india two-wheeler sector - niveza.in two-wheeler sector ... product mix continues to move towards...

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22 April 2016

Asia Pacific/India

Equity Research

Automobiles & Components (Automobiles & Components IN (Asia))

India Two-Wheeler Sector SECTOR REVIEW

Cyclical recovery already priced in

Figure 1: Hero to have lowest volume growth; TVS to have maximum earnings

disappointment, it also has the most stretched valuations

10

13

16

19

22

0.0%

3.0%

6.0%

9.0%

12.0%

Hero Bajaj TVS

Domestic Volume Growth (FY16-21E) Downside to FY18 consensus earnings P/E (FY18E) (RHS)

Note: Hero's valuations adjusted for expiry of excise incentives. Source: SIAM, Company data,

I/B/E/S DataStream, Credit Suisse estimates

■ Cyclical recovery likely but prefer 4W to play the same. A good monsoon

and a pickup in the pace of the economic recovery should augur well for

auto volumes. In our view, it is much better to play this recovery through 4W

rather than 2W. Not only is the cyclical correction deeper in 4W vs 2W (2%

CAGR vs 7% CAGR in the past five years), 4W also have a much higher

operating leverage once volumes bounce back. Fixed costs declined on an

average ~250 bp for 4W vs ~100 bp for 2W in previous upcycles.

■ With commodity benefits behind us, 2W industry to again face margin

headwinds. Whilst the Honda threat has diminished, competitive intensity

remains high in the 2W industry. Pricing remains under pressure as OEMs

continue to launch aggressively priced variants. Product mix continues to

move towards scooters, which is a structurally lower-margin product.

Slowdown in higher-margin exports and the expiry of excise and income tax

exemptions presents another headwind.

■ Initiate with UNDERPERFORM on TVS; prefer Bajaj to Hero in 2W. We

believe the trend of scooters gaining share from the lower executive segment

will continue. Hence, Hero will have the lowest volume growth CAGR of ~6%

over next 5 years, and TVS, Honda the best at 10% CAGR. We prefer Bajaj to

Hero and initiate coverage on TVS with UNDERPERFORM and TP of Rs260

(20% downside) as we believe street expectations of 300 bp margin

improvement over the next 2 years are unlikely to be met. Key risk to our TVS

call is that recently launched Victor is a big success and exports recover earlier

than expected.

Research Analysts

Jatin Chawla

91 22 6777 3719

[email protected]

Akshay Saxena

91 22 6777 3825

[email protected]

22 April 2016

India Two-Wheeler Sector 2

Focus charts Figure 2: Prefer 4W in a recovery as they have seen a

significantly deeper cyclical correction

Figure 3: Once volumes bounce back, operating leverage

is also higher in PVs than in 2W

0%

5%

10%

15%

20%

FY95 FY98 FY01 FY04 FY07 FY10 FY13 FY16

5 year average 4W's growth 5 year average 2W's growth

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Maruti (FY09-11) Hero Motocorp (FY08-11)

Volume growth in recovery Reduction in fixed cost (RHS)

Source: SIAM Source: Company data, Credit Suisse estimates

Figure 4: Scooters and premium bikes to see faster

growth, while commuter bikes will come down

Figure 5: Hero Motocorp's margins have peaked as it

faces multiple headwinds ahead

6% 4% 3%

14% 15% 11%

35%24%

18%

14%

12%

13%

12%

14%

15%

19%31%

40%

0%

20%

40%

60%

80%

100%

FY12 FY16 FY21E

Mopeds Economy Executive (100 cc)

Executive (125 cc) Premium Scooters

13%

14%

15%

16%

FY16margins

R&D Ad FX Op Lev CostSavings

FY17Emargins

Hero Motocorp

Source: SIAM, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 6: We expect TVS to disappoint on both its

margins and market-share targets

Figure 7: All 2W stocks trading at premium to historic

average of 14-15x earnings, biggest premium for TVS

0%

5%

10%

15%

20%

Market-share Margins

Current Management FY18 target CS estimates

TVS

5.0

10.0

15.0

20.0

25.0

30.0

Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15

Hero P/E Bajaj P/E TVS P/E

Source: Company data, Credit Suisse estimates Source: I/B/E/S DataStream

22 April 2016


Cyclical recovery already priced in Cyclical recovery likely; prefer 4W to play the same A good monsoon and a pickup in the pace of the economic recovery should augur well for

auto volumes. In our view, it is much better to play this recovery through 4W rather than

2W. Not only are the penetration levels for 4W significantly lower than 2W, 4W have also

seen a much deeper cyclical slowdown than 2W with only a 2% CAGR in last 5 years for

4W vs a 7% CAGR for 2W. Also, the operating leverage benefit for 4W is much higher

than 2W. We note that in the previous recovery between FY09 and FY12 whilst fixed costs

declined ~250 bp for MSIL, there was only a ~100 bp swing for 2W companies.

For listed 2W players, exports have a significant contribution to volumes and they are

likely to decline in FY17. Currency in some of the large export markets has depreciated by

30-50% in the past one year. Whilst Indian companies take payments from distributors in

USD, it does result in prices going up in local markets hence impacting demand. Also,

USD availability has become an issue and hence Bajaj (largest exporter) has guided for a

10% decline in exports in FY17.

Scooters growing at expense of lower executive bikes Over the past five years, the share of scooters has increased from ~20% to ~30% and in

the same period the share of lower executive bikes (~Rs50k price, same as scooters) has

shrunk from ~35% to ~25%. In more developed states, scooter share has already crossed

40% and is still increasing. We expect the share of scooters to reach ~40% by FY20,

which should be the most positive for Honda, which completely dominates the space.

Hero has broadly maintained its lower executive segment volumes by growing market share

from 70% to 85% at Bajaj's expense. Bajaj has responded by aggressively priced products in

the economy segment leading to both market share increase and segment growth. The share

of premium segment is once again rising, especially with cruisers from both RE and Bajaj

doing very well. Hero has high exposure to the weakest growth segments and hence will have

the lowest volume CAGR of 6% over the next 5 years; we expect Bajaj to have an 8% CAGR,

and TVS and Honda to post 10% CAGR over next 5 years.

Margins to disappoint for most 2W companies While the threat from Honda on motorcycle market share has stabilised now, competitive

intensity in the 2W industry remains high with smaller players like Eicher, Yamaha and TVS

also doing well within their respective niches. The 2W industry has witnessed gross margin

expansion in FY16 on account of the sharp fall in commodities but pricing power remains

capped. The trend of players launching aggressively priced products has continued. This

combined with a shift in product mix towards lower margin scooters should put pressure on

margins. Slowdown in exports should also negatively impact margins as given Chinese

competition, they usually have much higher margins. The expiry of excise duty and income

tax incentives in Uttarakhand should also negatively impact margins for Hero, Bajaj and TVS.

Initiate on TVS with UNDERPERFORM; prefer Bajaj to Hero We initiate coverage on TVS Motors with an UNDERPERFORM rating. TVS has executed

really well in creating the new brand Jupiter in the scooters segment and on the exports

side. However, despite strong volumes, margin expansion has been muted given that it

has not seen even as much commodity-led gross margin expansion as other players have

in the industry. We believe street expectations from both (1) its new launch Victor in the

lower executive segment (shrinking category) and (2) margin expansion are very

aggressive. In an environment where industry margins will be under pressure, we fail to

see how TVS will be able to improve its margins by 300 bp over the next two years.

We believe Hero also faces multiple margin headwinds: (1) higher R&D spending; (2)

higher advertising spends; (3) negative product mix; and (4) the impact from the yen

appreciation. Thus, we prefer Bajaj to Hero despite headwinds in export markets.

Given deeper cyclical

correction 4W likely to

bounce back harder…

…also have much better

operating leverage

Segment growth trends will

dictate OEM performance;

TVS, Honda best placed

followed by Bajaj and then

Hero

Post commodity-led

expansion in FY16, margin

pressures from competition,

exports and excise duty

expiry to come to the fore

TVS unlikely to achieve both

its market share and margin

target

Hero likely to face margin

headwinds going forward

22 April 2016


Financial summary

Figure 8: Recommendation summary

Company CMP (Rs) Target

Price (Rs) Rating Key arguments

TVS Motors 325 260 U

See downside risks to both company's 10% margin and 18% market-share target.

Industry margins likely to stay under pressure and with commodity tailwinds no longer

there, taking up margins further will be a challenge. A lot is riding on the new Victor

launch, but we don't expect material volumes from it, as: (1) the 100cc executive

segment has been shrinking, losing to motorcycles and (2) creating a brand here is

difficult as seen from continued Hero's dominance despite Honda's aggression.

Hero Motocorp 2,989 2,590 N

Market-leader but likely to see lowest volume growth in medium term of the major

OEMs, primarily due to market-shift trend towards the segments where the company is

weaker (scooters, premium bikes). Margins have peaked in FY16, with headwinds

ahead from higher R&D, higher advertising, forex (yen appreciation), adverse product

mix and the expiry of excise incentives.

Bajaj Auto 2,496 2,420 N

We like the company's strategy with recent launches—aggressively priced CT100 in

economy, recreating premium positioning in executive with "V" and catching the cruiser

trend with Avenger, but the absence from the fast-growing scooter space will continue

to hurt. Additional near-term headwinds due to weakness in key export markets.

Eicher Motors 20,313 19,200 N

Will remain by far the fastest growing, given the still nascent segment and the absence

of meaningful competition, along with the strong aspirational values associated with the

Royal Enfield brand. However, at CMP, we see this as largely being captured and next

leg-up can only come from the success in 2-3 large export markets on which there is

limited visibility.

Source: Company data, Credit Suisse estimates

Material changes table Price Price Rating* Target Price Year EPS EPS FY1E EPS FY2E EPS FY3E

Company ccy 21 Apr 16 Prev. Cur. Prev. Cur. End Ccy Prev. Cur. Prev. Cur. Prev. Cur.

Bajaj Auto Limited (BAJA.BO) Rs 2,496.10 — N — 2,420.00 Mar 15 Rs 135.21 132.90 150.88 147.98 164.91 161.56

Hero Motocorp Ltd (HROM.BO)

Rs 2,988.50 — N 2,420.00 2,590.00 Mar 15 Rs 154.94 156.16 171.40 167.96 188.45 183.95

TVS Motors (TVSM.BO) Rs 324.60 — U — 260.00 Mar 15 Rs — 8.98 — 12.46 — 15.97

*O – Outperform, N – Neutral, U – Underperform, R – Restricted [V] = Stock considered volatile (see Disclosure Appendix).

Figure 9: Sector valuation table

Company CMP Market cap P/E EV/EBITDA ROE P/B

(Rs (US$ bn) FY17 FY18 FY17 FY18 FY17 FY17

Maruti Suzuki 3,704 16.9 17.8 15.0 8.7 7.0 20.6 3.5

Bajaj Auto Limited 2,496 10.9 17.2 15.0 11.3 9.7 30.3 5.0

Hero Motocorp Ltd 2,989 9.0 17.1 15.5 11.5 10.3 39.3 6.3

Eicher Motors 20,313 8.3 33.8 26.7 17.8 13.9 37.1 11.3

TVS Motors 325 2.3 23.3 18.1 14.6 11.3 29.4 6.4

Source: Company data, I/B/E/S Datastream. Note all are consensus estimates

22 April 2016


Cyclical recovery likely; prefer 4W to play the same A good monsoon and a pickup in the pace of the economic recovery should augur well for

auto volumes. In our view, it is much better to play this recovery through 4W rather than 2W.

Not only are the penetration levels for 4W significantly lower than 2W, 4W have also seen a

much deeper cyclical slowdown than 2W with only a 2% CAGR in the past five years for 4W

vs a 7% CAGR for 2W. Also, the operating leverage benefit for 4W is much higher than 2W.

We note that in the previous recovery witnessed between FY09 and FY12 whilst fixed costs

declined ~250 bp for MSIL, there was only a ~100 bp swing for 2W companies.

For listed 2W players, exports have a significant contribution to volumes and they are

likely to decline in FY17. Currency in some of the large export markets has depreciated by

30-50% in the past one year. While Indian companies take payments from distributors in

USD, it does result in prices going up in local markets hence impacting demand. Also,

USD availability has become an issue and hence Bajaj (largest exporter) has guided for a

10% decline in exports in FY17.

Prefer 4W in a cyclical recovery

Good monsoons can revive 2W demand

Key driver of 2W growth in India has been the acceleration in the rural economy. Over the

longer term, rural India’s contribution to overall volumes has been continuously rising.

Rural share in 2W now stands at ~45%, compared to ~20% in 1985. Even in the past five

years or so, rural had been growing well ahead of urban, barring last fiscal (FY16) when

there was an adverse impact of two straight bad monsoons.

Hence, normal monsoons this year will be key to FY17 volumes for the 2W industry. With

early forecasts of normal monsoons this year (though monsoons forecasts have not

always been accurate) along with a gradual recovery in urban demand, we expect 10%

growth in FY17 volumes, after a 3% growth only in FY16.

Figure 10: Share of rural India in 2W has been growing… Figure 11: …hence, growth slowdown in FY16 was on

account of two straight bad monsoons

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1984 1990 1995 2000 2004 2008 Current

Share of rural in 2W sales

-15%

0%

15%

30%

-30%

-15%

0%

15%

1994 1997 2000 2003 2006 2009 2012 2015

Monsoon rainfall deviation from normal 2W growth (RHS)

Source: Company data, Credit Suisse estimates Source: SIAM, IMD

22 April 2016


However, 4W will see an even stronger recovery

Given that we have had two consecutive droughts, and overall economic growth has

slowed down since FY12, 2W industry growth has slowed down to a 7% CAGR in the past

five years against its long-term growth of 12% CAGR. Hence, there will be a cyclical

rebound in industry volumes over the next two years if the monsoon is good and economic

recovery continues. However, we note that PV growth normally tends to bounce back

much more than 2W growth in the event of a recovery. The cyclical correction this time

around also has been much deeper for PVs with only a 2% CAGR in the past five years.

The current slowdown is in fact one of the worst the industry has ever seen.

Figure 12: 4W are more cyclical than 2W… Figure 13: …and have seen a deeper cyclical correction

-20%

0%

20%

40%

FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 FY16

Domestic 2W's growth 4W's growth

0%

5%

10%

15%

20%


5 year average 4W's growth 5 year average 2W's growth

Source: SIAM Source: SIAM

Penetration gap is also higher in 4Ws than 2Ws

With the auto association (SIAM) now starting to share state-wise auto sales, we also

analyse the key sales trends in states within India. As expected, there is a strong

correlation between income levels and 2W sales. States with higher per capita GDP have

higher 2W sales per capita. This indicates continued growth potential from lower-ranked

states as they develop and their penetration catches up. However, we note that state-wide

disparity is much higher in cars than in two-wheelers, suggesting the higher discretionary

nature of cars as well as bigger upside possible on car sales.

Figure 14: Good correlation between income levels and

2W sales in the state…

Figure 15: …however, state-wide disparity in per capita

sales much higher in cars than in 2Ws

0

40

80

120

160

200

0

400

800

1,200

1,600

2,000

DL PU HA GU KA TN KE RJ MH AP OR MP JH UP AS WB BI

Monthly 2W Sales/ Mn population GSDP/ capita (RHS in Rs '000)

0

200

400

600

800

1,000

0

400

800

1,200

1,600

2,000

DL PU HA GU KA TN KE RJ MH AP MP JH UP AS WB BI

Monthly 2W Sales/ Mn population PV Sales/ Mn population (RHS)

Source: SIAM, MOSPI Source: SIAM, MOSPI

22 April 2016


Figure 16: India's 2W penetration still low compared to

other mature countries…

Figure 17: …gap in 4W penetration is even larger

0%

20%

40%

60%

80%

100%

120%

140%

160%

India Indonesia Thailand Malaysia Taiwan Vietnam

2W penetration per household (%)

530

454 441403

340

195180

7540

16

0

100

200

300

400

500

600

Germany UK Japan USA MalaysiaMexico Brazil China Indones India

Car penetration per 1000 people

Source: World Bank statistics Source: World Bank statistics

Operating leverage also much higher for 4W

Not only is the rebound in volumes much better for 4W, they also tend to have a much

higher operating leverage. In previous cycles, 2W have witnessed a ~100 bp reduction in

fixed costs, whilst 4W have witnessed a ~250 bp reduction in an up-cycle. There is also

higher benefit on gross margins for 4W as fixed costs with vendors also are higher for 4W

companies, and hence the volume discount available to 4W companies is higher than 2W

companies. Moreover, while 2W don’t have any significant discounts to consumers, 4W

have also seen a 300 bp increase in discounts to consumers in the slowdown, which could

also reverse if volumes start to come back.

Figure 18: Hero Motocorp's fixed costs only saw

cumulative 100 bp reduction in upcycle…

Figure 19: …for Maruti, improvement was as high as 250

bp

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

FY09 FY10 FY11

Volume growth Reduction in fixed cost from base (RHS)

Hero Motocorp

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

FY10 FY11

Volume growth Reduction in fixed cost from base (RHS)

Maruti

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

22 April 2016


Figure 20: 2Ws have lowest operating leverage Figure 21: Discount reduction another margin lever in 4W

0

100

200

300

400

500

600

700

800

Autos-2W Autos-4W Auto components Autos-CV

Change in operating leverage in bear versus bull cycle (change in bps)

7,000

10,000

13,000

16,000

19,000

22,000

3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16

Discounts/ vehicle (Rs)

Source: Company data, Credit Suisse estimates Source: Company data

2W will also face headwinds in exports

We have been quite sanguine on medium-term export potential for Indian 2Ws on low

penetration in regions like Africa as well as the fact that Indian autos have been gaining

share from Chinese (who are the main competitors). However, of late, export growth has

been weak, with continuous double-digit decline over the past six months in Bajaj's

exports (Bajaj has a dominant >60% share in exports). Management's latest guidance of

~1.6 mn units exports in FY17 also implies a ~10% YoY decline. This follows a ~5%

decline in FY16, and is a sharp slowdown from >20% growth trend since FY08.

Figure 22: Bajaj's monthly exports have been on a

declining trajectory…

Figure 23: …after robust growth in exports since FY08,

management's guidance implies second consecutive year

of decline in exports in FY17

75,000

100,000

125,000

150,000

175,000

200,000

Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16

Bajaj Exports

-10%

0%

10%

20%

30%

40%

0

400,000

800,000

1,200,000

1,600,000

2,000,000

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E

Bajaj Total Exports YoY growth

Source: Company data Source: Company data, Credit Suisse estimates

Currency issues dragging export growth

One of the main factors for this export weakness has been forex issues in some of the key

markets like Nigeria, Egypt. The Nigerian currency (Naira) already had a sharp

devaluation last year from ~160/USD to ~200/USD as the Central bank freed it up partially

(currency is pegged in the country). The unofficial rate for the Naira has in fact already

22 April 2016


crossed the ~300/USD mark. Other currencies like the Argentine Peso, Colombian Peso

and Egyptian pound have also seen a sharp fall.

Bajaj takes payments from its distributors in these countries in USD only to insulate itself

from forex fluctuations. However, this sharp fall in forex does impact margins, as

companies have to take price cuts to partially cushion the impact of the currency fall for

end customers. Moreover, there has been a severe shortage of USD in these countries,

which also impacts sales (a sale is made only when a distributor is able to arrange a USD

line of credit).

Figure 24: Most of the key 2W export countries have seen much larger depreciation in

their currency than INR

0%

20%

40%

60%

80%

India Nigeria(Black

market rate)

Colombia Egypt Uganda Kenya Angola Peru Argentina Mexico

Depreciation in each country's FX since Jan-15

Source: Bloomberg

The Commerce Ministry's trade data (comes with a quarter lag) shows that none of the top

2W export destinations have had any growth this year. Nigeria volumes particularly saw a

sharp fall in Jan-16 (the last available data as of now), and this trend is likely to have

continued in February and March.

Figure 25: None of the major export markets have seen

growth this year

Figure 26: Given forex issues, exports particularly to

Nigeria fell sharply in Jan-16 (last available data)

-20%

-10%

0%

10%

0%

10%

20%

30%

Nig

eria

Sri

Lank

a

Col

ombi

a

Ban

glad

esh

Phi

lippi

nes

Contribution to India 2W exports 9MFY16 volume growth (RHS)

0

10

20

30

40

50

Nigeria Colombia Philippines Sri Lanka Bangladesh

1Q16 2Q16 3Q16 Jan-16

Avg monthly 2W exports ('000 units)

Source: Ministry of Commerce Source: Ministry of Commerce

22 April 2016


One of the ways by which companies have been somewhat offsetting this is by entry into

new markets. Trade data shows that for 9M FY16, while the exports to the top six markets

(~60% of total exports) declined at ~10%, they were offset by ~10% growth in other

regions, resulting in overall flattish growth for Indian 2W exports. There has been scale-up

in countries such as Argentina, Peru, Mexico, Iran, Kenya, Guinea and Congo.

Figure 27: Even with decline in top markets, overall Indian

exports in FY16 have been flattish

Figure 28: Nigeria and Egypt contribute to >40% of Indian

3W, so forex issues impact 3W exports as well

-10%

0%

10%

20%

0%

25%

50%

75%

Top 6 countries (Nigeria, Sri-Lanka,Colombia, Nepal, Bangla, Phili)

Others

Contribution to India 2W exports 9MFY16 volume growth (RHS)

Sri-Lanka32%

Nigeria23%

Egypt20%

Bangladesh6%

Peru4%

Others15%

3W exports split (FY16)

Source: Ministry of Commerce Source: Ministry of Commerce

For the past eight years, Bajaj has maintained ~60-65% share in 2W exports out of India

despite aggressive scaling-up plans of other companies. Of the Indian OEMs, Bajaj also

has by far the highest share of revenues from exports and hence gets hurt the most from

an export slowdown.

However, the medium-term export story for Indian 2W players remains intact. Players like

Hero and TVS have ambitious targets on exports. We believe it would be difficult for them

to emulate Bajaj, given the early-mover advantage Bajaj has in establishing relationship

with big distributors in these countries and the strong brand that the company has created.

Figure 29: Bajaj remains dominant 2W exporter from India

with ~60% share

Figure 30: Among Indian OEMs, share of exports is

highest for Bajaj and quite meaningful for TVS

63% 65% 66% 63% 62% 59%

9% 9% 8%6% 8%

8%

7% 6% 8%8% 8% 8%

6% 7% 7%9% 7% 6%

15% 13% 11% 12% 13% 14%

0%

20%

40%

60%

80%

100%

FY11 FY12 FY13 FY14 FY15 FY16

Bajaj Hero Motocorp Honda Yamaha TVS Others

Market-share (2W exports)

0%

10%

20%

30%

40%

50%

Bajaj TVS Hero

Share of exports in revenues

Source: SIAM Source: Company data, Credit Suisse estimates

22 April 2016


Scooters gaining at expense of lower executive bikes Over the past five years, the share of scooters has increased from 19% to 31% and in

the same period the share of lower executive bikes (priced around ~Rs50k, same as

scooters) has shrunk from 35% to 24%. In the more developed states, scooter share has

already crossed the 40% mark and is still increasing. Trend towards scooters is most

positive for Honda, which completely dominates the space. Hero has extended its

dominance of the lower executive segment by improving its share from 70% to ~85% at

Bajaj's expense (Discover).

Bajaj has responded by launching aggressively priced products in the economy segment,

which has resulted in not only the company gaining >10% share in the segment but also

the share of the segment once again starting to grow after a multi-year decline. Hero has

done well in the upper executive segment (125cc space) with the success of Glamour and

Super Splendor, but with the recent launch of 'V', Bajaj once again has a product with the

right positioning to garner share in the space. The share of the premium segment is once

again rising with the success of the Royal Enfield. Bajaj too has caught onto the cruiser

trend and has witnessed a sharp rise in Avenger volumes. We reckon Bajaj seems to be

the best placed to deliver a strong growth in domestic volumes in FY17.

Figure 31: Key segmental trends that will govern Indian 2W space

Segment growth trends Market-share movements

Japanese led by Honda dominate with 65% share

Honda’ share has further increased in last few years, though

Hero and TVS challenging hard. Bajaj absent from segment

Scooters

(31% share)

15% CAGR

In five years, share has grown from ~20% to ~30%

Even higher share in developed states and mature countries

Driven by universal usage advantage, convenience etc

Bajaj’s share increased from ~25% to ~35% with launch of

CT100 (10% discount) and CT100B (further 10% discount)

Hero (50%), TVS (15%) have both seen some share drop

Economy bike

(15% share)

2.5% CAGR

Over longer period, sharp fall with up-trading trend in market

Launch of aggressively priced models though has led to

segment growing ahead of market in last 2 years

Hero remains dominant with ~80% share despite efforts by

Bajaj and Honda indicating difficulty in establishing brand

This also implies challenge for TVS new bike Victor

Executive 100

(24% share)

2.5% CAGR

Biggest segment but share drop from 35% to 25% in 5 yrs

Given similar pricing; unisex nature; preference from

mileage to convenience; driving shift from here to scooters

Hero has grown share here too at the expense of Bajaj

(Discover)

With new “V”, Bajaj should again gain some foothold

Executive 125

(12% share)

10% CAGR

Share has remained relatively steady at ~12% of 2W

market, with preference towards higher cc bikes

Royal Enfield has already grown to ~25% of segment

Segment leader – Bajaj has maintained share if RE excluded,

company also catching cruiser trend with Avenger

Premium bike

(14% share)

12% CAGR

Share has more than doubled in last 10 years with

preference for sportier and more powerful bikes

Within premium - trend towards cruiser (leisure bikes)

TVS is the only player present

Mopeds

(4% share)

2% CAGR

Bottom-most segment present mainly in South which

constitutes ~60% of sales

Source: SIAM, Credit Suisse estimates

Scooters to continue growing faster

While motorcycles is the dominant 2W segment in India, gearless scooters have steadily

gained popularity over the years. Scooters have had a robust double-digit growth in each

of the last few years and their share in 2W has almost doubled from 16% in FY10 to 31%

now. Scooters have especially taken off in urban areas; in many cities, anecdotally

scooters actually sell more than motorcycles now.

22 April 2016


Figure 32: Scooters' share steadily increasing… Figure 33: …with continuous robust double-digit growth

79% 78% 76% 75% 73% 71% 67% 65%

15% 16% 18% 19% 21% 24% 28% 31%

6% 6% 6% 6% 6% 5% 5% 4%

0%

20%

40%

60%

80%

100%


Share of Motorcycles Scooters Mopeds

11%9%

27%

42%

24%

14%

23%25%

12%

0%

10%

20%

30%

40%

50%

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Scooters growth


The following reasons have contributed to this increasing share of scooters and why we

believe they will continue to grow much faster ahead:

Rising female literacy: Women have a clear preference for scooters and hence once

they start going to schools/colleges/offices, scooters' sales increase (given they can be

used by all members of family). This is the reason why states with high female literacy like

Kerala have much higher scoter share.

Increasing income levels: Motorcycles are fuel efficient and comparatively cheaper, but as

income levels rise, the choice is moving towards scooters. Even middle-aged men prefer the

convenience of a scooter (which is gearless and hence has greater ease of driving), given the

traffic woes in cities. This is the reason why in South and West India (where income levels are

higher compared to North and East), the share of scooters is higher.

Improving road conditions: The bigger wheels of bikes make them easier to ride in bad

road conditions and hence they are the default choice in rural areas, but now with road

quality improving, the trend is moving towards scooters

Universal usage: Unlike motorcycles, which tend to be favoured only by men, scooters

are a unisex product and even if men are the primary users, they are increasingly opting

for scooters so that their wives/daughters can also use the vehicle when needed.

Narrowing fuel efficiency: Over the years, the mileage gap between scooters and

motorcycles has reduced; scooter mileage, which used to be ~30kmpl, has improved to

~45kmpl, whilst motorcycle fuel efficiency has been stagnant at ~60kmpl.

22 April 2016


Figure 34: Strong correlation between literacy and

scooters share

Figure 35: Reflecting income trends—the share of

scooters highest in South and lowest in East

50.0

60.0

70.0

80.0

90.0

100.0

0.0

15.0

30.0

45.0

60.0

75.0

KE DL GU PU KA MH TN AP HA OR MP WB RJ JH UP BI

Share of scooters in state Literacy Rate (RHS)

26 2031

39

7276

67 53

0

20

40

60

80

100

120

North East West South

Scooters Bikes Mopeds

Share in each region

Source: SIAM, MOSPI Source: SIAM

Experience from other countries shows that the share of scooters rises as markets mature.

In Indonesia, for instance, the share of scooters as a percentage of the total 2W sales has

risen from ~25% in 2008 to ~60% in 2012.

Within scooters, there can be a sub-division into two segments: Female-only category

(typically lighter cc and trendy looks as only young girls use the vehicle) and Unisex (all family

members use this vehicle and hence technology perception and reliability are also important

parameters). The share of 'female-only' scooters has come down over the years, again

indicating that scooters are increasingly being purchased for usage by all family members.

Figure 36: Even Indonesia, which is ahead of India by

almost a decade in terms of its 2W penetration, saw sharp

increase in scooter sales from 2008 to 2012

Figure 37: In India, within scooters, the share of unisex is

increasing and that of 'female only' is coming down

63%52%

45%38%

26%

26%39%

46%52%

60%

11% 10% 9% 11% 14%

0%

20%

40%

60%

80%

100%

2008 2009 2010 2011 2012

Share of cubs in Indonesia Scooters Sports

21%14% 10% 8%

79%86% 90% 92%

0%

20%

40%

60%

80%

100%

FY13 FY14 FY15 FY16

Share of female scooters Unisex

Source: Company data, Credit Suisse estimates Source: SIAM

The Japanese have an edge in scooter technology over their Indian counterparts, given

their experience of selling scooters in more mature 2W markets such as South-East Asia.

Honda’s Activa is well renowned for its reliability and is a clear leader. Indian players like

Hero and TVS have made attempts to break its stronghold but despite some success of

late, they have found it difficult to break Honda's stranglehold on the segment; hence, the

continued trend towards scooters is an advantage for Honda.

22 April 2016


Figure 38: Honda is the dominant player in scooters

57%51%

43% 48% 49% 53% 56% 55%

13%14%

17%16% 19%

19% 17% 16%

21%20%

22%19% 15%

13% 15% 15%

7%10%

11% 11% 11%8% 6% 4%

0%

20%

40%

60%

80%

100%

2009 2010 2011 2012 2013 2014 2015 2016

Honda Hero Motocorp TVS Yamaha Suzuki M&M

Market-share in scooters

Source: SIAM

Middle segment struggling, but premium and

economy starting to grow

The motorcycle market can be segregated into four main segments based on price points.

Different players have varied strength in each of these, with Hero the leader in the

economy segment. Hero is completely dominant in the executive segment and Bajaj is the

leader in the premium segment.

Figure 39: Segmentation of motorcycle market by price point

Segment Price point (Rs) Engine cc Size Major models

Economy <45k 100 23% Hero Dawn, Bajaj CT, Bajaj Platina, TVS Star City

Lower Executive 45k to 55k 100-110 37% Hero Splendor, Hero Passion, Honda Dream, TVS Victor, Bajaj Discover

Upper Executive 55k to 65k 125-150 19% Hero Glamour, Honda Shine, Bajaj V

Premium >65k >150 21% Bajaj Pulsar, Avenger; Honda Unicorn, Yamaha FZ, TVS Apache, Royal Enfield


Lower executive segment seems to have been most impacted by scooters

The biggest segment in motorcycles is executive at ~60% of total. It can be further

segregated into two—lower executive (100-110cc) and upper executive (125-150 cc).

While the lower executive segment is the biggest part of motorcycles, its share has been

coming down in the past few years.

In fact, the interesting trend is that all the share movement in the past five years from

motorcycles to scooters can be explained by the drop in the share of lower executive only,

as all the other motorcycle segments have been relatively steady. We reckon this is

explained by similar price point at which scooters and lower executive bikes sell. Models

like Honda Activa are priced starting ~Rs50k (ex-showroom), which is almost equal to the

price of the most popular lower executive segment bike Splendor Pro. In the past five

years, when the share of scooters in 2W has increased from 19% to 31%, that of lower

executive has dropped from 35% to 24%.

A customer who is mileage-conscious is likely to opt for economy segment bikes, and a

customer looking for style and power is likely to opt for premium segment bikes. It is a

customer who is looking for a combination of both mileage and quality who will opt for

executive segment bikes. As highlighted earlier, a slight shift in preference from

mileage to convenience along with universal usage is driving a shift from lower

executive bikes to scooters.

22 April 2016


Figure 40: Segregation of overall 2W market shows that it is lower executive segment

only in motorcycles that has lost out the most to scooters, given similar price point

6% 6% 5% 5% 4%

14% 14% 13% 13% 15%

35% 34% 34% 29% 24%

14% 13%12%

12%12%

12% 12%12%

13%14%

19% 21% 24% 28% 31%

0%

20%

40%

60%

80%

100%

FY12 FY13 FY14 FY15 FY16

Mopeds Economy Executive (100 cc) Executive (125 cc) Premium Scooters

Source: SIAM

Hero has further consolidated its position at Bajaj's expense

In the executive segment, Hero Motocorp is the clear market leader, especially in the

lower executive segment. The company has done a good job of further growing its market

share here in the past two years, even with the aggressiveness of players like Honda

whose "Dream" series has not found much success. This also shows challenge for TVS in

establishing its new motorcycle "Victor" here.

Bajaj has lost out the most with a steep fall in "Discover" sales. It has recently launched "V15,"

which has a slightly premium positioning with retro looks. The vehicle has had good initial

response, and will be key to revive the company's fortunes in the upper executive segment.

Figure 41: Hero has done a good job of consolidating its

leadership position in lower executive…

Figure 42: …even in upper executive, it has done well,

with Bajaj (Discover) completely crashing

0%

20%

40%

60%

80%

100%

Hero Bajaj

FY14 FY16

Market-share in lower executive (100cc)

0%

20%

40%

60%

Hero Bajaj

FY14 FY16

Market-share in upper executive (125cc)


22 April 2016


Aggressively priced bikes by Bajaj have led to revival of economy segment

The bottom-most segment is economy—no-frills bikes with fewer features, less power,

lower engine cc, etc. The main parameter on which products sold in this segment score is

price (both initial upfront cost is lower and ownership cost is lower with high mileage). This

segment had been on a wane with the share dropping from 42% in FY06 to 17% in FY11.

However, in the past couple of years, the share of the economy segment has again started

moving up. This has been driven by aggressive launches by Bajaj—first launching

"CT100" in early 2015, which was priced at a 10% discount to the cheapest prevailing bike

in the market then, following it up with "CT100-B" this year priced at a further 10%

discount. Not surprisingly, Bajaj has had strong market share gains in the economy

segment in the past two years on the back of these launches.

Figure 43: Share of economy segment has been declining

in long-run, but trend has reversed in past two years

Figure 44: Launch of attractively priced CT100 by Bajaj

has resulted in this trend back towards economy

0%

9%

18%

27%

36%

45%

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Share of Economy in motorcycles

0%

20%

40%

60%

Hero Bajaj TVS

FY14 FY16

Market-share in economy


Trend towards cruisers driving premium segment growth

Over the longer run, there has been a clear aspiration for higher cc bikes. Excluding couple of

years in the downturn (FY12 and FY13), premium segment bike sales have always grown

ahead of the industry. The premium segment share has more than doubled from ~9% in

FY06 to 21% currently, as customer preferences shifted towards more sporty bikes.

22 April 2016


Figure 45: In longer run, share of premium bikes should

continue increasing..

Figure 46: ..within premium bikes, there has been trend

towards cruiser driven by Royal Enfield

0%

5%

10%

15%

20%

25%

FY06 FY08 FY10 FY12 FY14 FY16

Share of Premium motorcycles

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY11 FY12 FY13 FY14 FY15 FY16 Current

Share of cruiser in premium segment (Royal Enfield, Avenger)


Within premium bikes, Royal Enfield has had exponential growth in the past few years with

its share rising from 3% in FY11 to 22% now. This has also meant a sharp rise in the

share of cruiser bikes (niche segment where RE operates). The other company with

presence in cruiser bikes is Bajaj, whose new series of Avenger bikes has also had a good

response. The share of cruiser bikes in the premium segment is as high as 36% currently.

Excluding cruiser models, Bajaj has managed to retain its overall share in the premium

segment on the back of its Pulsar model (overall share loss in premium, due to faster

growth of RE). TVS Apache has done exceedingly well in the space, leading to TVS's

share in the overall premium increasing from 8% to 12% in the past two years and its

share excluding cruisers improving from 10% to 17% in the past two years.

Figure 47: Royal Enfield has had strong share gains in premium; excluding it, Bajaj has

maintained share in this segment

22% 20% 20% 19% 16% 11% 8% 6%

40% 46% 48%42%

41%37%

35% 36%

10% 9% 9%8%

7%

8%10% 12%

9% 8% 8%10%

14%18%

14% 9%

13% 11% 11%15% 14%

14%15%

12%

5% 4% 3% 5% 7% 12% 16%22%

0%

20%

40%

60%

80%

100%

120%


Hero Motocorp Bajaj TVS Motors HMSI Yamaha Suzuki Royal Enfield

Market-share in premium bikes

Source: SIAM

Going forward, we expect faster growth in scooters to continue and their share in the

market to increase to ~40% in five years' time from ~30% today. This would largely be at

the cost of lower executive bikes (100 cc bikes). The higher cc bikes (premium) will

continue to grow the fastest in motorcycles. Hero stands to lose the most from this trend,

given its weaker positioning in both premium bikes and scooters. While we like Bajaj's

strategy in motorcycles, its absence from scooters will hurt margins. TVS will have higher

growth aided by entry in the lower executive space (where it was absent till now).

22 April 2016


Figure 48: Scooters and premium bikes will continue to

grow ahead of the market

Figure 49: Hero to have slowest growth on account of

higher share from low growth segments

0.0%

5.0%

10.0%

15.0%

Mopeds Economy Executive(100 cc)

Executive(125 cc)

Premium Scooters Overall2W

Segmental Growth (FY16-21E)

0.0%

5.0%

10.0%

15.0%

Hero Bajaj TVS Honda

Company-wise domestic 2W growth (FY16-21E)

Source: SIAM, Credit Suisse estimates Source: SIAM, Credit Suisse estimates

22 April 2016


Margins to disappoint for most 2W companies While the threat from Honda on motorcycle market share has stabilised now, competitive

intensity in the 2W industry remains high with smaller players like Eicher, Yamaha and

TVS also doing well within their respective niches. The 2W industry has witnessed gross

margin expansion in FY16 on account of the sharp fall in commodities, but pricing power

remains capped. The trend of players launching aggressively priced products has

continued. This combined with a shift in product mix towards lower-margin scooters should

put pressure on margins. Also, given that in export markets the competition has been with

Chinese bikes, Indian players have enjoyed healthy margins, and export slowdown will

also put pressure on margins. Another factor that will impact players like Hero, Bajaj and

TVS is the expiry of excise duty and income tax incentives in Uttarakhand.

Honda threat seems to be diminishing, at least in motorcycles…

Since Honda split from Hero in 2011, one of the biggest overhang on Indian 2W stocks

has been the aggression of Honda hurting the market share and profitability of incumbents.

Honda gained a massive 1,200 bp market share in a period of three years from FY12 to

FY15, with share gains in both motorcycles and scooters, driven by factors like capacity

expansion (to clear backlog), distribution expansion and new product introduction.

However, of late, the company hasn't been doing well in motorcycles, losing share across

segments in FY16. This indicates that Honda's threat in motorcycles is now stabilising.

Figure 50: While Honda’s market share in 2Ws has

increased ~1,200 bp from FY12 to FY15…

Figure 51: …its share has actually dropped in FY16, with

share loss across motorcycle segments

19% 18% 14% 11% 12%

45% 43%41%

40% 39%

15% 19%24%

27% 26%

14% 13% 12% 13% 13%

7% 8% 9% 9% 10%

0%

20%

40%

60%

80%

100%

FY12 FY13 FY14 FY15 FY16

Mkt share 2W's Bajaj Hero Honda TVS Others

0%

20%

40%

60%

Overall 2Ws Scooters Executive (100cc)

Executive (125cc)

Premium

FY13 FY14 FY15 FY16

Honda's market-share


…but industry structure has still changed with increasing competition over the years

However, we do note that the competitive intensity in the industry has still increased over

the years. The Herfindhal Index (HH index) has been continuously falling over the past

eight years, indicating greater fragmentation. This is in contrast to the car industry where

market leaders like Maruti and Hyundai have actually strengthened in the past few years.

In the 2W space, smaller players like Royal Enfield and Yamaha have gained significant

foothold in certain niches.

Hence, there has been a marked change in the industry structure over the years. The

competitive intensity is similar in both motorcycles and scooters: while in scooters the

Japanese players are very strong, some Indian players like Royal Enfield and Bajaj have

presence in motorcycles. Even for FY17, multiple players like Bajaj, Royal Enfield, TVS

and Honda have aspirations to grow well ahead of the industry.

22 April 2016


Figure 52: Competitive intensity in 2W space has deteriorated over the years

0.20

0.23

0.26

0.29

0.32


Herfindahl index index (2W's) 4W's

Source: SIAM

Pricing power capped with indirect discounting

Unlike the car segment, the 2W industry has not seen heavy discounting even with the

weakening of industry demand. Most players realise that price cuts would only destroy the

brand with consumers not getting swayed in their purchase decisions on account of small

price differences. Hence, rather than destroying the brand, companies have resorted to

lower-priced variants to make it affordable for consumers struggling with low income

growth and high inflation; these variants usually have slightly fewer features. There have

been a number of launches with minimal changes in features, but big price cuts in the past

two years—Honda Activa i, Bajaj CT100, Hero Maestro Edge.

Bajaj has launched CT100-B—priced at a ~10% discount to CT100 (which was anyway

priced at a ~10% discount to the cheapest Hero model when launched last year). Starting

at ~Rs32.5k (ex-showroom), CT100-B would now be at a ~20% discount to the cheapest

Hero model. CT100 had already triggered a downtrading in the market as the economy

segment bikes grew ahead of executive bikes, and this trend may further accelerate now.

Figure 53: Down-trading trend with higher growth in

economy bikes with launch of lower-priced CT100

Figure 54: Even with sharp increase in volumes, Honda's

margins have fallen

Company Model Type Price Spoke

Price Alloy

Bajaj CT100 B Kick 31,500

Bajaj CT100 Kick 35,034 38,034

Bajaj Platina Kick 43,241

Bajaj Platina Self-start 45,252

Hero HF Dawn Kick 39,470

Hero HF Deluxe Kick 42,200 43,100

Hero HF Deluxe Self-start 44,250 45,250

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

FY09 FY10 FY11 FY12 FY13 FY14 FY15

Honda 2W India (HMSI) Volumes EBITDA margins (RHS)

Source: Company data. Prices in Rs are ex-showroom Delhi Source: Company data

22 April 2016


Anecdotally, scooters are also lower margin products than bikes (for companies other than

Honda), and that segmental shift also hurts industry profitability. Even though Honda's

volumes have increased 4x over the past six years, there has been no operating leverage

benefit and its margins have actually fallen ~300 bp, indicating (apart from mix) its

willingness to fight on pricing to gain market share.

Aggressive capacity additions to put further pricing pressure in absence of major

growth pick-up

Capacity utilisation levels in the 2W industry had peaked at ~85% in FY12 and have been

steadily falling since then, given the slowdown in industry demand coinciding with capacity

expansions by players like Honda and Yamaha. In 2017 also, new plants of Hero and

Honda will start in Gujarat. With production growth likely to be ~8% only in FY17E (higher

growth in domestic but decline in exports), industry utilisation will remain under pressure.

Figure 55: With new plants of Honda and Hero, utilisations to fall ahead

50%

60%

70%

80%

90%

-

5

10

15

20

25

30

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E

Production (Mn Units) Capacity Capacity utilization (RHS)

Source: SIAM, Company data, Credit Suisse estimates

Commodity only benefit so far, should normalise ahead

Most auto companies have seen strong gross margin expansion this year due to

commodity tailwinds. Hero, Bajaj and TVS have all seen 150-300 bp gross margin

expansion this year. While there are some company-specific factors at play—cost savings

programme of Hero, forex benefit for Bajaj—by and large, this gross margin expansion

reflects the benefit of the commodity fall. However, this should now normalise. Our raw

material index is up ~5% from the lows of January, largely on account of >10% steel price

rise in the country (both on some global rebound and with the imposition of minimum

import price). Hence, commodity will no longer remain a tailwind for margins.

22 April 2016


Figure 56: All companies have seen strong gross margin

expansion this year on commodity; TVS despite strong

volume growth has witnessed the lowest expansion

Figure 57: RM prices have inched up from lows driven by

increase in steel prices

20.0%

25.0%

30.0%

35.0%

Hero Bajaj TVS

9mFY15 9mFY16

Gross margins

80

90

100

110

120

Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16

Raw material Index 2WRaw material Index 2W

Source: Company data. Hero' margins adjusted for excise difference Source: Bloomberg, Credit Suisse estimates

Expiry of excise incentives another headwind

Going forward, there would be additional headwinds as excise and income tax incentives

in Uttarakhand expire. Hero Motocorp, TVS and Bajaj had all set up plants in Uttarakhand

to avail tax sops (ten-year excise duty exemption, complete income tax exemption for five

years and 30% income tax exemption for another five years). These will expire post FY17

for Bajaj and TVS, and post FY18 for Hero.

While incentives are expiring earlier for Bajaj and TVS, the impact will be much greater for

Hero, as ~30% of its production is from this plant. Bajaj produces just economy and

executive segment bikes for the domestic market from its plant in the state (which form

~15% of revenues and just ~5% of profits). Hero's margins were affected by ~100 bp when

the government chose to reduce excise duties by 4% temporarily from March 2014 to

December 2014 to boost industry demand. This time, there will be the full impact of the

12% change in excise duty; however, the company would be able to set-off what the

vendors pay (RM costs is ~70% of sales), hence the aggregate impact on margins would

be similar at 100 bp only. For Bajaj and TVS, the impact will be lower than 50 bp. There

will be additional impact of a higher tax rate (30% exemption on profits from plant going

away), which will be again much higher for Hero, as for Bajaj, the profit contribution from

this plant is low anyway. This might be offset by the marginal tax rate reduction that the

government is planning.

Figure 58: Bajaj's and TVS's incentives expiring earlier, but higher impact on Hero

Company Capacity in Uttarakhand Production % of revenues % of profits Exemptions ending

Hero Motocorp 2.1 Mn bikes ~2.1 Mn ~30% ~35% FY18

TVS 0.5 Mn bikes ~0.4 Mn ~12% ~10% FY17

Bajaj Auto 1.8 Mn bikes ~1.2 Mn ~15% ~5% FY17


Headwinds on R&D and advertising for Hero

For Hero Motocorp, FY16 was a particularly good year on the profitability front, as it saw a

~270 bp margin expansion YoY (of which ~100 bp was on account of excise anomaly at

the Haridwar plant going away). Hence, adjusted margin improvement has been ~170 bp.

However, there have been two big positive factors: (1) large commodity benefit as

discussed above and (2) the benefit of the costs savings (LEAP programme), which has

22 April 2016


been ~100 bp in each of the past two years. Hence, margin expansion should have

actually been higher, indicating that the company has had to pass on some savings.

In the near term, we expect the company's margins to have now peaked out. Two major

headwinds for margins will be increasing R&D spends (with the company setting up a new

dedicated facility) and the increase in advertising. Management has also acknowledged

that making a break-through in the exports market is difficult, hence extra investments in

exports will be further margin dilutive. We expect FY17 margins to fall ~50 bp to ~15%.

Figure 59: Hero has additionally realised ~300 bp benefit

from cost savings, but much lower gain in overall margins

Figure 60: Advertising and R&D will also inch up in the

future for the company

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

FY14 FY15 FY16

Margin benefit for Hero Motocorp from costs savings (LEAP)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Advertising R&D

FY16 FY17E

Hero Motocorp (% of sales)

Source: Company data Source: Company data, Credit Suisse estimates

No evidence of any operating leverage despite strong volume momentum

The main bullish thesis on TVS is that its margins are much lower than peers and as its

volumes scale up, there should be an improvement in margins. Whilst its gross margins

are 3%/5% lower than Hero/Bajaj, its EBITDA margins are 8%/14% lower than Hero/Bajaj.

The key gap is on staff costs and advertising spends. Staff costs are 150 bp higher than

Hero and Bajaj, while advertising spends are 300/400 bp higher. Thus, logically, it seems

that there is definitely scope for margins to expand once volumes start scaling up.

However, so far, there has been little evidence of this. Despite the fact that TVS has had a

17% volume CAGR in the past three years, its staff costs and advertising spend have shown

no operating leverage. In fact, in the past few quarters when players like Hero and Bajaj have

witnessed ~250 bp gross margin expansion, TVS witnessed only ~150 bp improvement.

22 April 2016


Figure 61: For TVS, staff costs and marketing are major

gaps to Hero, on account of lower scale

Figure 62: TVS's fixed costs (as % of sales) have not seen

an improvement, indicating challenges

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Staff Costs Advertising and marketing

Hero TVS

16.0%

19.0%

22.0%

25.0%

1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16

TVS staff costs+ other expendit (% sales)

Source: Company data Source: Company data

22 April 2016


Initiate on TVS with UNDERPERFORM, still prefer Bajaj to Hero We initiate coverage on TVS Motors with an UNDERPERFORM rating. TVS has executed

really well in creating a new brand Jupiter in the scooters segment and on the exports side.

However, despite strong volumes; margin expansion has been muted, given that it has not

seen even as much commodity-led gross margin expansion as other players have in the

industry. We believe street expectations from both (1) its new launch Victor in the lower

executive segment (shrinking category) and (2) margin expansion are very aggressive. In

an environment where industry margins will be under pressure, we fail to see how TVS will

be able to improve its margins by 300 bp over the next two years.

We believe Hero also faces multiple margin headwinds: (1) higher R&D spending; (2)

higher advertising spends; (3) negative product mix; (4) the impact from yen appreciation.

And hence prefer Bajaj to Hero despite the headwinds in the export markets.

The below table summarises our thesis on Indian 2W stocks.

Figure 63: Recommendation summary

Company CMP (Rs) Target

Price (Rs) Rating Key arguments

TVS Motors 325 260 U

See downside risks to both company's 10% margin and 18% market-share target.

Industry margins likely to stay under pressure and with commodity tailwinds no longer

there, taking up margins further will be a challenge. A lot is riding on the new Victor

launch, but we don't expect material volumes from it, as: (1) the 100cc executive

segment has been shrinking, losing to motorcycles and (2) creating a brand here is

difficult as seen from continued Hero's dominance despite Honda's aggression.

Hero Motocorp 2,989 2,590 N

Market-leader but likely to see lowest volume growth in medium term of the major

OEMs, primarily due to market-shift trend towards the segments where the company is

weaker (scooters, premium bikes). Margins have peaked in FY16, with headwinds

ahead from higher R&D, higher advertising, forex (yen appreciation), adverse product

mix and the expiry of excise incentives.

Bajaj Auto 2,496 2,420 N

We like the company's strategy with recent launches—aggressively priced CT100 in

economy, recreating premium positioning in executive with "V" and catching the cruiser

trend with Avenger, but the absence from the fast-growing scooter space will continue

to hurt. Additional near-term headwinds due to weakness in key export markets.

Eicher Motors 20,313 19,200 N

Will remain by far the fastest growing, given the still nascent segment and the absence

of meaningful competition, along with the strong aspirational values associated with the

Royal Enfield brand. However, at CMP, we see this as largely being captured and next

leg-up can only come from the success in 2-3 large export markets on which there is

limited visibility.


In the past three months, 2W stocks on an average have delivered ~15% returns on

expectations of good monsoons leading to an acceleration in industry growth. TVS (25x),

Bajaj (17x) and Hero (19x adjusted) are all trading at premiums to their historic average of

14-15x one-year forward earnings with the biggest premium for TVS.

22 April 2016


Figure 64: All 2W stocks trading at premiums to historic average of 14-15x earnings;

biggest premium for TVS

5.0

10.0

15.0

20.0

25.0

30.0

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Hero P/E Bajaj P/E TVS P/E

Source: I/B/E/S DataStream

On FY18 earnings, we are below consensus for all the three stocks. We expect the

biggest disappointment in TVS where we see downside to both volume and margin

estimates of consensus, followed by Hero where we expect a margin decline ahead.

Figure 65: We expect biggest earnings disappointment for

TVS followed by Hero

Figure 66: Valuations of Indian OEMs under our coverage

-12.0%

-8.0%

-4.0%

0.0%

4.0%

Hero Bajaj TVS

FY17 FY18

CS versus consensus earnings

Maruti

M&M

Tata

AL

Hero

Bajaj

TVS

Eicher

0.0

3.0

6.0

9.0

10.0 15.0 20.0 25.0 30.0 35.0 40.0

P/B (FY18E)

ROE (FY18E)

Source: : I/B/E/S DataStream, Credit Suisse estimates Source: : I/B/E/S Datastream

22 April 2016


Asia Pacific / India

Automobile Manufacturers

TVS Motors

(TVSM.BO) INITIATION

Sky-high expectations

■ Initiate with UNDERPERFORM (20% downside). We initiate coverage on

TVS Motors with an UNDERPERFORM rating and a TP of Rs260, valuing

the standalone business at Rs240 (15x FY18) and the BMW tie-up at Rs20

(10x FY18).

■ 10% margin in FY18 looks unlikely. We believe management guidance of

10% margins by FY18 is unlikely to be achieved. As argued above, we

believe the competitive intensity in the industry has changed, and with that,

there is pressure on margins for every 2W company. As a result, while Hero

has not been able to show any benefit from its cost reduction programme,

TVS has not shown any operating leverage benefit. For the entire space, the

only margin benefit that has come has been on account of lower

commodities, and with that starting to reverse, margins will once again come

under pressure. Additional pressure will come from the decline in higher-

margin exports and the run-out of excise duty exemptions in FY17.

■ Victor launch: a lot riding on it. There is a lot riding on the recently

launched Victor for TVS—both in terms of volumes and stock multiples. TVS

has executed really well in the past couple of years; especially in creating

the new brand Jupiter in the scooters segment, and on the exports side.

However, establishing a new brand in the shrinking lower executive segment

is a significantly more difficult proposition and has proven to be a big

challenge for both Bajaj and Honda.

■ The stock is pricing in a blue-sky scenario. We believe at its current price,

the stock is pricing in a blue-sky scenario where the company is able to

achieve its 10% margin target by FY18, valuing the India business at

Rs300/share, and also is able to sell 50,000 units to BMW under the joint

product development plan at a PAT margin of 15%, valuing that at

~Rs30/share. TVS trades at ~25x FY17; a 30% premium to Hero and Bajaj.

Key risk to our call: recently launched Victor is a big success and slowdown

in exports is lower than expected.

Share price performance

0

100

200

300

400

0

100

200

300

400

Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the S&P

BSE SENSEX IDX which closed at 25880.38 on 21/04/16

On 21/04/16 the spot exchange rate was Rs66.27/US$1

Performance over 1M 3M 12M Absolute (%) 2.3 13.9 36.4 — Relative (%) 0.2 8.0 43.6 —

Financial and valuation metrics

Year 3/15A 3/16E 3/17E 3/18E Revenue (Rs mn) 100,982.2 112,296.1 130,744.0 149,339.0 EBITDA (Rs mn) 6,043.0 7,770.9 10,076.0 12,443.7 EBIT (Rs mn) 4,509.7 6,007.6 8,136.4 10,310.1 Net profit (Rs mn) 3,478.3 4,266.3 5,921.2 7,588.4 EPS (CS adj.) (Rs) 7.32 8.98 12.46 15.97 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 9.6 13.9 18.0 EPS growth (%) 32.9 22.7 38.8 28.2 P/E (x) 44.3 36.1 26.0 20.3 Dividend yield (%) 0.59 0.62 0.68 0.74 EV/EBITDA (x) 27.1 21.0 15.9 12.5 P/B (x) 9.4 7.9 6.3 5.0 ROE (%) 22.7 23.7 27.0 27.7 Net debt/equity (%) 58.7 43.9 23.1 3.2

Source: Company data, Thomson Reuters, Credit Suisse estimates.

Rating UNDERPERFORM* Price (21 Apr 16, Rs) 324.60 Target price (Rs) 260.00¹ Upside/downside (%) -19.9 Mkt cap (Rs mn) 154,213 (US$2,327 mn) Enterprise value (Rs mn) 162,819 Number of shares (mn) 475.09 Free float (%) 42.6 52-week price range 335.9 - 213.6 ADTO - 6M (US$ mn) 9.3

*Stock ratings are relative to the coverage universe in each

analyst's or each team's respective sector.

¹Target price is for 12 months.

Research Analysts

Jatin Chawla

91 22 6777 3719

[email protected]

22 April 2016


TVS Motors TVSM.BO / TVSL IN Price (21 Apr 16): Rs324.60, Rating: UNDERPERFORM, Target Price: Rs260.00, Analyst: Jatin Chawla

Target price scenario

Scenario TP %Up/Dwn Assumptions

Upside 380.00 17.07 Margins expand to ~10% and TVS also has faster market-share gains

Central Case 260.00 (19.90)

Downside 220.00 (32.22) No margin expansion or market-share improvement

Key earnings drivers 3/15A 3/16E 3/17E 3/18E

— — — — — — — — — — — — — — — — — — — —

Income statement (Rs mn) 3/15A 3/16E 3/17E 3/18E

Sales revenue 100,982 112,296 130,744 149,339 Cost of goods sold 72,971 80,462 93,366 106,533 SG&A — — — — Other operating exp./(inc.) 21,968 24,063 27,302 30,363 EBITDA 6,043 7,771 10,076 12,444 Depreciation & amortisation 1,533 1,763 1,940 2,134 EBIT 4,510 6,008 8,136 10,310 Net interest expense/(inc.) 274.2 383.9 307.1 204.7 Non-operating inc./(exp.) 326.1 358.7 394.6 434.0 Associates/JV — — — — Recurring PBT 4,562 5,982 8,224 10,539

Exceptionals/extraordinaries — (57.0) — — Taxes 1,083 1,659 2,303 2,951 Profit after tax 3,478 4,266 5,921 7,588 Other after tax income — — — — Minority interests — — — — Preferred dividends — — — — Reported net profit 3,478 4,266 5,921 7,588 Analyst adjustments — — — — Net profit (Credit Suisse) 3,478 4,266 5,921 7,588

Cash flow (Rs mn) 3/15A 3/16E 3/17E 3/18E

EBIT 4,510 6,008 8,136 10,310 Net interest (274.2) (383.9) (307.1) (204.7) Tax paid (1,083) (1,659) (2,303) (2,951) Working capital (4,070) (372) (156) (232) Other cash & non-cash items 1,859 2,065 2,334 2,568 Operating cash flow 941 5,657 7,705 9,490 Capex (3,495) (3,500) (3,500) (3,500) Free cash flow to the firm (2,553) 2,157 4,205 5,990 Disposals of fixed assets — — — — Acquisitions — — — — Divestments — — — — Associate investments (1,165) — — — Other investment/(outflows) — — — — Investing cash flow (4,660) (3,500) (3,500) (3,500) Equity raised — — — — Dividends paid (1,075) (1,112) (1,223) (1,334) Net borrowings 4,429 — (3,000) (3,000) Other financing cash flow — — — — Financing cash flow 3,354 (1,112) (4,223) (4,334) Total cash flow (365) 1,045 (18) 1,656 Adjustments — — — — Net change in cash (365) 1,045 (18) 1,656

Balance sheet (Rs mn) 3/15A 3/16E 3/17E 3/18E

Cash & cash equivalents 54 1,099 1,082 2,738 Current receivables 5,039 5,538 6,448 7,365 Inventories 8,197 9,230 10,746 12,274 Other current assets 8,438 9,282 10,210 11,231 Current assets 21,728 25,149 28,486 33,608 Property, plant & equip. 13,296 15,033 16,593 17,960 Investments 10,125 10,125 10,125 10,125 Intangibles — — — — Other non-current assets 893.6 893.6 893.6 893.6 Total assets 46,042 51,200 56,097 62,586

Accounts payable 12,638 14,114 16,732 19,327 Short-term debt — — — — Current provisions 1,050 1,155 1,271 1,398 Other current liabilities 4,230 4,653 5,119 5,631 Current liabilities 17,919 19,923 23,121 26,356 Long-term debt 9,705 9,705 6,705 3,705 Non-current provisions — — — — Other non-current liab. 1,965 1,965 1,965 1,965 Total liabilities 29,588 31,592 31,791 32,025 Shareholders' equity 16,454 19,608 24,306 30,561 Minority interests — — — — Total liabilities & equity 46,042 51,200 56,097 62,586

Per share data 3/15A 3/16E 3/17E 3/18E

Shares (wtd avg.) (mn) 475.1 475.1 475.1 475.1 EPS (Credit Suisse) (Rs) 7.3 9.0 12.5 16.0 DPS (Rs) 1.90 2.00 2.20 2.40 BVPS (Rs) 34.6 41.3 51.2 64.3 Operating CFPS (Rs) 2.0 11.9 16.2 20.0

Key ratios and valuation

3/15A 3/16E 3/17E 3/18E

Growth(%) Sales revenue 26.8 11.2 16.4 14.2 EBIT 28.7 33.2 35.4 26.7 Net profit 32.9 22.7 38.8 28.2 EPS 32.9 22.7 38.8 28.2 Margins (%) EBITDA 5.98 6.92 7.71 8.33 EBIT 4.47 5.35 6.22 6.90 Pre-tax profit 4.52 5.33 6.29 7.06 Net profit 3.44 3.80 4.53 5.08 Valuation metrics (x) P/E 44.3 36.1 26.0 20.3 P/B 9.4 7.9 6.3 5.0 Dividend yield (%) 0.59 0.62 0.68 0.74 P/CF 164 27 20 16 EV/sales 1.62 1.45 1.22 1.04 EV/EBITDA 27.1 21.0 15.9 12.5 EV/EBIT 36.3 27.1 19.6 15.1 ROE analysis (%) ROE 22.7 23.7 27.0 27.7 ROIC 15.4 16.0 20.2 24.2 Asset turnover (x) 2.19 2.19 2.33 2.39 Interest burden (x) 1.01 1.00 1.01 1.02 Tax burden (x) 0.76 0.72 0.72 0.72 Financial leverage (x) 2.80 2.61 2.31 2.05 Credit ratios

Net debt/equity (%) 58.7 43.9 23.1 3.2 Net debt/EBITDA (x) 1.60 1.11 0.56 0.08 Interest cover (x) 16.4 15.6 26.5 50.4


0

5

10

15

20

25

30

35

2011 2012 2013 2014 2015 2016

12MF P/E multiple

0

1

2

3

4

5

6

7

8

2011 2012 2013 2014 2015 2016

12MF P/B multiple

Source: IBES

22 April 2016


TVS has higher exposure to growth segments than peers

Among listed players, TVS has the highest exposure to scooters, which is the fastest

growing segment in the market. Adding premium bikes and exports as other high growth

segments, almost ~65% of its revenues come from higher growth segments. It has a

negligible presence in the executive segment, which is why the Victor launch is so

important for the company.

Figure 67: ~65% of revenues come from higher growth segments; better than peers

Scooters24%

Economy bikes11%

Executive bikes2%

Premium bikes13%

Mopeds13%

2W Exports14%

3W domestic1%

3W exports9%

Spares & Others13%


TVS has executed well in creating the new brand Jupiter and ramping up 3W exports

One of the main reasons for the stock rally in the past few years has been good execution

by the company. It has managed to do what very few 2W players have managed in the

past ten years, i.e. create a new 2W brand in Jupiter. Jupiter has helped recover some of

the lost market share to Activa post its scaleup. TVS has also done well to penetrate its

existing 2W export markets with 3Ws, and built a ~Rs10 bn 3W exports business within a

short period of seven years.

Figure 68: Jupiter launch has helped revive scooter

market share

Figure 69: TVS has done a commendable job in

developing a 3W exports business in past five years

10%

15%

20%

25%

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

2W market share

0

5,000

10,000

15,000

20,000

25,000

30,000

FY10 FY11 FY12 FY13 FY14 FY15 FY16

Revenue for 2W exports 3W exports


22 April 2016


However, limited evidence yet of any operating leverage despite strong volumes

The main bullish thesis on TVS is that its margins are much lower than peers, and as its

volumes scale up, there should be an improvement in margins. While its gross margins

are 3%/5% lower than Hero/Bajaj, its EBITDA margins are 8%/14% lower than Hero/Bajaj.

The key gap is on staff costs and advertising spends. Staff costs are 150 bp higher than

Hero and Bajaj, while advertising spend as a percentage of sales is 300/400 bp higher

than Hero/Bajaj. Thus, logically, it seems that there is definitely scope for margins to

expand once volumes start scaling up.

However, so far, there has been little evidence of this. Despite the fact that TVS has had a

17% volume CAGR in the past three years, its staff costs and advertising spends have shown

limited decline. In fact, when players like Hero and Bajaj have witnessed a ~250 bp gross

margin expansion in the past 18 months, TVS has seen only a ~150 bp margin expansion.

Going forward, we expect TVS to have some margin benefits on account of operating

leverage—we assume ~150 bp of overall operating leverage; there will be headwinds from

the decline in exports and the expiry of excise incentives.

Figure 70: For TVS, staff costs and marketing are major

gaps to Hero, on account of lower scale

Figure 71: TVS's fixed costs (as % of sales) have not seen

any improvement, indicating challenges

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Staff Costs Advertising and marketing

Hero TVS

16.0%

19.0%

22.0%

25.0%

1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16

TVS staff costs+ other expendit (% sales)


Figure 72: TVS's 10% EBITDA margin target looks difficult to us

6.0%

6.5%

7.0%

7.5%

8.0%

8.5%

9.0%

FY16 EBITDAmargins

Staff costs op lev Red in ad spends Other op lev Excise duty expiry FY18 EBITDAmargins


22 April 2016


BMW tie-up will start contributing from FY17

While the company has not shared a lot of details of the tie-up with BMW, what we know

so far is as follows:

■ The tie-up is for the joint development of sub 500cc motorcycles; there will be two

variants of each product developed; one sold by TVS and one by BMW

■ TVS will be the sole manufacturer of the products and hence manufacturing margins

will be captured by TVS only

■ Whilst TVS benefits from BMW's technology; BMW gets access to TVS's low-cost

supplier network and cost-effective manufacturing operations

The first product is likely to come in 2Q FY17; it will be a 310cc stunt bike, which was

unveiled recently in Brazil. BMW Motorrad has plans to scale up its global volumes from

137k in 2015 to 200k in 2020. Since details are so sketchy at this stage, we are not able to

build the financials in our model, but in order to ensure that we still value the tie-up, we

make certain broad assumptions. We assume TVS will produce 50k units (combined for

both TVS and BMW) in FY18 (slightly optimistic, in our view) with an ASP of Rs200k, thus

a revenue of Rs10 bn and with a PAT margin of 10%. We value the entity at 10x P/E and

thus put the value of the tie-up at Rs20/share. TVS is investing €20 mn for this project.

Initiate with UNDERPERFORM and TP of Rs260

We initiate coverage on TVS Motors with an UNDERPERFORM rating and a TP of Rs260.

We value the core standalone business at Rs240/share (15x FY18 earnings) and the

BMW tie-up at Rs20/share (10x FY18 earnings).

We believe at its current price, the stock is pricing in a blue-sky scenario where the

company is able to achieve its 10% margin target by FY18, valuing the India business at

Rs300/share, and also is able to sell 50,000 units to BMW under the joint product

development plan at a PAT margin of 15%, valuing that at ~Rs30/share. TVS trades at

~25x FY17 earnings—a 30% premium to Hero and Bajaj.

Key risks

The key risks to our call include the following:

Victor is a big success: In our base case, we have assumed modest 15k-20k units per

month from the new Victor. However, the segment where it has been launched (lower

executive) is large, with total volume size of 330k units per month. Hence, if the model

finds success, it can be a significant volume contributor.

Larger-than-expected margin expansion: One of the main bullish argument on the stock

has been the potential for large margin improvement ahead. However, here again we have

assumed modest improvement ahead, given margin pressure in the industry as well as the

fact that there has been limited benefit of operating leverage till now. Hence, greater-than-

expected expansion in margins can lead to upside to our estimates.

Recovery in export markets: While TVS's exports have been growing at a fast clip

(~20% CAGR in the past five years), we have assumed flattish growth only for FY17,

given forex issues in some of the large export markets. Hence, recovery in some of these

export markets can also lead to upside to our estimates.

22 April 2016


HOLT® analysis

TVS Motors (TVMS) has an average CFROI® (economic returns) of 5% in recent years.

Although CFROI improved to 6.9% in 2014, which is close to its highest level over the past

ten years, this remains significantly below the industry average CFROI of almost 20%.

Using IBES consensus forecast for 2015 to 2017 and extending it to 2019, TVSM is

expected to deliver CFROI improvements to 15.6% over the next five years, driven by a

combination of mid-teens annual sales growth, higher EBITDA margins and asset turns.

Valuation is not compelling, however, with the HOLT fair value of Rs222.3 per share

representing a -34% downside to the current share price. This valuation scenario assumes

a five-year median real HOLT® discount rate of 4.6% (Link to HOLT Lens).

Figure 73: TVSM has a -34% downside risk in HOLT despite strong CFROI improvements based on consensus forecast

Source: Credit Suisse HOLT

https://holtlens.credit-suisse.com/dal/TmnGALYLFis7rm0

22 April 2016


Asia Pacific / India

Automobile Manufacturers

Hero Motocorp Ltd

(HROM.BO / HMCL IN) INCREASE TARGET PRICE

Margin pressure to cancel volume growth

■ Stay NEUTRAL. Hero Motocorp stock has rallied ~15% in the past three

months as prospects of a good monsoon have led to the hope of a strong

revival in volumes. While we agree that FY17 could see a volume recovery,

we believe the stock is not factoring in the likely pressure on margins, and

hence we prefer to stay NEUTRAL with a revised TP of Rs2,590 (from

Rs2,420) at 15x FY18E EPS.

■ Good monsoons should revive demand… We believe that even though a

good monsoon will drive a recovery, it will not be a 15%+ kind of volume

recovery, but more a 8-10% growth, as 1H is likely to remain muted in rural

India. Hero is also likely to do well in scooters in FY17 on the back of its two

recent launches—Maestro Edge and Duet. While we expect only a ~6%

CAGR in its domestic volumes in the next five years, we are building in 10%

growth in volumes for FY17.

■ …but margins have peaked. We believe 4Q FY16 will mark a peak for

margins. There are multiple margin headwinds going forward: (1) higher

R&D spending (50 bp); (2) higher advertising spends (30-40 bp); (3)

negative product mix (40 bp); and (4) the impact from the yen appreciation

(40 bp). The benefits of its cost reduction programme LEAP are largely done

now. We note that while LEAP contributed to 300 bp margin savings for the

company, the only margin improvement visible over the past few years has

been on account of a commodity-led gross margin expansion. Additionally,

the ending of excise duty exemptions also hurts Hero the most as 35% of its

profits come from the Haridwar plant; hence, its FY17/FY18 numbers should

be adjusted by ~10% before valuing the company.

■ Trading at 20x FY17, 33% premium to historical valuations. Adjusted for

the excise duty exemptions, Hero is trading at 20x FY17, which represents a

33% premium to its average P/E multiple of 15x over the past ten years. We

believe such a premium is not justified, given the industry now is significantly

more competitive and also closer to a peak-out vs earlier.

Share price performance

80

100

120

140

2000

2500

3000

Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15

Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the S&P

BSE SENSEX IDX which closed at 25880.38 on 21/04/16

On 21/04/16 the spot exchange rate was Rs66.27/US$1

Performance over 1M 3M 12M Absolute (%) 4.2 15.6 24.1 — Relative (%) 2.1 9.7 31.3 —

Financial and valuation metrics

Year 3/15A 3/16E 3/17E 3/18E Revenue (Rs mn) 275,853.0 284,198.3 314,901.4 343,361.2 EBITDA (Rs mn) 35,421.8 44,130.9 47,647.5 52,250.7 EBIT (Rs mn) 30,022.1 39,708.4 42,916.2 47,114.4 Net profit (Rs mn) 25,406.8 31,185.5 33,542.2 36,734.8 EPS (CS adj.) (Rs) 127 156 168 184 Change from previous EPS (%) n.a. 0.8 -2.0 -2.4 Consensus EPS (Rs) n.a. 155 175 193 EPS growth (%) 20.5 22.7 7.6 9.5 P/E (x) 23.5 19.1 17.8 16.2 Dividend yield (%) 2.0 2.5 2.7 2.9 EV/EBITDA (x) 16.2 12.9 11.7 10.4 P/B (x) 9.1 7.5 6.3 5.4 ROE (%) 41.9 43.1 38.5 35.7 Net debt/equity (%) Net cash Net cash Net cash Net cash


Rating NEUTRAL* Price (21 Apr 16, Rs) 2,988.50 Target price (Rs) (from 2,420.00) 2,590.00¹ Upside/downside (%) -13.3 Mkt cap (Rs mn) 596,774 (US$ 9,005) Enterprise value (Rs mn) 569,487 Number of shares (mn) 199.69 Free float (%) 65.0 52-week price range 3,151.6 - 2,279.8 ADTO - 6M (US$ mn) 16.5

*Stock ratings are relative to the coverage universe in each

analyst's or each team's respective sector.

¹Target price is for 12 months.

Research Analysts

Jatin Chawla

91 22 6777 3719

[email protected]

22 April 2016


Hero Motocorp Ltd HROM.BO / HMCL IN Price (21 Apr 16): Rs2,988.50, Rating: NEUTRAL, Target Price: Rs2,590.00, Analyst: Jatin Chawla

Target price scenario

Scenario TP %Up/Dwn Assumptions

Upside 3,300.0

0 10.42

Volume growth in domestic 2W industry revives, concerns on competition come down

Central Case 2,590.0

0 (13.33)

Downside 2,000.0

0 (33.08)

Domestic volume growth slows down and larger market-share loss for Hero

Key earnings drivers 3/15A 3/16E 3/17E 3/18E

Volumes 6,631,703

6,632,147

7,294,914

7,815,230 Margins (%) 12.8 15.5 15.1 15.2

— — — — — — — — — — — —

Income statement (Rs mn) 3/15A 3/16E 3/17E 3/18E

Sales revenue 275,853 284,198 314,901 343,361 Cost of goods sold 197,539 194,091 215,653 235,398 SG&A 18,418 19,840 22,193 24,050 Other operating exp./(inc.) 24,474 26,137 29,408 31,662 EBITDA 35,422 44,131 47,648 52,251 Depreciation & amortisation 5,400 4,422 4,731 5,136 EBIT 30,022 39,708 42,916 47,114 Net interest expense/(inc.) (1,583) (1,266) (1,393) (1,532) Non-operating inc./(exp.) 3,234 2,609 2,877 3,171 Associates/JV — — — — Recurring PBT 34,839 43,584 47,186 51,818 Exceptionals/extraordinaries — — — — Taxes 9,432 12,398 13,644 15,083 Profit after tax 25,407 31,186 33,542 36,735 Other after tax income — — — — Minority interests — — — — Preferred dividends — — — — Reported net profit 25,407 31,186 33,542 36,735 Analyst adjustments — — — — Net profit (Credit Suisse) 25,407 31,186 33,542 36,735

Cash flow (Rs mn) 3/15A 3/16E 3/17E 3/18E

EBIT 30,022 39,708 42,916 47,114 Net interest — — — — Tax paid — — — — Working capital — — — — Other cash & non-cash items 5,400 4,422 4,731 5,136 Operating cash flow 35,422 44,131 47,648 52,251 Capex (10,678) (15,000) (6,874) (6,000) Free cash flow to the firm 25,608 30,055 41,789 47,368 Disposals of fixed assets — — — — Acquisitions — — — — Divestments — — — — Associate investments — — — — Other investment/(outflows) — — — — Investing cash flow (10,678) (15,000) (6,874) (6,000) Equity raised — — — — Dividends paid (14,219) (17,133) (18,428) (20,182) Net borrowings — — — — Other financing cash flow 9,347 — — — Financing cash flow (4,872) (17,133) (18,428) (20,182) Total cash flow 19,871 11,998 22,345 26,069 Adjustments — — — — Net change in cash 19,871 11,998 22,345 26,069

Balance sheet (Rs mn) 3/15A 3/16E 3/17E 3/18E

Cash & cash equivalents 24,496 27,287 39,882 55,073 Current receivables 13,896 14,316 15,863 17,297 Inventories 8,155 8,402 9,309 10,151 Other current assets 13,045 14,229 15,652 17,180 Current assets 59,591 64,234 80,707 99,700 Property, plant & equip. 27,628 38,205 42,474 46,338 Investments 8,638 8,638 8,638 8,638 Intangibles 1,499 1,499 1,499 1,499 Other non-current assets 7,548 7,548 5,422 2,422 Total assets 104,904 120,124 138,740 158,597 Accounts payable 28,419 29,278 32,442 35,373 Short-term debt — — — — Current provisions — — — — Other current liabilities 11,072 11,379 11,717 12,089 Current liabilities 39,490 40,658 44,159 47,463 Long-term debt — — — — Non-current provisions — — — — Other non-current liab. — — — — Total liabilities 39,490 40,658 44,159 47,463 Shareholders' equity 65,413 79,466 94,581 111,134 Minority interests — — — — Total liabilities & equity 104,904 120,124 138,740 158,597

Per share data 3/15A 3/16E 3/17E 3/18E

Shares (wtd avg.) (mn) 199.7 199.7 199.7 199.7 EPS (Credit Suisse) (Rs) 127 156 168 184 DPS (Rs) 60.0 73.6 79.2 86.7 BVPS (Rs) 328 398 474 557 Operating CFPS (Rs) 177 221 239 262

Key ratios and valuation

3/15A 3/16E 3/17E 3/18E

Growth(%) Sales revenue 9.1 3.0 10.8 9.0 EBIT 23.4 32.3 8.1 9.8 Net profit 20.5 22.7 7.6 9.5 EPS 20.5 22.7 7.6 9.5 Margins (%) EBITDA 12.8 15.5 15.1 15.2 EBIT 10.9 14.0 13.6 13.7 Pre-tax profit 12.6 15.3 15.0 15.1 Net profit 9.2 11.0 10.7 10.7 Valuation metrics (x) P/E 23.5 19.1 17.8 16.2 P/B 9.1 7.5 6.3 5.4 Dividend yield (%) 2.01 2.46 2.65 2.90 P/CF 16.8 13.5 12.5 11.4 EV/sales 2.07 2.00 1.77 1.58 EV/EBITDA 16.2 12.9 11.7 10.4 EV/EBIT 19.1 14.3 13.0 11.5 ROE analysis (%) ROE 41.9 43.1 38.5 35.7 ROIC 66.5 61.0 57.1 60.3 Asset turnover (x) 2.63 2.37 2.27 2.16 Interest burden (x) 1.16 1.10 1.10 1.10 Tax burden (x) 0.73 0.72 0.71 0.71 Financial leverage (x) 1.60 1.51 1.47 1.43 Credit ratios Net debt/equity (%) (37.4) (34.3) (42.2) (49.6) Net debt/EBITDA (x) (0.69) (0.62) (0.84) (1.05) Interest cover (x) (19.0) (31.4) (30.8) (30.8)


0

5

10

15

20

25

2011 2012 2013 2014 2015 2016

12MF P/E multiple

0

2

4

6

8

10

12

2011 2012 2013 2014 2015 2016

12MF P/B multiple

Source: IBES

22 April 2016


Companies Mentioned (Price as of 21-Apr-2016)

Ashok Leyland Ltd (ASOK.BO, Rs106.5) BMW (BMWG.DE, €84.15) Bajaj Auto Limited (BAJA.BO, Rs2496.1, NEUTRAL, TP Rs2420.0) Eicher Motors (EICH.BO, Rs20312.7, NEUTRAL, TP Rs19200.0) Hero Motocorp Ltd (HROM.BO, Rs2988.5, NEUTRAL, TP Rs2590.0) Honda Motor (7267.T, ¥3,115) Mahindra & Mahindra (MAHM.BO, Rs1308.15) Maruti Suzuki India Ltd (MRTI.BO, Rs3703.6) TVS Motors (TVSM.BO, Rs324.6, UNDERPERFORM, TP Rs260.0) Tata Motors Ltd. (TAMO.BO, Rs411.45) Yamaha Motor (7272.T, ¥1,943)

Disclosure Appendix

Important Global Disclosures

Jatin Chawla and Akshay Saxena each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Bajaj Auto Limited (BAJA.BO)

BAJA.BO Closing Price Target Price

Date (Rs) (Rs) Rating

17-May-13 1833.80 2126.00 O

25-Jun-13 1799.90 2132.00

09-Jul-13 1895.00 2090.00

22-Jul-13 1985.65 2210.00

15-Oct-13 2124.15 2270.00 N

17-Jan-14 1934.00 2090.00

22-Apr-14 2005.50 2040.00

18-Jul-14 2081.40 2000.00

16-Oct-14 2362.90 2300.00

06-Apr-15 2031.35 2220.00

21-May-15 2299.75 2280.00

24-Jul-15 2497.45 2390.00

23-Oct-15 2513.85 2480.00

06-Jan-16 2485.50 2390.00

08-Feb-16 2348.70 2420.00

* Asterisk signifies initiation or assumption of coverage.

O U T PERFO RM

N EU T RA L

3-Year Price and Rating History for Eicher Motors (EICH.BO)

EICH.BO Closing Price Target Price


26-Jun-14 7385.00 9000.00 O *

12-Aug-14 9280.85 10180.00

13-Nov-14 13181.75 15200.00

16-Feb-15 16109.45 18500.00

13-Jul-15 21171.05 19000.00 N

08-Nov-15 16692.75 18400.00

08-Feb-16 18374.20 19200.00


O U T PERFO RM

N EU T RA L

22 April 2016


3-Year Price and Rating History for Hero Motocorp Ltd (HROM.BO)

HROM.BO Closing Price Target Price


29-Apr-13 1648.65 1742.00 N

09-Jul-13 1658.45 1710.00

24-Jul-13 1757.75 1780.00

15-Oct-13 2048.75 1850.00 U

23-Oct-13 2087.70 1900.00

30-Jan-14 1999.75 1930.00

22-Apr-14 2266.20 1990.00

19-May-14 2444.40 2250.00

29-May-14 2344.05 2270.00

05-Aug-14 2584.20 2340.00

17-Oct-14 2877.10 2710.00

25-Feb-15 2625.55 2710.00 N

04-May-15 2386.00 2450.00

08-May-15 2301.55 2420.00

04-Aug-15 2624.25 2500.00

06-Jan-16 2581.75 2390.00

12-Feb-16 2486.50 2420.00


N EU T RA L

U N D ERPERFO RM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities

As of December 10, 2012 Analysts’ stock rating are defined as follows:

Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months.

Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months.

Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months.

*Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment oppor tunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calcula tion includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011.

Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.

Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation:

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Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.

Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months.

*An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

22 April 2016


Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings Distribution

Rating Versus universe (%) Of which banking clients (%)

Outperform/Buy* 57% (39% banking clients)

Neutral/Hold* 32% (28% banking clients)

Underperform/Sell* 10% (50% banking clients)

Restricted 1%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors.

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Target Price and Rating Valuation Methodology and Risks: (12 months) for Bajaj Auto Limited (BAJA.BO)

Method: Our Rs2,420 target price for Bajaj Auto is based on a 3-year average P/E (price-to-earnings) multiple of 15x Mar-18 earnings. We apply the average historic multiple as higher growth in exports gets offset by slower domestic growth. We have a Neutral rating given the headwinds in domestic 2W market (faster growth in scooters where Bajaj is not present and high competitve intensity), even though we are positive on export growth potential.

Risk: Risks to our Rs2,420 target price and Neutral rating for Bajaj Auto is muted growth in export markets and Bajaj losing more share in domestic markets.

Target Price and Rating Valuation Methodology and Risks: (12 months) for Eicher Motors (EICH.BO)

Method: We value Eicher Motors on a DCF (discounted cash flow)-based target price of Rs 19,200/ share. We are valuing its motorcycle business at Rs 17,000/share (Royal Enfield) and VECV division (including engine business) at Rs 2,200/share. We use a WACC (weighted average cost of capital) of 12% and terminal growth rate of 5%. We have NEUTRAL rating on stock given limited visibility on exports as we see domestic potential largely captured in the stock.

Risk: Downside risks to our Rs19,200 target price and NEUTRAL rating for Eicher Motors include moderation in motorcycle growth and rising competitive intensity from either mass-market or global players. Upside risk can come if company finds success in 2-3 large export markets

Target Price and Rating Valuation Methodology and Risks: (12 months) for Hero Motocorp Ltd (HROM.BO)

Method: Our Rs2,590 target price for Hero Motocorp is based on 15x Mar-18E earnings (adjusted for excise benefit at Haridwar going away) - inline with three year average multiple. We have NEUTRAL rating given concerns on higher competition hurting both volumes and profits, though valuations provide support.

Risk: The key upside risk to our Rs2,590 target price and NEUTRAL rating for Hero Motocorp is strong recovery in 2W industry volumes. Downside risk can come if Honda makes further dent in the market.

Target Price and Rating Valuation Methodology and Risks: (12 months) for TVS Motors (TVSM.BO)

Method: Our Rs 260 target price for TVS Motors is based on a 3-year average P/E (price-to-earnings) multiple of 15x Mar-18 earnings and adding Rs 20/ share for the BMW venture. We have an UNDERPERFORM rating as we see downside risks to both the company's targets of reaching 18% market-share and having 10% margins by FY18.

22 April 2016


Risk: Risks to our Rs 260 target price and Underperform rating for TVS Motors is the new motorcycle launch - Victor doing well, improvement in pricing discipline in the industry leading to margin expansion and recovery in exports markets

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names

The subject company (7267.T, ASOK.BO, TAMO.BO, MAHM.BO, BMWG.DE) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.

Credit Suisse provided investment banking services to the subject company (ASOK.BO, TAMO.BO, BMWG.DE) within the past 12 months.

Credit Suisse provided non-investment banking services to the subject company (BMWG.DE) within the past 12 months

Credit Suisse has managed or co-managed a public offering of securities for the subject company (ASOK.BO, TAMO.BO, BMWG.DE) within the past 12 months.

Credit Suisse has received investment banking related compensation from the subject company (ASOK.BO, TAMO.BO, BMWG.DE) within the past 12 months

Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (TVSM.BO, HROM.BO, 7267.T, ASOK.BO, TAMO.BO, MAHM.BO, 7272.T, BMWG.DE) within the next 3 months.

Credit Suisse has received compensation for products and services other than investment banking services from the subject company (BMWG.DE) within the past 12 months

As of the date of this report, Credit Suisse makes a market in the following subject companies (7267.T).

Please visit https://credit-suisse.com/in/researchdisclosure for additional disclosures mandated vide Securities And Exchange Board of India (Research Analysts) Regulations, 2014

Credit Suisse may have interest in (BAJA.BO, EICH.BO, TVSM.BO, HROM.BO, ASOK.BO, MRTI.BO, TAMO.BO, MAHM.BO)

As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (MAHM.BO).

For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.

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The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events.

Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares.

Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.

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The following disclosed European company/ies have estimates that comply with IFRS: (BMWG.DE).

Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (7267.T, ASOK.BO, TAMO.BO, BMWG.DE) within the past 3 years.

As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.

Principal is not guaranteed in the case of equities because equity prices are variable.

Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.

To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

Credit Suisse Securities (India) Private Limited ...................................................................................................... Jatin Chawla ; Akshay Saxena

22 April 2016


Important Credit Suisse HOLT Disclosures

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22 April 2016


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This research may relate to investments or services of a person outside of the UK or to other matters which are not authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority or in respect of which the protections of the Prudential Regulation Authority and Financial Conduct Authority for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. CS may provide various services to US municipal entities or obligated persons ("municipalities"), including suggesting individual transactions or trades and entering into such transactions. Any services CS provides to municipalities are not viewed as "advice" within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 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Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments. When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay the purchase price only.

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