There’s no gain without pain". Bajaj Auto Ltd’s December quarter performance ratifies this idiom, although investors seem to be finding the pain too much to bear. Without doubt, its aggressive pricing strategy in motorcycles over the last few quarters accelerated sales. It also helped regain lost market share. But it took a hefty toll on profitability.

Bajaj Auto’s Ebitda (earnings before interest, taxes, depreciation and amortization) margin at 15.6% plunged 400 basis points year-on-year. This dampened an already weak investor sentiment. Analysts had estimated margins of 16-17%, which the management was also confident of achieving. Ebitda fell 7.5% to 1,156 crore, below the average forecast of 22 analysts on Bloomberg.

The margin problem is centred around Bajaj Auto’s need to regain market share in domestic motorcycles. Recall that about six months ago, its managing director Rajiv Bajaj had said the company was pursuing aggressive pricing in the entry-level segment. Analysts had then turned cautious in their earnings outlook, estimating that it would take a toll on profitability.

Of course, the pricing strategy improved the market share in motorcycles by 400 basis points to 20%. Higher sales also grew revenue by 16% despite an 8% drop in net realizations.

(Naveen Kumar Saini/ Mint)

Meanwhile, there have been other challenges too. Bajaj Auto’s commercial vehicle (mainly three-wheelers) sales fell 17% year-on-year.

What disappointed the Street even more was the sequential drop of 120 basis points in profit margins, in spite of lower material costs. In the analysts’ concall, the management explained that this was due to adverse foreign exchange impact, lower exports and lower commercial vehicle volumes.

The moot question is whether margins would continue their downward trajectory. At this juncture, it does not look like things will turn in a jiffy given both the industry and the company are faced with headwinds. The Street and industry expect demand to remain subdued for the next 12-18 months. Higher ownership costs due to higher cost of insurance and emission-related technological modifications in the product, will lead to slower sales offtake at least for some quarters.

Further, Bajaj Auto is likely to incur high ad spend in the current quarter that would also weigh on profitability. In addition, “its strategy to gain market share in domestic motorcycles through pricing strategy would continue to hurt margins", explains Bharat Gianani, analyst at Sharekhan Ltd.

That said, the company is trying to enhance realizations through a better sales mix in the domestic markets and higher exports. The management is also trying to increase localization in exports in large markets such as Egypt and save costs.

However, stiff competition in the domestic two-wheeler segment and watered down realizations will keep margin expansion at bay for some more quarters. Obviously, this will keep the share price range bound. The Bajaj Auto stock has already fallen by about 9% since April. Even so, the current price of 2,499 discounts estimated FY21 earnings by around 15 times, which is not cheap given the challenges ahead.