. Furthermore, we expect Maruti to retain its dominant overall market share of ~44% (and domestic market share of 50 %+) in the key volumedriver small and compact-car segment (we have excluded the impact of Nano in our analysis). The key rationale: Maruti has one of best product portfolios in India to satisfy every customer need New models like A-Star (launched in Nov 2008), Ritz (launched in Apr 2009), Eeco (launched in March 2010), Alto K10 (launched in August 2010) along with refreshing the Swift and WagonR ranges are not only expected to help ward off competition, but also lower losses in market share in FY12. Maruti has a history of successful innovative and aggressive marketing strategies, resulting in good volume growth over the years, keeping the company ahead of competition. Fig 11 Maruti: Innovative marketing campaigns Wheels of India First Class Offer Power Deal Steel Wheel Teachers Scheme Dil Se Direct marketing to Govt. employees
Source: Company
for state government employees for Railway employees for NTPC employees for SAIL employees for teachers for non-resident Indians Post implementation of 6th Pay Commission recommendations
88
FY15e
FY06
FY07
FY08
FY09
FY10
Maruti has built a loyal customer base by offering easy service and exchange facilities through its pre-owned-cars True-Value network. By launching attractive models in the A3 class and entering the premium A4 class over the next three to four years, we believe Maruti would retain customers. Maruti is ahead of the market in creating capacities. Its capacity is expected to increase 4050% over FY10-14. Also, the expansion at Manesar is expected to address capacity constraints with regards to Swift, DZire and SX4, while creating additional capacity for new models. Maruti has been the most aggressive company in launching new models in the last 10 years. Fig 12 Maruti: Model launches Key launches FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10e
Source: Company
Baleno & WagonR Alto, Altura & CNG Omni Versa Grand Vitara Swift Swift diesel, Zen Estilo, WagonR Duo SX4, Swift Dzire A-Star, M-800 Uniq, Estilo Sport Splash / Ritz, new Omni
Maruti has successfully created and expanded the diesel car segment by launching various diesel variants. Maruti is the market leader in all alternate fuel segments diesel/LPG/CNG.
Benefits seen from European recovery

Marutis exports likely to grow at a CAGR of 12% over FY10-12 Although still suffering from the hangover of the cash-for-clunkers scheme, we expect most European markets to report steady recovery in auto demand over the next three years. We expect Marutis exports to benefit from this recovery and also from the companys efforts to tap new markets. We estimate Marutis exports to grow at a CAGR of 12% over FY10-12 (on a high base of FY10), raising exports share in volume to 13.4% by FY12 (from 6.9% in FY08). The A-Star is a key export-oriented model, which has enabled Maruti to re-enter the European market after a gap of two years. Marutis top five export markets are Algeria, Chile, Indonesia, Egypt and Sri Lanka. The other key export growth drivers are forays into new markets and the Pixo for export under the Nissan badge. Fig 13 Maruti: Export ramp-up
200 150 120 80 40 0 -40 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e %
Fig 14 Maruti: Exports and dom. sales

100 90 80
'000 units
100 50 0
% 70 60 50 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Maruti's export volume (LHS)
Growth (RHS)
Maruti's export volume Maruti's domestic volume
89
Valuation
Fair value of Rs1,478 at 13x FY12e earnings Our target multiple for Maruti is 13x FY12e earnings, a 5% discount to its six-year forward average PE. On an EV/EBITDA basis, Maruti currently trades at 4.8x FY12e, which is at a 42% discount to its six-year average EV/EBITDA. Our target EV/EBITDA multiple is 7.4x, still 12% lower than the aforesaid average. Currently the valuation is weighed down on account of intense competition in the PC segment and the surprise higher royalty cost. Our earnings do capture the worst case scenario in terms of market share loss as well as cost increase. Our fair value for Maruti is Rs1,478 (21% upside). Fig 15 Maruti Suzuki: 12-month forward PE band
2,000 1,600 1,200 21x 18x 15x 12x 9x 6x 400 0
Rs
800
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Apr-10
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Oct-05
Oct-06
Oct-07
Oct-08
Fig 16 Maruti Suzuki: 12-month forward EV/EBITDA band

2,000 1,600 1,200 Rs 800 400 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 20x 16x 12x 9x 6x
Risks
Intensifying competition Currency impact: JPY depreciation benefits Maruti, 20/25% costs are in Yen. Euro depreciation hurts exports which form 15% of sales.
90
Oct-09
Jul-10
Financials
Growth likely to return to historical levels in FY12 We expect Maruti to register 16.5%, 20%, 13.4%, and 13.8% CAGR in volume, total income, EBITDA and adj. profit, respectively. EBITDA and earnings could be impacted because of the increase in royalty costs. We expect growth to return to historical levels in FY12 with 26% and 21% expected growth in adj. profits and EBITDA, respectively. Fig 17 Maruti: Revenue and growth
500,000 400,000 Rsm 300,000 200,000 100,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 50 40
Rsm
Fig 18 Maruti: Adj. net profit and growth

35,000 28,000 21,000 14,000 7,000 0 FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09 FY10 300 250 200 150 100 50 0 -50 % FY12e % 8 4 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY11e EBITDA (LHS) EBITDA margins (RHS) FY04 FY05 FY06 FY07 FY08 FY09 FY10
30 20 10 0 %
Revenue (LHS)
Growth (RHS)
Adj. Pat (LHS)
Adj. Pat growth (RHS)
Fig 19 Maruti: RM and RM as % of sales

400,000 300,000 Rsm 200,000 100,000 0 FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09 FY10 70 74
Fig 20 Maruti: EBITDA and margins

60,000 45,000 Rsm 20 16 12 30,000 15,000 0
72 % 68 Raw material (LHS) % of sales (RHS)
Fig 21 Maruti: Royalty as a % to net sales

24,000 18,000 Rsm 12,000 6,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e 6 5 4 3 2 1 0 %
Fig 22 Maruti: Realization per vehicle

320,000
270,000 Rs 220,000 170,000

Royalty (LHS)
% of Net Sales (RHS)
91
Fig 23 Maruti: Contribution per vehicle

80,000 72,000 64,000 Rs 56,000 48,000 40,000 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Fig 24 Maruti: EBITDA per vehicle

40,000 35,000 30,000 25,000 20,000 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Fig 25 Maruti Suzuki: Quarterly performance 1Q 226,729 17.7 280,719 13.73 63,647 33.9 1,283 64,930 -596 50,147 76.3 221,175 1,336 2.1 6,112 9.4 56,998 7,932 12.2 29.3 2,165 0 63 10,034 1,961 8,073 2,238 27.7 5,835 5,835 17.6 FY10 2Q 246,188 29.9 287,612 13.30 70,807 47.2 1,219 72,026 -154 54,709 75.7 222,226 1,263 1.8 7,047 9.8 62,865 9,161 12.7 55.6 1,100 0 60 10,202 2,031 8,171 2,471 30.2 5,700 5,700 64.1 3Q 258,026 48.7 285,733 9.10 73,727 62.3 1,302 75,029 -1,312 57,213 74.5 221,732 1,325 1.8 6,464 8.6 63,689 11,339 15.1 163.1 913 0 84 12,168 2,028 10,140 3,265 32.2 6,875 6,875 123.6 4Q 287,422 21.5 288,107 7.63 82,808 30.7 1,437 84,246 129 63,999 76.1 222,664 1,534 1.8 7,474 8.9 73,135 11,111 13.2 65.5 790 0 129 11,772 2,230 9,542 2,976 31.2 6,566 6,566 64.8 FY11 1Q 283,324 25.0 285,553 1.72 80,904 27.1 1,411 82,315 549 63,553 77.9 224,312 1,610 2.0 8,027 9.8 73,739 8,577 10.4 8.1 1,002 652 80 8,847 2,417 6,430 1,777 27.6 4,654 5,110 -12.4 FY10 1,018,365 28.6 285,741 10.7 290,989 42.4 5,242 296,230 0 224,134 75.7 220,092 5,456 1.8 27,097 9.1 256,687 39,543 13.3 71.6 4,968 0 335 44,176 8,250 35,925 10,949 30.5 24,976 24,976 61.2 FY11e 1,207,386 18.6 297,072 4.0% 358,681 23.3 5,609 364,289 0 278,681 76.5 230,814 5,829 1.6 37,522 10.3 322,032 42,258 11.6 6.9 3,240 652 394 44,452 8,835 35,616 9,973 28.0 25,644 26,100 4.5
Total volumes (nos) Change (%) Average realisations: % change Net Sales Change (%) Other operating income Total Income (Inc) / dec in stock Net raw materials RM/sales RM/vehicle Staff costs Staff costs/net sales Mfg & other expenses Mfg & OE as a % of sales Total cost EBITDA As % of sales Change (%) Non-operating income Extraordinary expense Interest PBDT Less: depreciation PBT Tax Effective tax rate (%) PAT Adjusted PAT Change (%)
92
Rs
Fig 26 Maruti Suzuki: Income statement Year end March (Rs m) Net sales Change (%) Income from services Other operating income Total Income Change (%) Total cost EBITDA Change (%) % of net sales Depreciation EBIT Change (%) Def revenue exp. / others Interest & finance charges Other income Non-recurring expense PBT Tax Effective rate (%) PAT Change (%) Adj. PAT Change (%) % of net sales FY09 203,441 13.6 970 4,572 208,983 13.1 185,561 23,423 -16.8 11.2 7,065 16,358 -27.2 -223 510 5,413 4,867 16,758 4,571 27.3 12,187 -29.6 15,495 -14.0 7.4 FY10 289,585 42.3 1,404 5,242 296,230 41.7 256,687 39,543 68.8 13.3 8,250 31,293 91.3 -296 335 4,968 296 35,925 10,949 30.5 24,976 104.9 25,184 62.5 8.5 FY11e 357,207 23.4 1,474 5,609 364,289 23.0 322,032 42,258 6.9 11.6 8,835 33,422 6.8 -258 394 2,982 652 35,616 9,973 28.0 25,644 2.7 26,100 3.6 7.2 FY12e 420,770 17.8 1,548 6,001 428,318 17.6 377,134 51,184 21.1 12.0 9,858 41,326 23.6 -271 394 4,449 652 44,999 12,600 28.0 32,400 26.3 32,856 25.9 7.7 FY13e 489,937 16.4 1,625 6,301 497,863 16.2 437,124 60,739 18.7 12.2 10,983 49,756 20.4 -284 394 6,978 652 55,972 15,672 28.0 40,300 24.4 40,756 24.0 8.2
Fig 27 Maruti Suzuki: Balance sheet As at end March (Rs m) Share capital Reserves Net worth Loans Deferred tax liability Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr. assets, loans Inventory Sundry debtors Cash & bank balances Loans & advances Current liab. & prov. Sundry creditors Provisions Net current assets No. of days Appl. of funds FY09 1,445 92,004 93,449 6,989 1,551 101,989 87,206 46,498 40,708 8,613 31,733 55,100 9,023 9,378 19,390 16,328 34,165 30,358 3,807 20,935 38 101,989 FY10 1,445 116,906 118,351 8,214 1,370 127,935 104,067 53,820 50,247 3,876 71,766 37,724 12,088 8,099 982 15,707 35,678 29,394 6,284 2,046 3 127,935 FY11e 1,445 140,527 141,972 8,214 1,370 151,556 123,943 62,655 61,288 0 71,766 54,387 14,971 11,977 15,996 10,596 35,885 31,164 4,721 18,502 19 151,556 FY12e 1,445 170,614 172,059 8,214 1,370 181,643 138,943 72,514 66,429 0 71,766 83,719 17,602 14,082 40,591 10,596 40,271 35,550 4,721 43,448 38 181,643 FY13e 1,445 208,603 210,048 8,214 1,370 219,632 153,943 83,497 70,446 0 71,766 122,454 20,460 16,368 74,182 10,596 45,035 40,313 4,722 77,419 58 219,632
93
Fig 28 Maruti Suzuki: Ratios Year end March Basic (Rs) Adjusted EPS EPS growth (%) Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) Profitability ratios (%) RoE RoCE Turnover ratios Debtors (days) Inventory (days) Creditors (days) Asset turnover (x) Leverage ratio Debt/equity (x) FY09 53.6 -14.0 78.1 323.4 3.5 6.5 22.7 15.6 13.1 1.5 3.8 0.3 13.0 21.6 16 16 45 2.0 0.1 FY10 87.1 62.5 115.7 409.5 6.0 6.9 14.0 10.5 7.3 1.0 3.0 0.5 21.1 28.6 10 15 29 2.3 0.1 FY11e 90.3 3.6 120.9 491.3 7.0 7.8 13.5 10.1 6.4 0.8 2.5 0.6 18.1 24.2 12 15 25 2.4 0.1 FY12e 113.7 25.9 147.8 595.4 8.0 7.0 10.7 8.2 4.8 0.6 2.0 0.7 18.8 25.3 11 17 40 2 0.0 FY13e 141.0 24.0 179.0 726.8 8.0 5.7 8.6 6.8 3.5 0.4 1.7 0.7 19.2 26.0 11 17 39 2 0.0
Fig 29 Maruti Suzuki: Cash flow statement Year end March (Rs m) OP/(loss) before tax Int./dividends received Depreciation & amort. Direct taxes paid (Inc)/Dec in wkg. capital Other items CF from oper. activity Extra-ordinary items Other items CF after EO items (Inc)/Dec in FA+CWIP (Pur)/Sale of invest. CF from inv. activity Change in net worth Inc/(dec) in debt Interest paid Dividends paid CF from fin. activity Inc/(dec) in cash Add: beginning balance Closing balance FY09 16,581 5,413 7,065 -4,721 -2,063 22,275 -4,725 0 17,549 -16,058 20,074 4,016 -1,881 -2,013 -510 -1,011 -5,415 16,150 3,240 19,390 FY10 31,589 4,968 8,250 -11,130 481 34,158 -296 0 33,861 -13,052 -40,033 -53,085 1,660 1,225 -335 -1,734 816 -18,408 19,390 982 FY11e 33,680 2,982 8,835 -9,973 -1,442 34,083 -652 0 33,431 -16,000 0 -16,000 0 0 -394 -2,023 -2,417 15,014 982 15,996 FY12e 41,597 4,449 9,858 -12,600 -351 42,953 -652 0 42,301 -15,000 0 -15,000 0 0 -394 -2,312 -2,706 24,595 15,996 40,591 FY13e 50,041 6,978 10,983 -15,672 -380 51,949 -652 0 51,298 -15,000 0 -15,000 -2,312 0 -394 0 -2,706 33,591 40,591 74,182
94
Company profile
Maruti Suzuki is Indias largest passenger-vehicle manufacturer Maruti dominates the small and compact car sub-segments. Initially set up as a JV of the government of India and Suzuki Motors, Japan, the government subsequently divested a part of its stake, giving Suzuki a majority stake. Maruti Suzuki India has a wide network of 802 sales outlets in 555 towns and cities, and employee strength of over 8,000 as of Mar 10. The management team has been very stable over the years. RC Bhargava is the chairman and Shinzo Nakanishi the managing director and chief executive officer. Under this management team, Maruti Suzuki India has seen its volume and revenue shoot up at 14% and 25.4% CAGR respectively over FY04-10; profitability has also grown at a CAGR of 26% over the same period. Fig 30 Maruti Suzuki: Shareholding pattern
FII 20% DII 17% Others 9%
Promoter 54%
Source: BSE
95
Tata Motors
Back on track; initiate with Outperform

Rs991
We initiate coverage on Tata Motors with an Outperform rating and fair value of Rs1,452. We expect the strong revival at JLR, increasing commercial vehicle demand in India, and improving operating leverage to lead to consolidated earnings growth of 167% over FY10-12, the highest in the sector. Tata Motors currently trades at the sector average and looks attractive for multiple reasons uptrend in the CV cycle, Nano production ramp-up, strong product pipleline and re-rating of JLR.
TTMT IN
Market cap
TAMO.BO
12 month range
US$12.6bn
Rs490-1,054
JLR to the fore Tata Motors JLR division reported strong growth in realization and profit in 1Q FY11, driven by an improvement in the global economy and the success of its new products (most priced higher than earlier models). Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating a continued revival in auto demand. In addition, JLR managements aggressive cost reduction push through various measures turned the division FCF positive in 1QFY11. Domestic business, cyclical uptrend Given strong FY11 GDP growth expectations, the governments thrust on infrastructure and normal monsoons, we expect the commercial vehicle (CV) segment to post good growth in the coming quarters. With Tata Motors dominant position in the CV industry, we expect it to benefit the most from this upturn. Improving balance sheet and cash flow Driven by the turnaround at the JLR division, uptick in the domestic market and prudent capital issuance, Tata Motors has been able to reduce its net automotive debt to equity ratio from a high of 6:1 to 2.0 in 1Q FY11. With JLR turning free cash flow positive in 1Q FY11 and capital expenditure at the standalone business expected to decline, we believe Tata Motors net automotive debt to equity could come down substantially over the next year. Valuation Tata Motors currently trades at the sector average valuation, and is attractive given the CV cycle uptrend, Nano ramp-up and re-rating of JLR. Our fair value is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (20% discount), holding in Tata Sons at Rs60, and value of investment in JLR at Rs717 (6x EBITDA). Our fair value is Rs1,452 (47% upside).
FY10 FY11e FY12e FY13e 355,931 455,147 548,181 640,161 32,444 37,633 45,237 52,675 42,783 50,417 59,483 68,221 28,295 24,015 32,227 39,607 14,548 18,011 24,170 29,705 23.31 28.86 38.73 47.60 169.5 23.8 34.2 22.9 15.00 18.00 20.00 21.00 150.0 20.0 11.1 5.0 12.0 11.1 10.9 10.7 9.1 8.3 8.3 8.2 4.1 4.0 4.4 4.6 57.8 64.2 54.5 46.5 262.28 273.85 293.15 320.99 99.4 96.1 87.4 68.4 9.7 11.5 14.4 16.2 10.5 12.0 13.9 15.5 85,592.1 22,881.9 29,554.5 47,193.4 1.4 1.1 0.9 0.7 11.5 9.8 8.2 6.8 3.8 3.6 3.4 3.1 42.5 34.3 25.6 20.8 1.5 1.8 2.0 2.1

1,100 1,000 900 800 700 600 500 400 Aug09 Nov09 Feb10 May10 Aug10
TataMotorsLtd
-1 mth 17 18 13
-3 mth -12 mth 32 104 25 90 17 52 Promoter: 37.02% 51.16% US$91m
Amit Kasat
96

We expect the strong revival of JLR, increasing demand for commercial vehicles in India, and improving operating leverage would lead to consolidated earnings growth of 167% over FY10-12, the highest in the sector. Tata Motors is currently trading at the sector average and looks attractive for multiple reasons uptrend in the CV cycle, Nano production ramp-up, strong product pipleline and re-rating of JLR.
JLR to the fore

Tata Motors JLR division reported strong growth in realisation and profit in 1Q FY11 Tata Motors JLR division reported strong growth in realisation and profit in 1QFY11, driven by an improving global economy and successful product launches, most of which were priced higher than the earlier models. Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating continued revival in auto demand. In addition, JLR managements aggressive cost reduction push through various measures has turned the division FCF positive in 1Q FY11. JLR to maintain volume momentum Volume at JLR is witnessing strong growth momentum, driven by the improvement in the global economy and successful new product launches. Volume has been increasing steadily every quarter from 35,900 units in 1Q FY10 to 59,200 units in 1Q FY11. Fig 1 JLR: Quarterly volume trend
60,000 50,000 Nos
Fig 2 JLR: Quarterly volume break up

50,000 40,000 30,000 Nos
40,000 30,000 20,000 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11
20,000 10,000 0 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11
Land Rover
Source: Company
Jaguar
Source: Company
All major markets of the company reported good growth
All major markets of the company UK (+23%), North America (+23%), China (+104%), Europe (+18%) and Russia (+13%) have reported strong growth in volume during 1Q FY11 on a yoy basis. Most top-end car manufacturers, too, have witnessed strong sales growth in the past few quarters, indicating continued revival in auto demand.
97
Fig 3 JLR: Quarterly geographically volume break-up Global wholesale volumes ('000 units) Jaguar Land Rover Total JLR Retail volumes ('000 units) Jaguar - total North America UK Europe (ex-Russia) Russia China Others Land Rover - total North America UK Europe (ex-Russia) Russia China Others JLR - total North America UK Europe (ex-Russia) Russia China Others
Source: Company
4QFY09 1QFY10 7.7 24.9 32.6 11.6 24.3 35.9
qoq ch 2QFY10 (%) 50.6 11.8 -2.4 32.5 10.1 44.3 qoq ch 2QFY10 (%) 14.6 12.1 27.6 2.8 -2.2 4.8 33.3 2.3 -50.0 0.2 33.3 0.5 21.4 1.5 -4.6 34.7 3.1 6.8 -34.0 9.6 7.1 8.0 -36.7 1.9 61.1 2.9 14.8 5.5 0.4 46.8 10.6 9.6 -23.6 14.4 13.4 10.3 -38.2 2.1 57.1 3.4 16.2 7.0
qoq ch 3QFY10 (%) 1.7 13.1 33.7 43.6 23.4 56.7 qoq ch 3QFY10 (%) -14.2 13.4 -24.3 3.5 6.7 4.3 -36.1 3.1 0.0 0.2 25.0 0.6 -11.8 1.7 5.2 41.9 1.5 8.7 54.8 8.3 -12.1 11.5 0.0 2.5 0.0 4.0 -11.3 6.9 -0.6 55.3 -7.7 12.2 34.6 12.6 -18.9 14.6 0.0 2.7 3.0 4.6 -11.4 8.6
qoq ch 4QFY10 (%) 11.0 10.9 34.2 46.1 28.0 57.0 qoq ch 4QFY10 (%) 10.7 10.3 25.0 2.5 -10.4 4.0 34.8 2.5 0.0 0.1 20.0 0.6 13.3 0.6 20.7 32.8 27.9 7.3 -13.5 15.0 43.8 10.4 31.6 1.9 37.9 5.2 25.5 -7.0 18.2 43.1 27.1 9.8 -12.5 19.0 41.7 12.9 28.6 2.0 35.3 5.8 22.9 -6.4
qoq ch 1QFY11 (%) -16.7 15.5 5.7 43.7 0.5 59.2 qoq ch 1QFY11 (%) -23.1 13.9 -28.6 3.7 -7.0 4.2 -19.4 3.3 -50.0 0.2 0.0 0.9 -64.7 1.6 -21.7 45.2 -16.1 8.9 80.7 9.1 -9.6 11.5 -24.0 2.1 30.0 5.8 -201.4 7.8 -22.1 59.1 -19.7 12.6 50.8 13.3 -11.6 14.8 -25.9 2.3 26.1 6.7 -174.4 9.4
qoq ch (%) 42.1 -5.2 3.9 qoq ch (%) 35.0 48.0 5.0 32.0 100.0 50.0 166.7 37.8 21.9 -39.3 10.6 10.5 11.5 -211.4 37.1 28.6 -30.0 14.7 15.0 15.5 -246.9
4QFY09 1QFY10 12.3 2.9 4.6 2.7 0.4 0.3 1.4 34.6 6.5 9.4 8.5 3.0 1.8 5.4 46.9 9.4 14.0 11.2 3.4 2.1 6.8 14.1 3.7 4.5 3.6 0.2 0.4 1.7 33.0 6.7 6.2 9.1 1.9 2.9 6.2 47.1 10.4 10.7 12.7 2.1 3.3 7.9
Launched the new Land Rover model in 2010 and the new XJ in 1Q FY11
New product launched to sustain momentum JLR has also benefited from the launches of the new Land Rover model in 2010 and the new XJ in 1Q FY11. The new XJ has been well received. While sales have been strong in the US, UK and China, they have been weak in the EU (ex UK). Land Rover sales across markets have been doing well; in the US, Land Rover incentives have steadily decreased, implying strong demand. Higher pricing for the new products has helped realizations and profitability. Fig 4 JLR: Total volume and growth
320,000 280,000 Nos 240,000 200,000 160,000 FY10 FY11e FY12e FY09* 13.7 26.2 30 23
Fig 5 JLR: Sales break up

240,000 200,000 160,000 Nos 120,000 80,000 40,000 0 FY10 FY11e FY12e FY09*
% 9 2 -5
16
JLR's total volume
Growth (RHS)
Land Rover
Jaguar (LHS)
Source: Company, Standard Chartered Research estimates; FY09 annualised
98
Aggressively reducing costs
Cost reduction initiatives and volume momentum to improve profitability JLR management has been aggressively trying to reduce costs using various measures such as manpower rationalization, low cost sourcing and better cost control. During the downturn, management reduced headcount by 2,000 to around 14,000 employees and also entered into agreements with workers to freeze wages. At present, they are selectively hiring employees, in line with growing auto demand. It is also looking to increase sourcing from low-cost countries from the current level of 20% to more than 30% in the near term and have opened purchasing offices in China and India for the same. JLR is also looking for greater co-operation with the parent company Tata Motors to design and develop smaller capacity engines. This could reduce costs as well as its dependence on Ford for supply of engines. As part of its medium-term strategy, the company plans to reduce the number of plants from three to two, which could result in further savings by reducing overheads. At present, the new launches at JLR have a waiting period of two-three months, which gives strong visibility for 2Q FY11 (traditionally also, the second half of the financial year have been strong for JLR). We expect volume, revenue and EBITDA CAGRs of 19.8%, 22.1% and 71.9%, respectively, over FY10-12.
Also co-operating with parent for small engines
Fig 6 JLR: Improvement in quarterly performance showcases management efforts on cost reduction qoq growth qoq growth qoq growth qoq growth Rs mn 1QFY10 2QFY10 (%) 3QFY10 (%) 4QFY10 (%) 1QFY11 (%) Land Rover 24,300 32,500 33.7 43,600 34.2 46,096 5.7 43,700 -5.2 Jaguar 11,600 11,800 1.7 13,100 11.0 10,908 -16.7 15,500 42.1 Total Volume 35,900 44,300 23.4 56,700 28.0 57,004 0.5 59,200 3.9 Sales 85,725 113,657 26.2 150,086 32.1 141,312 4.4 151,554 10.4 Realisation 2,387,883 2,565,616 2.3 2,647,017 3.2 2,478,984 3.9 2,560,034 6.4 Less: Expenditure 88,316 110,375 19.0 135,391 22.7 125,166 2.5 128,104 5.4 RM and components 62,027 78,999 21.3 102,404 29.6 89,700 -2.8 93,331 7.2 % of sales 72.4 69.5 68.2 63.5 61.6 Staff expenses 13,373 14,967 6.6 14,695 -1.8 12,075 -8.9 12,797 9.1 % of sales 15.6 13.2 9.8 8.5 8.4 Mfg. & other expenses 12,916 16,408 20.9 18,292 11.5 23,391 41.8 21,976 -3.2 % of sales 15.1 14.4 12.2 16.6 14.5 EBITDA -2,591 3,282 -220.6 14,695 347.8 16,146 21.9 23,450 49.6 EBITDA margin (%) -3.0 2.9 9.8 11.4 15.5 EBDIT -2,591 3,282 -220.6 14,695 347.8 16,146 21.9 23,450 49.6 Product dev. exp. 838 720 -18.2 612 -15.0 1,380 150.0 737 -45.0 Depreciation 5,258 4,642 -15.9 9,031 94.5 4,554 -44.1 5,829 31.8 EBIT -8,687 -2,081 -77.2 5,051 -342.7 10,212 124.2 16,884 70.3 Interest 991 800 -23.1 842 5.2 1,283 69.1 1,139 -8.6 Forex -4,953 1,241 -123.8 -153 -112.3 2,801 -2130.0 67 -97.5 PBT -4,724 -4,122 -16.9 4,363 -205.8 6,127 55.8 15,678 163.5 Tax 152 680 325.0 153 -77.5 1,104 700.0 871 -18.8 ETR -3.2 -16.5 3.5 18.0 5.6 PAT -4,877 -4,802 -6.3 4,209 -187.7 5,023 32.4 14,807 203.6
Source: Company
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Fig 7 JLR: Financials (FY10-12e) Rs mn Land Rover Jaguar Total Volume Sales Realisation Less: expenditure RM and components % of sales Staff expenses % of sales Mfg. & other expenses % of sales EBITDA EBITDA margin (%) EBDIT Product dev. exp. Depreciation EBIT Interest Forex PBT Tax ETR PAT
FY10 146,496 47,408 193,904 490,780 2,531,045 459,248 333,131 67.9 55,110 11.2 71,007 14.5 31,532 6.4 31,532 3,551 23,485 4,495 3,916 -1,064 1,643 2,090 127.2 -447
FY11e 181,200 63,500 244,700 616,889 2,521,001 537,271 393,537 63.8 52,744 8.5 90,990 14.7 79,618 12.9 79,618 2,882 24,094 52,642 4,454 262 47,926 2,967 6.2 44,959
FY12e 208,380 69,850 278,230 731,088 2,627,638 637,874 471,552 64.5 63,970 8.8 102,352 14.0 93,214 12.8 93,214 3,432 27,508 62,274 4,862 260 57,152 3,429 6.0 53,723
Cyclical uptrend in domestic business

Given strong FY11 GDP growth expectations, the governments thrust on infrastructure, and normal monsoons, we expect the commercial vehicle (CV) segment would show strong growth in the coming quarters. Tata Motors would benefit from this, given its dominance in the segment. Strong growth in the Indian CV industry augurs well After the sharp slowdown in the auto industry in 2009, the commercial vehicle industry grew at 38.3% in FY10. In the first four months of FY11, it has shown growth of 49.8%. Given strong GDP growth expectations of FY11 (8.1% in FY11) and a normal monsoon season, we believe the CV industry will grow well in the coming quarters. We expect Tata Motors volume in the commercial vehicle portfolio to register CAGR of 15.7% over FY10-12 (domestic 15.9%, export 13.6%). It will be driven by M&HCV growth of 16.1% (domestic 16.4%, exports 12.5%) and LCV growth of 15.4% (domestic 15.5%, exports 14.6%) over the same period.
In the first four months of FY11, the CV industry has grown at 49.8% Tata Motors volume in CV likely CAGR of 15.7% over FY10-12
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Fig 8 Tata Motors: CV vol. and growth

550,000 480,000 Nos 410,000 340,000 270,000 200,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 50 40 30 20
Fig 9 Tata Motors: M&HCV vol & growth

260,000 220,000 Nos 45 30 15 % 62.7 FY12e 0
10 0
180,000 140,000 100,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 63.1 FY11e
-10 -20 -30
-15 -30 -45
Commercial volumes (LHS)
Growth (RHS)
M&HCV volume (LHS)
Growth (RHS)
Fig 10 Tata Motors: LCV vol. and growth

350,000 280,000 Nos 210,000 15 140,000 70,000 FY11e FY12e FY06 FY07 FY08 FY09 FY10 0 -15 60 45 30 %
Fig 11 Tata Motors: M&HCV market share

64.5 63.5 63.4 62.5 61.5 60.5 FY07 FY08 FY09 FY10 %
LCV volume (LHS)
Growth (RHS)
To launch new products in the LCV and M&HCV segment
Healthy product pipeline to counter competition from M&M Tata Motors plans to launch new products in the LCV and M&HCV segment, which could lead to expansion of the commercial vehicle market. Launches of smaller variants of ACE and ACE Magic are also planned for the coming months. Factors such as low cost of ownership, better ergonomics and superior brand image are likely to help Tata Motors further grab share from the three-wheeler industry as well as gain additional customers. We believe the smaller ACE family products will give a further boost to volume and counter increasing competition from M&M. Prima rollout may gradually increase the market for high-end trucks in India, which currently stands at less than 2,000 units. Passenger vehicles Nano to improve market share The Indian passenger vehicle industry is set to witness strong growth over the next few years, driven by high growth in per capita incomes, recovering urban demand, and aggressive vehicle financing by private sector banks. We expect industry volume (including Nano) to report CAGR of 25.5% over FY10-12. We expect Tata Motors to retain dominance and remain among the top 3 players in the segment; we expect it to register volume CAGR of 39.5% (domestic 40.3%; exports 6.8%) over FY10-12. The growth in volume will be driven by growth of 42.9% in passenger cars (domestic 43.7%; exports 8.0%) and 16.9% in utility vehicles (domestic 17.3%; exports -5.1%) over FY10-12.
Industry volume growth (including Nano) likely to be 25.5% over FY10-12 Tata Motors to remain among the top 3 players
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Fig 12 Tata Motors: PV sales and growth

550,000 50 40 400,000 Nos 30 20 10 0 -10 100,000 FY11e FY12e FY06 FY07 FY08 FY09 FY10 -20 %
Fig 13 Tata Motors: PC sales and growth

500,000 400,000 Nos 300,000 200,000 100,000 FY11e FY12e FY06 FY07 FY08 FY09 FY10 50 40 30 % 20 10 0 -10
250,000
Passenger vehicles (LHS)
Growth (RHS)
Passenger cars (LHS)
Growth (RHS)
Fig 14 Tata Motors: UV sales and growth

55,000 50,000 Nos 45,000 40,000 35,000 30,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 30 20 10
Fig 15 Tata Motors: PC market share

16 14 12 10 8 FY07 FY08 FY09 FY10 FY11e FY12e 12.7 10.8 11.6 10.5 15.4
14.4
-10 -20 -30
Utility vehicles (LHS)
Growth (RHS)
Nano wait to end in September: Of the total initial bookings of 100,000 units, the company had ~40,000 cancellations. 52,000 of the remaining 60,000 have been delivered by July 2010. The remaining deliveries will be completed by September this year. Nano likely to drive volume As Nano has been well received by customers, going forward, we expect it to drive volumes for the passenger car segment, once the waiting comes down to zero days; this could help the company regain market share it lost over the past two years. Product launches already in pipeline Tata Motors is going to launch the UV crossover Aria in this segment. As capacity constraints for the Ace family are removed by shifting Nano production from Pantnagar to Sanand, capacity for other products is freed up. Also FY11 will see various launches in both passenger cars as well as goods vehicles: Magic Iris (launched in Rajasthan) will be launched nationwide, Venture will be launched in 2Q FY11 and Penguin will be launched in 3Q FY11. Tata Motors is still working at a capacity utilization of 65-70%. Hence, in our view, it will incur a capex of Rs25-30b every year on product development and not on capacity expansion.
New launches: Magic Iris (launched), Venture in 2QFY11 and Penguin in 3QFY11
Improving balance sheet and cash flows

Net automotive debtequity ratio falls from high of 5.9 in FY09 to 2.0 in 1Q FY11 Driven by the turnaround of the JLR business, uptick in the domestic market and prudent capital issuance, Tata Motors has managed to reduce its net automotive debt-equity ratio from a high of 5.9 in FY09 to 2.0 in 1Q FY11. With JLR becoming free cash flow positive in 1Q FY11 and capital expenditure for the standalone business expected to decline, we believe Tata Motors net automotive debt to equity would come down substantially over the next year. 102
to 1.5x by FY12e
We believe operational efficiencies and cash flow generation over FY10-12e may strengthen the companys balance sheet. On our expected strong cash flow generation assumption for the consolidated entity, the leverage could come down to 1.5x in FY12e from 4.3x in FY10. The company has approval for an US$1bn equity raising. Fig 16 Tata Motors: Net debt to equity
6.0 5.0 4.0 x 3.0 2.0 1.0 0.0 FY07 FY08 FY09 FY10 FY11e FY12e 0.9 1.3 0.6 0.8 1.1 1.1 2.4 1.1 1.5 1.0 5.9 4.3
Consolidated
Standalone
Valuation
Fair value of Rs1,452 using SOTP Tata Motors is currently trading at the sector average valuation, and is an attractive stock given the uptrend in the CV cycle, Nano ramp-up and re-rating of JLR. Our fair value for Tata Motors is based on the value of the standalone business at Rs578 (15x FY12e core earnings), investments in key subsidiaries (ex-JLR) at Rs97 (after 20% discount), holding in Tata Sons at Rs60, and the value of investment in JLR at Rs717 (6x EBITDA). Our fair value for Tata Motors is Rs1,452 (47% upside). Fig 17 Tata Motors: SOTP valuation Standalone EPS (Rs) Less: Dividend from subsidiaries EPS Value (Rs) PE Multiple (x) Value per share (Rs) Subsidiary value per share (Rs) Value of stake in Tata Sons per share (Rs) Fair value (Rs) Value of Jaguar Land Rover Total fair value (Rs) Subsidiary Contribution to SOTP (Rs/share) HV Transmission HV Axles Telco Construction Equipment Tata Daewoo CV Tata Technologies TML Financial Services / Tata Motors Finance TAL Manufacturing Solutions Stake in associates Subsidiary & Associate valuation Subsidiary & Associate valuation (after 20% discount) Stake in Tata Sons (after 20% discount) Total fair value (Rs)
FY09 8.7 4.9 3.7 15.0 56 36 60 152 -48 104 FY09 4 6 16 28 17 -29 2 1 45 36 60 96
FY10 23.3 0.1 23.2 15.0 348 69 60 477 243 720 FY10 11 13 17 21 24 -2 2 1 87 69 60 129
FY11e 28.9 0.2 28.7 15.0 430 81 60 571 612 1,183 FY11e 13 15 14 26 26 4 2 1 101 81 60 140
FY12e 38.7 0.2 38.5 15.0 578 97 60 735 717 1,452 FY12e 14 16 19 36 29 5 2 1 122 97 60 157
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Fig 18 Tata Motors: 12-month forward PE band

2,000 57x 1,500 1,000 500 0 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 44x 31x 18x 5x
Fig 19 Tata Motors: 12-month forward EV/EBITDA band

1,800 1,500 1,200 Rs 900 600 300 0 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 45x 35x 25x 18x
Risks
Competitive pressures in the passenger vehicle business and slowdown in volume for Nano. If the global economy goes into a double-dip recession, it may result in a decline in the global luxury car market and JLR sales. Slower-than-anticipated macroeconomic recovery in India may impact CV volumes negatively in FY11. Adverse currency movements may impact profitability of JLR as it derives around 52% of its total volumes from European markets. Also a major part of the JLR cost base is denominated in GBP and Euro. This exposes the company to fluctuations in profitability depending on the exchange rate movements.
Rs
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Financials
We expect standalone Tata Motors to register CAGRs of 25.2%, 24.1%, 17.9% and 28.9% in volume, total income, EBITDA and adj. profits over FY10-12. The standalone performance is likely to be driven by an improvement in product mix in favour of profitable products, increased utilization of capacities across segments and decrease in interest burden over the forecast period on strong cash flow generation. On a consolidated basis, we expect Tata Motors to register a CAGR of 21.7%, 40% and 167% in total income, EBITDA and adj. profits over FY10-12. On a consolidated basis, its performance will be driven by JLR (+50% of consolidated revenue; +50% contribution to EBITDA and +60% contribution to profit in FY11e). Other subsidiaries are also expected to register strong performance. Fig 20 Tata Motors (Consolidated): Break-up of revenue and profitability FY08 Income Tata Motors standalone JLR HVTL HVAL TMF TDCV Others Tata Motors consolidated EBITDA Tata Motors standalone JLR HVAL HVTL TMF TDCV Others Tata Motors consolidated EBITDA Margin (%) Tata Motors standalone JLR HVAL HVTL TMF TDCV Others Tata Motors consolidated Adjusted profit Tata Motors standalone JLR HVAL HVTL TMF TDCV Others Tata Motors Consolidated 285,314 0 1,923 2,027 8,328 30,697 25,189 353,478 27,553 0 1,120 980 -850 2,810 8,082 39,695 9.7 NA 58.2 48.3 -10.2 9.2 32.1 11.2 19,816 0 634 474 448 1,589 -3,914 19,048 FY09 254,712 386,022 1,429 1,585 9,109 25,408 31,124 709,389 15,628 -5,148 75 600 -2,590 2,220 11,180 21,965 6.1 -1.3 5.3 37.9 -28.4 8.7 35.9 3.1 18,091 -23,946 278 194 -1,207 1,109 -23,329 -28,809 FY10 FY11e FY12e FY08 80.7 0.0 0.5 0.6 2.4 8.7 7.1 100.0 69.4 0.0 2.8 2.5 -2.1 7.1 20.4 100.0 % of Consolidated FY09 FY10 FY11e 35.9 54.4 0.2 0.2 1.3 3.6 4.4 100.0 71.2 -23.4 0.3 2.7 -11.8 10.1 50.9 100.0 38.5 53.0 0.2 0.3 0.4 3.0 4.6 100.0 49.1 36.2 1.6 1.3 -0.1 2.2 9.6 100.0 39.3 53.3 0.2 0.2 0.4 2.5 4.1 100.0 32.7 51.7 1.1 1.0 0.0 1.9 11.6 100.0 FY12e 40.0 53.4 0.2 0.2 0.3 2.3 3.5 100.0 34.8 54.6 1.0 0.9 0.0 1.5 7.1 100.0
355,931 455,147 548,181 490,780 616,889 731,088 2,093 2,511 2,825 2,394 2,873 3,232 3,643 4,080 4,570 27,338 29,525 31,887 43,015 47,316 48,499 925,193 1,158,342 1,370,282 42,783 31,532 1,390 1,140 -50 1,950 8,397 87,142 12.0 6.4 66.4 47.6 -1.4 7.1 19.5 9.4 5,399 -447 639 526 -75 816 4,933 11,791 50,417 79,618 1,632 1,580 41 2,952 17,904 154,145 11.1 12.9 65.0 55.0 1.0 10.0 37.8 13.3 14,548 44,959 732 614 164 1,023 9,859 71,898 59,483 93,214 1,695 1,616 46 2,551 12,125 170,729 10.9 12.8 60.0 50.0 1.0 8.0 25.0 12.5 18,011 53,723 801 672 206 1,400 9,004 83,818
104.0 0.0 3.3 2.5 2.4 8.3 -20.5 100.0
-62.8 83.1 -1.0 -0.7 4.2 -3.8 81.0 100.0
45.8 -3.8 5.4 4.5 -0.6 6.9 41.8 100.0
20.2 62.5 1.0 0.9 0.2 1.4 13.7 100.0
21.5 64.1 1.0 0.8 0.2 1.7 10.7 100.0
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Hence, on account of strong performance, the debt-equity ratio is forecast to fall to 1.5 in FY12 from 4.3 in FY10. The return ratios both on a standalone basis (ROE: from 9.7% in FY10 to 14.4% in FY12e; RoCE: from 10.5% in FY10 to 14% in FY12e) and on a consolidated basis (ROE: from 30.7% in FY10 to 39% in FY12e; RoCE: from 10.9% in FY10 to 23% in FY12e) are set to improve over FY10-12e. Fig 21 Tata Motors: Segmental performance Rs million Net Income from operations Tata vehicles, spares, financing JLR Less: inter-segmental Total automotive Others Total revenues Less: inter-segmental Net segment revenue Segment results Tata vehicles, spares, financing JLR Total automotive Others Total revenues Less: inter-segmental Net segment revenue Add: Unallocable income Less: Interest expense Add: Exceptional items PBT EBIT Margin (%) Tata vehicles, spares, financing JLR Total automotive Others Total revenues Less: inter-segmental Net segment revenue Capital employed Tata vehicles, spares, financing JLR Total automotive Others Total capital employed Less: inter-segmental Net CE Return on capital employed (%) Tata vehicles, spares, financing JLR Total automotive Others Total capital employed Less: inter-segmental Net capital employed
FY08 323,542 0 0 323,542 37,038 360,581 3,980 356,601 28,451 0 28,451 5,583 34,034 22 34,011 2,675 7,431 1,607 30,863 8.8 na 8.8 15.1 9.4 0.6 9.5 189,833 0 189,833 8,694 198,527 2,056 196,471 15.0 na 15.0 64.2 17.1 1.1 17.3
FY09 286,643 392,707 0 679,350 34,656 714,006 4,617 709,389 9,584 -17,774 -8,190 2,175 -6,014 566 -6,580 7,990 19,309 -3,393 -21,293 3.3 -4.5 -1.2 6.3 -0.8 12.3 -0.9 237,255 123,361 360,616 13,540 374,156 1,608 372,548 4.0 -14.4 -2.3 16.1 -1.6 35.2 -1.8
FY10 403,593 493,442 884 896,151 34,380 930,530 5,338 925,193 37,581 538 38,120 2,890 41,010 1,112 39,898 17,931 22,397 -206 35,226 9.3 0.1 4.3 8.4 4.4 20.8 4.3 229,299 194,038 423,337 7,646 430,983 2,975 428,008 16.4 0.3 9.0 37.8 9.5 37.4 9.3
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Fig 22 Tata Motors: Quarterly performance (Standalone) Year end March (Rs m) Total volumes (nos) Change (%) Average realisation Change (%) Total income Change (%) Total cost EBITDA EBITDA margin (%) Change (%) Non-operating income Interest Gross profit Depreciation & amort. Product dev. expenses PBT Tax Effective tax rate (%) PAT Change (%) Adj PAT PAT margin (%) Change (%) 1Q 123,113 -6.5 520,224 -1.1 64,046 -7.6 56,766 7,280 11.4 37.2 5 2,535 7,884 2,291 112 5,480 343 6.3 5,138 57.5 2,001 3.1 -51.6 FY10 2Q 3Q 150,377 159,139 12.3 63.0 530,588 564,280 0.4 15.8 79,788 89,799 12.7 88.7 69,131 78,280 10,657 11,519 13.4 12.8 85.2 1,156.9 510 2 2,856 2,861 11,857 8,418 2,634 2,641 154 226 9,068 5,550 1,777 1,549 19.6 27.9 7,291 4,001 110.1 -252.0 3,714 4,231 4.7 4.7 43.4 -541.4 4Q 210,057 55.8 582,209 17.1 122,297 82.4 108,970 13,327 10.9 264.8 7 2,786 11,916 2,772 948 8,196 2,226 27.2 5,970 1.0 4,602 3.8 -308.3 FY11 1Q 181,711 47.6 573,232 10.2 104,163 62.6 92,416 11,747 11.3 61.4 693 3,140 8,640 3,074 190 5,377 1,419 26.4 3,957 -23.0 4,452 4.3 122.5 FY10 642,686 29.0 553,818 8.3 355,931 39.7 313,148 42,783 12.0 173.8 523 11,038 40,075 10,339 1,440 28,296 5,895 20.8 22,401 123.7 14,548 4.1 308.8 FY11e 810,299 26.1 561,703 1.4 455,147 27.9 404,731 50,417 11.1 17.8 1,023 12,469 38,311 12,783 1,512 24,015 6,004 25.0 18,011 -19.6 18,627 4.1 28.0
Fig 23 Tata Motors: Quarterly performance (Consolidated) Year end March (Rs m) Total Income Change (%) Total cost EBITDA EBITDA margin (%) Change (%) Non-operating income Forex gain / (loss) Extraordinary income Extraordinary expense Interest Gross Profit Depreciation & amort. Product dev. expenses PBT Tax Effective tax rate (%) Reported PAT before MI Change (%) Reported PAT after MI Change (%) Adj PAT 1Q 163,970 13.2 158,011 5,959 3.6 -64.9 22 3,339 3,189 0 5,835 6,674 8,442 930 -2,699 643 -23.8 -3,341 -145.0 -3,288 -145.7 -9,816 FY10 2Q 211,002 -8.2 195,086 15,916 7.5 6.8 348 -1,631 3,719 553 5,590 12,210 8,479 858 2,873 2,894 100.7 -22 -99.8 218 -102.3 -1,318 FY11 3Q 260,443 47.1 229,868 30,575 11.7 -636.5 47 -1,244 0 1,098 5,458 22,822 13,072 857 8,893 2,429 27.3 6,464 -124.7 6,503 -125.0 8,845 4Q 289,778 83.9 255,087 34,691 12.0 -923.3 -1 0 10,579 2,790 5,514 36,966 8,878 2,337 25,752 4,092 15.9 21,660 564.1 21,870 592.9 14,081 1Q 270,556 65.0 231,023 39,533 14.6 563.4 346 -414 0 0 5,616 33,849 10,115 979 22,754 2,960 13.0 19,794 -692.4 19,887 -704.9 20,239
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Fig 24 Tata Motors: Income statement (Standalone) Year end March (Rs m) Volume (units) Volume growth (%) Realisation (Rs) Operating other income Total Income Change (%) Expenditure EBITDA Change (%) % of net sales Depreciation EBIT Deferred revenue exp. Interest & fin. charges Other income Forex gain / (loss) PBT Tax Effective rate (%) PAT Change (%) Adj. PAT Change (%) PAT margin (%) FY09 498,147 -14.5 511,319 5,311 254,712 -10.7 239,084 15,628 -43.3 6.1 8,745 6,883 512 6,737 4,057 -653 10,138 125 1.2 10,013 -50.7 5,399 -70.2 2.1 FY10 642,686 29.0 553,817 4,389 355,931 39.7 313,148 42,783 173.7 12.0 10,339 32,444 1,440 11,038 523 -696 28,295 5,895 20.8 22,401 123.7 14,548 169.5 4.1 FY11e 810,299 26.1 561,703 4,982 455,147 27.9 404,731 50,417 17.8 11.1 12,783 37,633 1,512 12,469 1,023 -660 24,015 6,004 25.0 18,011 -19.6 18,011 23.8 4.0 FY12e 1,007,076 24.3 544,330 5,480 548,181 20.4 488,699 59,483 18.0 10.9 14,246 45,237 1,588 12,469 1,048 0 32,227 8,057 25.0 24,170 34.2 24,170 34.2 4.4 FY13e 1,209,195 20.1 529,411 5,973 640,161 16.8 571,940 68,221 14.7 10.7 15,546 52,675 1,667 12,469 1,069 0 39,607 9,902 25.0 29,705 22.9 29,705 22.9 4.6
Fig 25 Tata Motors: Balance Sheet (Standalone) As at end March (Rs m) Share Capital Reserves Net worth FCIMTDA Loans Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr.assets Inventory Sundry debtors Cash & bank balances Loans & advances Current liab. & prov. Sundry creditors Other liabilities Provisions Net current assets Deferred tax Appl. of funds FY09 5,141 117,161 122,302 1,641 131,656 255,598 139,052 62,599 76,453 69,540 129,681 96,917 22,298 15,552 11,418 47,648 108,355 87,313 2,270 18,773 -11,438 -8,658 255,598 FY10 5,706 143,949 149,655 -1,617 166,259 314,297 184,168 72,129 112,039 52,322 223,369 115,380 29,356 23,919 17,533 44,571 173,726 118,247 27,845 27,634 -58,346 -15,086 314,297 FY11e 5,706 150,554 156,260 -1,617 166,259 320,902 209,168 84,913 124,255 52,322 223,369 141,159 39,903 30,587 16,097 54,571 205,116 149,637 27,845 27,634 -63,958 -15,086 320,902 FY12e 5,706 161,563 167,269 -1,617 166,259 331,911 229,168 99,159 130,010 52,322 223,369 169,491 48,060 36,839 20,021 64,571 228,194 172,715 27,845 27,634 -58,702 -15,086 331,911 FY13e 5,706 177,451 183,157 -1,617 166,259 347,799 249,168 114,704 134,464 52,322 223,369 204,642 56,124 43,020 40,928 64,571 251,912 196,433 27,845 27,634 -47,269 -15,086 347,798
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Fig 26 Tata Motors: Ratios Year end March (Rs m) Basic (Rs) EPS EPS fully diluted Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) Standalone P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) M.Cap./EBITDA Profitability ratios (%) RoE RoCE Turnover ratios Asset turnover (x) Leverage ratio Debt/equity (x) FY09 10.5 8.7 22.7 237.9 6.0 94.9 114.5 32.0 2.0 4.2 0.6 32.6 4.4 4.3 1.0 1.1 FY10 25.5 23.3 39.9 262.3 15.0 57.8 42.5 11.5 1.4 3.8 1.5 13.2 9.7 10.5 1.1 1.1 FY11e 31.6 28.9 49.3 273.9 18.0 64.2 34.3 9.8 1.1 3.6 1.8 11.2 11.5 12.0 1.4 1.1 FY12e 42.4 38.7 61.6 293.1 20.0 54.5 25.6 8.2 0.9 3.4 2.0 9.5 14.4 13.9 1.7 1.0 FY13e 52.1 47.6 72.5 321.0 21.0 46.5 20.8 6.8 0.7 3.1 2.1 8.3 16.2 15.5 1.8 0.9
Fig 27 Tata Motors: Cash flow statement (Standalone) Year end March (Rs m) OP/(loss) before tax Interest/div. received Depreciation & amort. Direct taxes paid (Inc)/Dec in wkg. capital Other items CF from op activity Extra-ordinary items Other items CF after EO items (Inc)/dec in FA+CWIP (Pur)/sale of invest. CF from inv activity Free cash flow Issue of shares Inc/(dec) in debt Interest paid Dividends paid CF from fin activity Inc/(dec) in cash Add: beginning balance Closing balance FY09 6,371 4,057 8,745 -1,224 -3,805 37,707 51,852 6,446 58,298 -50,216 -80,579 -130,794 -72,497 1,285 68,850 -6,737 -3,457 59,942 -12,555 23,973 11,418 FY10 31,004 523 10,339 534 53,043 11,049 106,491 7,807 114,298 -28,706 -93,688 -122,394 -8,096 566 34,604 -11,038 -9,920 14,210 6,115 11,418 17,533 FY11e 36,121 1,023 12,783 -6,004 4,176 442 48,542 -660 47,882 -25,000 0 -25,000 22,882 0 0 -12,469 -11,848 -24,318 -1,436 17,533 16,097 FY12e 43,649 1,048 14,246 -8,057 -1,331 0 49,555 0 49,555 -20,000 0 -20,000 29,555 0 0 -12,469 -13,161 -25,630 3,924 16,097 20,021 FY13e 51,007 1,069 15,546 -9,902 9,473 0 67,193 0 67,193 -20,000 0 -20,000 47,193 0 0 -12,469 -13,817 -26,286 20,907 20,021 40,928
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Fig 28 Tata Motors: Income statement (Consolidated) Year end: Mar Sales Gross profit SG&A Other income Operating expenses EBIT Depreciation & Amortization EBITDA Net interest Exceptional items Pretax profit Taxation Minority interests Net profit Net profit (adjusted) Basic EPS (Rs) EPS (adjusted) (Rs) DPS (Rs) FY08 353,478 99,015 59,495 3,332 10,532 31,215 7,821 39,695 7,431 1,857 30,863 8,515 1,323 21,677 19,048 49.41 30.52 15.00 FY09 709,389 223,148 161,648 841 45,220 -6,580 25,068 21,965 19,309 7,149 -21,293 3,358 -115 -25,053 -28,809 -56.04 -46.17 6.06 FY10 925,193 303,981 167,324 416 55,773 43,288 38,871 87,142 22,397 13,075 35,226 10,058 303 25,711 11,791 20.66 18.90 15.06 FY11e 1,158,342 405,982 183,020 541 75,701 106,021 43,730 154,145 23,517 0 83,044 12,457 379 71,898 71,898 126.00 115.22 18.06 FY12e 1,370,282 453,482 199,222 622 91,103 118,699 47,010 170,729 22,341 0 96,979 14,547 474 83,818 83,818 146.89 134.32 20.06
Fig 29 Tata Motors: Balance sheet (Consolidated) Year end: Mar Cash Accounts receivables Inventory Other current assets Total current assets PP&E Investment Intangible Assets Other long term assets Total long term assets Total assets Accounts payables Other current liabilities Total current liabilities Long term debt Deferred tax Total long term liabilities Total liabilities Shareholders funds Minority Interests Total liab and equity FY08 38,332 20,605 32,946 100,790 192,674 128,634 26,658 5,662 69 161,024 353,697 109,148 27,298 136,446 115,849 9,745 125,593 262,039 86,975 4,683 353,697 FY09 41,213 48,001 101,547 126,514 317,276 357,333 12,574 37,187 7,226 414,319 731,595 236,584 75,034 311,618 349,739 6,802 356,541 668,158 59,406 4,030 731,595 FY10 87,433 71,912 113,120 152,831 425,296 385,063 22,191 34,229 -1,912 439,572 864,868 293,718 123,490 417,208 351,924 11,536 363,460 780,668 82,065 2,135 864,868 FY11e 108,928 90,108 157,734 172,831 529,601 396,333 22,191 34,229 -1,912 450,841 980,443 368,040 114,900 482,939 341,924 11,536 353,460 836,399 141,909 2,135 980,443 FY12e 178,418 106,640 186,673 192,831 664,562 379,323 22,191 34,229 -1,912 433,832 1,098,393 435,562 114,900 550,461 321,924 11,536 333,460 883,921 212,337 2,135 1,098,393
110
Fig 30 Tata Motors: Ratio (Consolidated) Year end: Mar Gross margin (%) EBIT margin (%) Effective tax rate (%) Interest cover (x) Op cash/EBIT (x) Depn/capex (x) Quick ratio (x) ROE (%) ROCE (%) Net gearing (%) Inventory days Accounts receivable days Accounts payable days Total asset turonver (x) PBR (x) EV/Sales (x) EV/EBITDA (x) PER (x) Dividend yield (%) No of shares, fully diluted (m)
FY08 28.01 8.83 27.6 4 -0.2 1.2 25.7 16.2 89.1 35 22 116 1.6 4.4 1.3 10.9 32.5 1.5 386
FY09 31.46 -0.93 -15.8 0 -23.8 0.1 0.7 -41.5 -0.5 519.3 53 25 123 1.7 8.6 1.1 36.7 n.m 0.6 514
FY10 32.86 4.68 28.6 2 2.8 1.5 0.7 30.7 10.9 322.3 45 29 117 2.1 6.9 0.9 9.3 52.4 1.5 571
FY11e 35.05 9.15 15.0 5 1.5 3.9 0.8 49.7 22.3 164.2 50 29 117 2.3 4.0 0.7 5.0 8.6 1.8 571
FY12e 33.09 8.66 15.0 5 0.0 -2.8 0.9 38.8 22.7 67.6 50 29 117 2.5 2.7 0.5 4.0 7.4 2.0 571
Fig 31 Tata Motors: Cash flow statement (Consolidated) Year end: Mar Pretax profit Interest/dividend paid Depreciation & Amortization Taxes paid (Inc)/Dec in Working Capital Others Cash flow from operations Capex Disposals Cash flow from investing Dividends Issue of shares Change in debt Interest Paid Cash flow from financing Change in cash Free cash flow FY08 31,865 3,332 7,821 -6,944 40,756 2,142 78,973 -60,082 -14,912 -74,994 -6,767 -5,822 42,830 -7,431 22,810 38,331 139,054 FY09 -3,103 841 25,068 -6,300 -33,383 9,889 -6,988 -215,877 14,084 -201,793 -3,646 727 233,890 -19,309 211,662 41,213 208,889 FY10 48,270 416 38,871 -5,323 63,826 10,335 156,395 -77,835 -9,617 -87,453 -10,051 7,540 2,185 -22,397 -22,723 87,434 234,231 FY11e 110,415 541 43,730 -12,457 -21,473 0 120,756 -55,000 0 -55,000 -12,054 1,311 -10,000 -23,517 -44,261 108,929 175,756 FY12e 123,719 622 47,010 -14,547 -2,968 0 153,836 -30,000 0 -30,000 -13,390 1,385 -20,000 -22,341 -54,346 178,418 183,836
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Company profile
Tata Motors is Indias largest commercial vehicle manufacturer Tata Motors product portfolio includes passenger/goods carriers, passenger cars and utility vehicles. Tata Motors became a global player when acquired Daewoos Korean CV manufacturing plant and Jaguar Land Rover in the UK. Incorporated in 1945, Tata Motors is Indias largest automotive company in revenue. According to Automotive World, Tata Motors is the worlds fourth-largest truck manufacturer. Last Auto Omnibus calls it the second-largest bus manufacturer in the above-six-ton category. In FY10, Tata Motors was the second largest company in the Tata Group in terms of revenue. The Tata Group, founded by Sir Jamshetji Tata in the mid-19th century, is one of Indias largest business conglomerates, operating in seven diverse business sectors in more than 80 countries. Tata Motors manufacturing base in India spans Jamshedpur (in the east), Pune (in the west), Lucknow (in the north) and Pantnagar (also in the north), supported by a nationwide network of dealers, sales, services and spare parts. Its widespread sales and distribution network covers over 1,500 sales outlets for its passenger and commercial vehicles. It has also set up at Sanand (in the west) and Dharwad (in the south). The management team is headed by chairman Ratan Tata and managing director Ravi Kant. Under this management, the company has made serious attempts to spread its wings globally by acquiring JLR in the UK, Daewoos CV plant in Korea and others. Over the years, it has maintained its leadership in CVs, launching innovative vehicles such as the Ace. A world truck, in collaboration with Tata Daewoo CV, is to be launched in the near future. In Jan 2008, it captured the worlds imagination by showcasing the Nano at the Delhi Auto Expo. Fig 32 Tata Motors: Shareholding pattern
DII 18% Others 22%
FII 23%
Promoter 37%
Source: BSE
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Company updates
TVS Motor
Fairly-valued marginal player; initiate with Underperform
We initiate coverage of TVS Motor (TVS) with an Underperform rating and fair value of Rs146. We expect TVS to improve its operating performance over the next two years. Yet, we expect it to remain a sector underperformer given low margins (50-70% below competitors), small market share and valuation on par to the sector, which, in our view, is not sustainable.
Underperform (initiating coverage)

Rs143
TVSL IN
Market cap
TVSM.BO
12 month range
US$0.8bn
Rs48-147
Operating profitability 50-70% lower than competitors Though we expect economies of scale, product mix improvement and ramp-up in 3W volume (3.0% of overall volume in FY12e) to stabilize TVS margins at over 8% (from a low 2.2% in FY08) in FY11-12e, it would still be 5070% below those of competitors. The main reason it lags industry leaders is its product portfolio, which is skewed towards low-margin mopeds and scooters. TVS has had margins higher than 8% only three times in the past 10 years (FY00, FY03 and FY04). Marginal player, growing at industry rate We expect TVS 2W portfolio to report a 20% CAGR over FY10-12e (in-line with 2W sector growth). Growth will be driven by motorcycles (21.8% CAGR), mopeds (16% CAGR) and scooters (21.5% CAGR). New launches such as the gearless scooter (Wego) and clutchless bike (JIVE) should lead the way and is the key to volume growth. Exports at 20% CAGR, passenger three wheeler opportunity We estimate TVS would post export volume CAGR of 20% over FY10-12e, resulting in a monthly run rate of 17-19,000 units (rising from the FY10 average of 13,500/month) and to stabilize at around 11-12% of overall volume. Entry into passenger 3Ws will be an opportunity for the company but will remain a small contributor over the forecast period. We expect 3W volume to register 100% CAGR over FY10-12e and contribute 3.0% of overall volume. Valuation We value TVS at 12x FY12e core earnings, which is a 15% discount to Hero Honda. We give it a discount given its low profitability margins (compared with those of Hero Honda and Bajaj Auto) and market share in the 2W space (though market share could improve over FY10-12e). We give a 20% discount to the cash on its balance sheet to arrive at the fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside).
FY10 44,240 2,394 3,417 761 1,280 5.39 289.57 1.20 71.4 7.8 5.4 2.9 37.9 36.55 89.5 14.7 12.8 1,283.3 0.9 10.9 3.9 26.5 0.8
FY11e 58,278 3,498 4,643 2,324 1,906 8.02 48.91 1.50 25.0 8.1 6.0 3.3 21.5 43.08 69.1 18.6 17.3 1,711.7 0.6 7.9 3.3 17.8 1.1
FY12e 69,973 4,362 5,648 3,163 2,593 10.92 36.07 2.00 33.3 8.2 6.2 3.8 21.1 52.00 41.9 21.0 19.5 3,041.4 0.5 6.2 2.7 13.1 1.4
FY13e 80,819 5,236 6,608 4,009 3,288 13.84 26.77 2.00 0.0 8.3 6.5 4.1 16.6 63.84 16.4 21.7 20.8 3,820.2 0.4 4.9 2.2 10.3 1.4

150 140 130 120 110 100 90 80 70 60 50 40 Aug09 Nov09 TVSMotorCoLtd Feb10 May10 Aug10
-1 mth 5 5 1
Amit Kasat
113

We expect TVS to improve its operating performance over the next two years. Yet, we expect it to remain a sector underperformer given low margins (50-70% below competitors), small market share and valuation on par to the sector, which, in our view, is not sustainable.
Volumes to grow in line with two-wheeler industry

TVS has underperformed industry volume growth in the past owing to a relatively weaker and volatile product portfolio in the motorcycle segment. In addition, it has been unable to cash in on the success of various models due to its inability to launch new products and variants frequently to support them. TVS motorcycle CAGR at 4.5% underperformed the industrys 14.1% Fig 1 TVS volume: FY02-10
1,000 800 '000 units 600 400 200 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 '000 units
Fig 2 Industry volume: FY02-10

9,000 7,500 6,000 4,500 3,000 1,500 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Motorcycle
Source: Company
Scooters
Mopeds
Motorcycle
Source: Companies, SIAM
Scooters
Mopeds
With volatile volume over FY02-10, its market share declined about 600bps. Fig 3 TVSs market share fell 600bps from FY02 to FY10 Market share has been declining
100 80 60 % 40 20 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Motorcycle
Source: Company
Scooters
Mopeds
T otal
It is still weaker than Hero Honda and Bajaj Auto in terms of product offerings
Going forward, market share to stabilise The company now has a more stable product portfolio in the scooter and motorcycle segments. Nevertheless, its product portfolio still does not match those of Hero Honda and Bajaj Auto. Going forward, we expect growth to be driven by motorcycles (21.9% CAGR), mopeds, (16% CAGR), and scooters (21.5% CAGR). We expect good performances from its existing product portfolio and from its recently-launched products such as the gearless scooter, Wego, and the clutchless bike, Jive. In our view, new launches hold the key to volume growth. We estimate its two-wheeler portfolio would grow at 20% over FY10-12, in line with the two-wheeler sector growth rate, and TVS market share to 114
remain stable at around 14.5%. We do not expect a huge gain in the motorcycle segment either, as the top players in that segment have become more aggressive. TVS motorcycle CAGR likely to be 21.9%, scooters at 21.4% and mopeds at 15.9% Fig 4 TVS volume: FY10-12e
1,000 800 '000 units 600 400 200 FY11e FY12e FY10
'000 units
Fig 5 Industry volume: FY10-12e

14,000 12,000 10,000 8,000 6,000 4,000 2,000 FY10 FY11e FY12e Mopeds
Industry motorcycle CAGR likely to be 20.2%, scooters at 18.1% and mopeds at 15.6%
Motorcycle
Scooters
Mopeds
Motorcycle
Scooters
Fig 6 TVS: Market share decline to be arrested

100 80 60 % 40 20 0 FY10 FY11e FY12e
Mopeds
Motorcycle
Scooters
Product mix to improve Going forward, we expect the company to reap benefits from economies of scale; volume growth is expected to be strong, countering its history of underperformance against the industry. Growth could come from motorcycles, scooters and the newly-launched three-wheeler products resulting in an improvement in product mix, which had deteriorated over the years. This is also likely to improve the companys operating performance. Fig 7 TVS: Improvement in product mix
100 80 60 % 40 20 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Motorcycle
Scooters
Mopeds
3-wheelers
115
Margin likely to improve, but still below industry
EBITDA margins to improve 40bps against the industry decline of 140bps Economies of scale, improvement in product mix, ramp-up in three-wheeler volume (expected to be 3% of overall volume in FY12), and increased production from the tax-free plant are likely to stabilise TVS margin at over 8% in FY11-12 (from a low of 2.2% in FY08). TVS has seen margins higher than 8% only thrice in the past 10 years in FY00, FY03 and FY04. Fig 8 TVS: Margins to improve
12 10 8 6 4 2 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
FY11e Hero Honda FY12e
9.7 6.7
9.2 7.4 6.3 3.6 2.2 7.7 6.6 8.0 8.1
Still operating profit 50-70% lower than competitors

TVS margins have been historically lower than competitors With a product mix inferior to other industry players (as low-margin products like scooters and mopeds constitute over 50% of overall volumes), TVS margins have been historically lower than those of the other players. Fig 9 EBITDA margin comparison
25 20 Rs 15 % 10 5 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Fig 10 EBITDA per vehicle comparison

10,000 8,000 6,000 4,000 2,000 FY06 FY07 FY08 FY09 Bajaj Auto FY10
TVS Motor
Bajaj Auto
Hero Honda
TVS Motor
Overseas penetration to increase

TVS has plans to increase its export footprint by increasing overseas penetration; currently, it exports to 53 countries. Its contribution from exports has steadily risen from 5.9% of overall volume in FY06 to 14.4% in FY09 before declining to 11% in FY10. Its Indonesian plant is expected to further the companys export targets by primarily catering to the Asian two-wheeler market, which has cumulative sales of nearly 10m vehicles.
116
Fig 11 TVS export and growth

250,000 200,000 Nos 150,000 100,000 50,000 0 FY11e FY12e FY05 FY06 FY07 FY08 FY09 FY10 80 60
Fig 12 TVS export contribution to vol.

250,000 200,000 Nos 150,000 8 100,000 50,000 0 FY11e* FY12e* FY05 FY06 FY07 FY08 FY09 FY10 4 0 % 16 12
40 20 0 -20 %
Exports (LHS)
Growth (RHS)
Exports (LHS)
Source: Company, Standard Chartered Research estimates; * overall export contribution is coming off mainly on account of 3-W addition in overall volumes
Fig 13 TVS market share of 2W exports

1,800,000 1,500,000 Nos 1,200,000 900,000 600,000 300,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 25 20 15 10 5 0 %
T VS exports (LHS)
Industry 2-W export (LHS)
Market share (RHS)
Three-wheeler volume to overall volume likely to remain small at 3%
Entry into the passenger three-wheeler segment seen as an opportunity The companys entry into the passenger three-wheeler segment is seen as an opportunity. The vehicle is available in multiple fuel variants throughout the country. We expect three-wheeler volume to register 100% CAGR from FY10 to FY12. However, its contribution to overall volume over the same period is expected to remain small at 3%. Fig 14 TVS three-wheeler volume and growth
70,000 60,000 50,000 Nos 40,000 30,000 20,000 10,000 0 FY09 FY10 FY11e FY12e 50 40 30 20 10 0 -10 %
T hree -wheelers
% growth
117
Valuation
Fair value of Rs146 at 12x FY12e core earnings We value TVS at 12x FY12e core earnings, at a 15% discount to our multiple for Hero Honda. We believe our PE rating is justified when compared with the profitability margins of Hero Honda and Bajaj Auto and the market share that TVS has in the two-wheeler space (though market share is likely to improve over FY10-12). We assign a 20% discount to the cash in the balance sheet to arrive at the fair value. At the current price, the stock appears to be fairly valued. Our fair value for TVS is Rs146 (3% upside). Fig 15 TVS Motor: SOTP valuation Core EPS (Rs) Mulitple (x) Value (Rs) Cash per share (Rs) Fair value (Rs)
FY09 1.3 12.0 15.1 9.2 24.2
FY10 5.3 12.0 63.3 12.1 75.4
FY11e 7.6 12.0 91.0 14.4 105.4
FY12e 10.5 12.0 125.5 20.8 146.3
Fig 16 TVS Motor: 12-month forward PE band

200 160 120
Rs
21x 18x 15x 12x 9x 6x
80 40 0
Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10
Fig 17 TVS Motor: 12-month forward EV/EBITDA band

500 50x 400 40x 300 Rs 200 100 0 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Apr-10 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Aug-10 30x 20x 10x
Risk
Earnings and margins higher than our estimates. Increase in motorcycle market share beyond our estimates.
118
Financials
TVS balance sheet is much smaller than Hero Hondas and Bajaj Autos. It also lacks the scale and resources to counter competitors resorting to aggressive pricing. We expect TVS to register a 20.6%, 25.7%, 28.6% and 42.3% CAGR in volume, revenue, EBITDA and adj. profits over FY10-12. Fig 18 Revenue and revenue growth
80,000 60,000 Rsm 40,000 20,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 40 30 20 % 10 0 -10 -20 Rsm
Fig 19 RM and RM as % of sales

70,000 60,000 50,000 40,000 30,000 20,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 76 75 74 73 72 71 70 %
Revenue (LHS)
Growth (RHS)
Raw material (LHS)
RM as % of sales (RHS)
Fig 20 EBITDA and EBITDA margins

6,000 5,000 4,000 Rsm 3,000 2,000 1,000 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e 4 2 0 10 8 6 %
Fig 21 Realization per vehicle

32,000 30,000 28,000 26,000 24,000 22,000 20,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e Rs
EBITDA (LHS)
EBITDA margins (RHS)
Fig 22 Contribution per vehicle

9,000 8,000 7,000 6,000 5,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e Rs
Fig 23 EBITDA per vehicle

3,000 2,500 2,000 1,500 1,000 500 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e Rs
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Return ratios to improve
Fig 24 TVS Motor: RoE and RoCE

25 20 15 % 10 5 0 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
RoE
RoCE
Fig 25 TVS Motor: Quarterly performance Year end March (Rs m) Total volumes (nos) Volume growth (%) Realization Increase in realization (%) Net sales yoy change (%) Other operating income yoy change (%) Total income yoy change (%) Total cost EBITDA EBITDA margin (%) yoy change (%) Other income Interest Depreciation Amortisation Extraordinary gain/(exp) PBT Tax Effective tax rate (%) Reported PAT yoy change (%) Adjusted PAT yoy change (%) PAT margin (%) 1Q 349,426 5.0 27,921 2.0 9,756 7.1 131 -2.3 9,887 6.9 9,111 776 7.9 27.5 3 171 254 150 -3 200 19 9.6 181 158.0 184 162.4 1.8 FY10 2Q 393,648 6.0 28,335 3.7 11,154 9.9 145 -24.3 11,299 9.3 10,438 860 7.6 34.7 28 153 253 157 -83 241 -4 -1.7 246 136.6 321 208.9 2.2 3Q 374,799 22.8 28,619 2.4 10,726 25.8 168 5.9 10,895 25.4 10,057 837 7.7 43.4 9 180 253 155 -4 254 19 7.4 236 -2,552.6 239 -2,585.5 2.2 4Q 419,130 29.8 28,450 3.0 11,924 33.7 236 35.7 12,160 33.7 11,217 943 7.8 50.6 33 123 263 155 -371 65 -138 -211.6 203 38.7 537 226.9 1.7 FY11 1Q 463,840 32.7 29,527 5.8 13,696 40.4 234 79.0 13,930 40.9 12,893 1,037 7.4 33.6 41 170 266 139 1 505 101 20.0 404 122.8 402 118.4 2.9 FY10 1,537,003 15.2 28,341 3.0 43,561 18.7 679 44,240 18.4 40,823 3,417 7.8 39.0 74 628 1,023 618 -461 761 -104 -13.7 865 178.3 1,280 289.6 2.0 FY11e 1,932,155 25.7 29,705 4.8 57,395 31.8 883 58,278 31.7 53,635 4,643 8.1 35.9 105 661 1,144 618 0 2,324 418 18.0 1,906 120.3 1,906 48.9 3.3
120
Fig 26 TVS Motor: Income statement Year end March (Rs m) Volume (units) YoY growth (%) Net realisation (rs) Yoy growth (%) Net sales Change (%) Operating other income Total Income Total expenditure EBITDA Change (%) % of net sales Depreciation EBIT Amortisation Interest & fin. ch. Other income PBT Tax Effective rate (%) PAT Change (%) Adj. PAT Change (%) PAT margin (%) FY08 1,277,524 -16.3 25,201 -0.2 32,195 -16.5 0 32,195 31,474 721 -47.5 2.2 946 -225 0 290 719 354 36 10.2 318 -52.3 201 -69.9 0.6 FY09 1,346,468 5.4 27,263 8.2 36,709 14.0 658 37,367 34,909 2,458 240.7 6.7 1,029 1,429 580 550 30 311 0 0.1 311 -2.1 329 63.7 0.9 FY10 1,537,003 14.2 28,341 4.0 43,561 18.7 679 44,240 40,823 3,417 39.0 7.8 1,023 2,394 618 628 74 761 -104 -13.7 865 178.4 1,280 289.6 2.9 FY11e 1,932,155 25.7 29,705 4.8 57,395 31.8 883 58,278 53,635 4,643 35.9 8.1 1,144 3,498 618 661 105 2,324 418 18.0 1,906 120.3 1,906 48.9 3.3 FY12e 2,234,864 15.7 30,905 4.0 69,068 20.3 905 69,973 64,325 5,648 21.7 8.2 1,286 4,362 648 661 110 3,163 569 18.0 2,593 36.1 2,593 36.1 3.8 FY13e 2,491,267 11.5 32,069 3.8 79,891 15.7 928 80,819 74,212 6,608 17.0 8.3 1,371 5,236 681 661 115 4,009 722 18.0 3,288 26.8 3,288 26.8 4.1
Fig 27 TVS Motor: Balance sheet As at end March (Rs m) Share capital Reserves Net worth Deferred tax Loans Capital employed Gross fixed assets Less: depreciation Net fixed assets Capital WIP Investments Curr.assets, l & adv. Inventory Sundry debtors Cash & bank balances Loans & advances Current liab.& prov. Sundry creditors Provisions Net current assets Miscellaneous expenditures Application of funds FY08 238 7,978 8,216 1,549 6,663 16,428 17,910 7,745 10,165 266 3,390 7,748 4,054 879 37 2,775 5,668 5,058 610 2,080 528 16,428 FY09 238 7,864 8,102 1,481 9,060 18,673 18,654 8,694 9,959 404 4,777 8,937 3,206 1,816 421 3,495 6,158 5,503 655 2,778 753 18,673 FY10e 238 8,444 8,682 1,481 9,060 19,252 19,808 9,717 10,091 0 4,277 10,753 3,819 2,148 1,291 3,495 6,622 5,967 655 4,131 753 19,252 FY11e 238 9,994 10,231 1,481 9,060 20,802 21,808 10,862 10,946 0 4,277 13,343 5,032 2,830 1,985 3,495 8,517 7,862 655 4,825 753 20,802 FY12e 238 12,112 12,349 1,481 9,060 22,920 23,308 12,147 11,161 0 4,277 16,847 6,055 3,406 3,890 3,495 10,117 9,461 656 6,729 753 22,920 FY13e 238 14,924 15,162 1,481 9,060 25,733 24,808 13,519 11,289 0 4,277 21,013 7,004 3,940 6,574 3,495 11,600 10,944 656 9,413 753 25,733
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Fig 28 TVS Motor: Cash flow statement Year end March (Rs m) OP/(loss) before tax Interest/div. received Depreciation & amort. Direct taxes paid (Inc)/Dec in working capital Other items CF from oper. activity Extra-ordinary items Other items CF after EO items (Inc)/Dec in FA+CWIP (Pur)/sale of invest. CF from inv. activity Changes in reserves Inc/(Dec) in debt Interest paid Dividends paid CF from fin. activity Inc/(Dec) in cash Add: beginning balance Closing balance FY08 -225 719 946 -77 -952 30 441 149 590 -1,347 58 -1,290 0 328 -290 -166 -128 -828 866 37 FY09 849 30 1,029 -68 -315 -226 1,299 -18 1,282 -962 -1,388 -2,350 0 2,396 -550 -166 1,680 612 37 649 FY10e 1,776 74 1,023 104 -482 0 2,494 -461 2,033 -750 500 -250 0 0 -628 -285 -913 871 421 1,291 FY11e 2,881 105 1,144 -418 0 0 3,712 0 3,712 -2,000 0 -2,000 0 0 -661 -356 -1,018 694 1,291 1,985 FY12e 3,714 110 1,286 -569 1 0 4,541 0 4,541 -1,500 0 -1,500 0 0 -661 -475 -1,136 1,905 1,985 3,890 FY13e 4,556 115 1,371 -722 0 0 5,320 0 5,320 -1,500 0 -1,500 0 0 -661 -475 -1136 2,684 3,890 6,574
Fig 29 TVS Motor: Ratios Year end March (Rs m) Basic (Rs) EPS Cash EPS Book value per share DPS Payout (incl. div. tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/sales Price to book value Dividend yield (%) Profitability ratios (%) RoE RoCE Turnover ratios Asset turnover (x) Leverage ratio Debt/equity (x) FY08 0.8 4.8 34.6 0.7 60.2 168.8 29.5 51.5 1.2 4.1 0.5 2.4 3.0 2.0 0.8 FY09 1.4 5.7 34.1 0.7 61.5 103.1 25.0 15.4 1.0 4.2 0.5 4.1 7.8 2.0 1.1 FY10e 5.4 9.7 36.6 1.2 37.9 26.5 14.7 10.9 0.9 3.9 0.8 14.7 12.8 2.3 1.0 FY11e 8.0 12.8 43.1 1.5 21.5 17.8 11.1 7.9 0.6 3.3 1.1 18.6 17.3 2.8 0.9 FY12e 10.9 16.3 52.0 2.0 21.1 13.1 8.7 6.2 0.5 2.7 1.4 21.0 19.5 3.0 0.7 FY12e 13.8 19.6 63.8 0.2 0.0 10.3 7.3 4.9 0.4 2.2 1.4 21.7 20.8 3.1 0.6
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Company profile
Part of the Sundaram Group, TVS Motor Company operates in all two-wheeler segments and recently entered the three-wheeler space. Its key products are Apache, Star, Jive and Flame (motorcycles), Scooty variants in scooters, and XL Super and XL Heavy Duty in mopeds. With the Scooty EV, it has entered the electric scooters segment. Chairman and managing director Venu Srinivasan is the grandson of the founder. Over the years, TVS has successfully helped the Indian two-wheeler segment touch new milestones such as launching the countrys first two-seater 50-cc moped in 1980 and pioneered the scooterette, Scooty, for women. As part of its plans to tap the markets overseas, TVS has commissioned a plant in Indonesia to meet demand in the Asean region. With both volumes and profitability declining, however, performance in recent years has been disappointing but is expected to improve. Fig 30 TVS Motors: Shareholding pattern
FII 7% Promoter 61% DII 13%
Others 19%
Source: BSE
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Disclosures appendix
Global disclaimer
The information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered Bank Singapore Branch, Standard Chartered - STCI Capital Markets Limited and/or one or more of its affiliates (together with its group of companies, SCB) and the research analyst(s) named in this report. SCB makes no representation or warranty of any kind, express, implied or statutory regarding this document or any information contained or referred to in the document. The research analysts responsible for the content of this research report certify that
The view expressed and attributed to the research analyst or Analysts in the research report accurately reflect their personal opinion(s) about the subject securities and issuers and/or other subject matter as appropriate; and No part of his or her compensation and other benefits was, is or will be directly related to the specific recommendations or views contained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisals of analysts. Our ratings are under constant review.
Additional information with respect to any securities referred to herein will be available upon request. THIS RESEARCH HAS NOT BEEN PRODUCED IN THE UNITED STATES AND MUST NOT BE SENT OR TAKEN OR TRANSMITTED INTO THE UNITED STATES OR DISTRIBUTED DIRECTLY OR INDIRECTLY IN THE UNITED STATES. Disclosures Appendix Where disclosure date appears below, this means the day prior to the report date. All share prices quoted are the closing price for the business day prior to the date of the report, unless otherwise stated. Company Ashok Leyland Ltd. At the disclosure date, the following applies:
Ashok Leyland Ltd - current rating is: IN-LINE
80 75 70 65 60 55 50 45 40 35 Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Mar 10
Apr 10
May 10
Jun 10
Jul 10
Aug 10
Source: FactSet prices / SCB ratings and fair values
Company Bajaj Auto Ltd. At the disclosure date, the following applies:
Bajaj Auto Ltd - current rating is: OUTPERFORM
3,500 3,000 2,500 2,000 1,500 1,000 Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Mar 10
Apr 10
May 10
Jun 10
Jul 10
Aug 10
124
Company Hero Honda Motors Ltd. At the disclosure date, the following applies:
Hero Honda Motors Ltd - current rating is: UNDERPERFORM
2,100 2,000 1,900 1,800 1,700 1,600 1,500 1,400 Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10
Company Mahindra & Mahindra Ltd. At the disclosure date, the following applies: Mahindra & Mahindra Financial Services - SCB and/or its affiliates owns 5% or more of any class of common equity securities of this company
Mahindra and Mahindra Ltd - current rating is: OUTPERFORM
800 750 700 650 600 550 500 450 400 Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Mar 10
Apr 10
May 10
Jun 10
Jul 10
Aug 10
Company Maruti Suzuki India Ltd. At the disclosure date, the following applies:
Maruti Suzuki India Ltd - current rating is: OUTPERFORM
1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 Jul 09 Aug 09 Sep 09 Oct 09 Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10
125
Company Tata Motors Ltd. At the disclosure date, the following applies: SCB and/or its affiliates have received compensation for the provision of investment banking or financial advisory services within the past one year
Tata Motors Ltd - current rating is: OUTPERFORM
1,500 1,400 1,300 1,200 1,100 1,000 900 800 700 600 500 400 Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Mar 10
Apr 10
May 10
Jun 10
Jul 10
Aug 10
Company TVS Motor Company Ltd. At the disclosure date, the following applies:
TVS Motor Co Ltd - current rating is: UNDERPERFORM
150 140 130 120 110 100 90 80 70 60 50 40 Jul 09
Aug 09
Sep 09
Oct 09
Nov 09
Dec 09
Jan 10
Feb 10
Mar 10
Apr 10
May 10
Jun 10
Jul 10
Aug 10
Recommendation Distribution and Investment Banking Relationships

% of covered companies currently assigned this rating % of companies assigned this rating with which SCB has provided investment banking services over the past 12 months
OUTPERFORM IN-LINE UNDERPERFORM
56.5% 27.6% 15.9%
10.7% 10.2% 5.9%
Research Recommendation Terminology OUTPERFORM (OP) IN-LINE (IL) UNDERPERFORM (UP) ecurity is expected to outperform the relevant market index by 5% or more over the next six months ecurity is not expected to outperform or underperform the relevant market index by 5% or more over the next six months expected to underperform the relevant market index by 5% or more over the next six months
126
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Auto Sector Intiation Sep2010

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India | Automobiles & Parts

EQUITY RESEARCH 2 September 2010

India Auto Sector

India | Automobiles & Parts

India Auto Sector

India Auto Sector Valuation Matrix

Sector research India Auto | 2 September 2010

Strong macro drivers to boost volume growth

Margins to stabilise lower, yet remain healthy

Fundamentals intact, competition intensifies

Sector research India Auto | 2 September 2010

Investment argument and valuation

Strong macro drivers to boost volume growth

Sector margins to stabilize at 12-13%

Sector research India Auto | 2 September 2010

Fig 2 Trend in industry EBITDA margins (FY99-13e)

Source: Companies, Standard Chartered Research estimates

Fundamentals intact, competition intensifying

FY09 840 21.4

FY10 1,027 17.6 12.2 2.2

FY11e 1,260 14.4 9.4 1.8

FY12e 1,468 12.7 8.4 1.6

Strong auto sector earnings growth to narrow discount

Sector research India Auto | 2 September 2010

Source: Companies, Standard Chartered Research estimates

Source: Standard Chartered Research estimates

Sector research India Auto | 2 September 2010

Source: Standard Chartered Research estimates

Ashok Leyland FY11 EPS sensitivity

Bajaj Auto FY11 EPS sensitivity

Sector research India Auto | 2 September 2010

Hero Honda FY11 EPS sensitivity

Mahindra & Mahindra (standalone) FY11 EPS sensitivity

Maruti Suzuki FY11 EPS sensitivity

TVS Motor FY11 EPS sensitivity

Tata Motors (standalone) FY11 EPS sensitivity

Source: Standard Chartered Research estimates

Sector research India Auto | 2 September 2010

FY10 16.4 62.0 58.2 25.4 21.1 9.7 30.7 14.7

FY12e 24.7 41.5 36.5 24.0 18.8 14.4 38.8 21.0

FY10 12.0 60.4 69.1 25.0 28.6 10.5 10.9 12.8

FY12e 16.9 46.6 43.4 23.1 25.3 13.9 22.7 19.5

* Standalone ** Consolidated Source: Companies, Bloomberg, Standard Chartered Research estimates

Sector research India Auto | 2 September 2010

21x 18x 15x 12x 9x 6x

Source: Bloomberg, Standard Chartered Research estimates

Bajaj Auto Fair value at 16x FY12e core earnings

Source: Bloomberg, Standard Chartered Research estimates

TVS Motor Fair value at 12x FY12e core earnings

Sector research India Auto | 2 September 2010

Fig 12 TVS Motor: 12-month forward PE band

Source: Bloomberg, Standard Chartered Research estimates

Maruti Suzuki Fair value at 13x FY12e earnings

Source: Bloomberg, Standard Chartered Research estimates

M&M Fair value using SOTP methodology

Sector research India Auto | 2 September 2010

Fig 14 Mahindra & Mahindra: 12-month forward PE band

Source: Bloomberg, Standard Chartered Research estimates

Ashok Leyland Fair value at 14x FY12e earnings

21x 18x 15x 12x 9x 6x

Source: Bloomberg, Standard Chartered Research estimates

Tata Motors Fair value using SOTP methodology

Source: Bloomberg, Standard Chartered Research estimates