Wednesday, March 12, 2014

Bajaj Auto - great company but a tad bit expensive!

BSE: 532977 | NSE: BAJAJ-AUTO | ISIN: INE917I01010

Has been a household name forever (has been around since 1926). Used to make scooters and transformed itself into the most profitable 2 wheeler company. The auto industry has slowed down tremendously and the big giant Hero Honda split into Hero Motocorp and Honda continued with its Honda motorcyles.



1. How good is the moat?


Grade A Moat.

  • Brand: Replacing the Bajaj name in Indian households would be probably a very long and expensive activity. They have also been able to price their products above the Hero products and have greater margins.
  • Product replication is not the big deal here. The issue is the replication of the dealer network, brand, sales pipeline - which other than Honda Motorcycles and Hero Motocorp no one else has. They so far have the most successful export strategy in the 2W and 3W segment. Even the 3W brand is impeccable.
  • Sales & Distribution: Massive dealer network with over 3750 rural outlets, 500 dealers and 1600 service centers - unlikely for a new entrant to replicate rapidly.
  • Pricing power - I don't understand why but Bajaj auto since its remake as a motorcycle manufacturer has been able to price their products over the competition and still make sales. Even though 9 months ended December 2013 sales numbers are down 9.9% the value of the sales has remained constant and the profits have gone up by 8.9%!
  • Depreciated assets - Also the plants and equipment have been around for years and are fully depreciated. Replication of these assets will be an uphill task.
  • Performance during recessions: This is likely to be a concern and is one the big reasons for the stock taking a beating. Taking a bet on it is akin to believing that 2W and 3W sales will catch up either in India or abroad. The good news is that 30%+ of the revenue comes from exports FY2013 - which means that this company can catch up there even if the Indian economy is sluggish.
  • Innovation - some amount of innovation is being attempted with the 4W cheap vehicle to replace the 3W market and the small car market. This is like having a option that could end up far in the money.

2. Risk factors


  • Market recovery: 
    • If there is no recovery in the 3wheeler market (sales are down 20% this YoY) then 3W capacities might take a beating
    • If there is no recovery in the motorcycle market in India
    • If the export growth is unable to counter the fall in market size in India
  • Saving grace:
    • Ability of the company to increase prices and get away with it
    • Presence in the high end segment - and possibility of absorbing this technology and exporting these products
    • Presence in many export markets: Europe, Indonesia, Africa (Nigeria)
  • Strained employee relations - Bajaj Auto has faced lots of unrest at its plants at Chakan and Pune. This could be a concern when capacity utilization is required to meet market demand.
  • Capacity utilization - is low. Total installed capacity was 5.4mil units at the end of FY2013 of which 

3. Financials


  • Cash flow from operations has lagged net income by an average of 13% or so over the last 5 years which is largely due to the investment income. Not a cause for concern.
  • Exceptional items - small changes due to currency hedges - expected due to the exports exposure.
  • Inventories are maintained between 3.5% and 4.3% of sales which is very healthy. News reports suggest that dealer inventories are high. Feb sales were down by 6% YoY so this is to be expected.
  • Inventory valuation is not much of a concern as the absolute value of the inventories is low
  • ROCE track record: Has been always over 19% and for the past 4 years has been over 38%. Exceptional record.
  • Debt - company has ZERO debt which reduced risk massively. Cash rich. Cash reserves are over 4,500 crores invested in bonds, debentures, commercial paper, mutual funds, etc.
  • Trade receivables - are very low: 3.5% of sales. Working capital is negative (payable are more than receivables + inventory)
  • Dividend % of earnings - Around half the earnings are paid out as dividends annually.

4. Soft factors

  • Shareholdings: 
    • Promoter shareholding - Over 50% - which is good in this case.
    • FII holdings are high at 16% - so expect volatility
    • Retail investor base is over 15%
  • Employee relations is a large source of risk and the company need to fix this or might cause severe losses.
  • Growth - sources are mainly export at this point. But buying this stock means betting on the Indian economy to do well and for people to buy more motorcycles. The 4W project might be an interesting source of growth as well.

5. Pricing

  • Currently trades at around 17 times earnings which is typically what it has traded at for the past 5 years consistently. I would not buy at current levels as a value investment but would be buying this stock anywhere under 15 times earnings.
  • Price to book currently stands at around 5.9 times which is cheaper than historic trading but that is clearly because there is growth overhang. I would not read much into the Price to book of this stock.