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Two-wheelers: Focus on profitability will pay

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At the start of the financial year, two-wheelers were expected to keep the sector in good cheer with 12-15 per cent volume growth. Hero MotoCorp and Bajaj Auto were the top picks. The former was expected to lead at the entry level and the latter the premium segment. This was driven by the belief that there was room for all players, as the two-wheeler market had the potential to grow at a CAGR of nine per cent for the full decade. Forecasts suggested two-wheeler sales growing to 28 million by FY21 from 12 million in FY11.

As demand comes under pressure and the competitive landscape changes, the Street is realising that in the end what will matter is profitability. Auto analysts are unable to make any forecast on Hero’s profitability, as the rupee is likely to wreak havoc if it continues to remain at these levels. Net of exports, the raw material cost forms around 14 per cent of net sales and the raw materials are largely imported by vendors in yen denomination. Sharekhan’s Deepak Jain estimates an earnings per share (EPS) impact of eight to nine per cent if the rupee sustains at 1.4 to the yen, since its payouts are not hedged. Bajaj, on the other hand, has hedged its receivables for FY12. If the rupee’s weakness persists in FY14, then it may see a substantial increase in earnings.

Analysts are also taking a view on the changing competition in the sector and valuations of Bajaj Auto and Hero MotoCorp. Hero’s shares, trading at 15x its FY14 EPS, do not reflect the risks faced from increased competition and higher technology costs. Deutsche Bank prefers Bajaj over Hero, due to its lower dependence on the slowing domestic market and valuation. The domestic market accounts for 51 per cent of Bajaj Auto’s revenues while it is 90 per cent for Hero. After its split from Honda, Hero also faces higher technology and market risks. Not all analysts agree with this theory though. Jain, for instance, believes even if one adds Honda’s upcoming capacity of 300,000 units to its current capacity of 850,000, it would only dent Hero’s marketshare marginally.

Given that the two-wheeler industry is planning to raise capacity by 34 per cent over FY12-14, players who are only dependent on the domestic market will face the heat. While exports help Bajaj Auto’s revenue mix, its presence in the three-wheeler space will improve its margins. With the launch of its RE60, Bajaj Auto’s four-wheeler, slated for later this year, the company is expected to defend its margin and marketshare in this segment, believe analysts.