BackInvestor exuberance in two-wheeler stocks: A risky proposition?
It is worth noting that Bajaj and Hero’s two-wheeler volumes for the first five months of FY24 are still about 16% and 36% lower than pre-covid levels of FY19 for the same period, respectively.
PremiumShares of two-wheeler companies are in the fast lane, suggesting a rosy outlook. This is perplexing given that the demand conditions are painting quite the opposite picture. For one, rural demand is subdued with weak rainfall adding to the woes. Further, price increases by two-wheeler companies are suppressing demand.
Despite this, in the past six months, shares of Eicher Motors Ltd, Bajaj Auto Ltd, Hero MotoCorp Ltd and TVS Motor Co. Ltd are up around 16%, 28%, 29% and 42%, respectively. Eicher is the listed parent of Royal Enfield. Yes, there are company-specific reasons for the uptick. For instance, TVS’s margin delivery has been strong and steady at around 10% in the past few quarters. Plus, its electric vehicle penetration has been better than peers. Besides, the launch of premium vehicles by Bajaj and Hero in collaboration with Triumph Motorcycles and Harley Davidson, respectively, has aided investor sentiments for the companies.
But the moot question is whether investors are ignoring the rising risks. “The exuberance in the two-wheeler segment is more than warranted as it continues to be plagued by demand challenges and margin woes. Hence, there is a risk of disappointment," said Kumar Rakesh, an automobile and technology analyst at BNP Paribas Securities India.
Notably, it is not just the domestic markets that are reeling under the pressure. Two-wheeler export volumes are also yet to gather momentum. This is critical, especially for Bajaj as exports formed almost 48% of its total two-wheeler volume in FY23, which itself is a drop from 57% share seen in FY22. One bright spot here is that after falling for many months, Bajaj’s export volume rose in August, by 2% year-on-year. On the margin front, a potential increase in the price of steel would be a threat, especially when demand is downbeat as it would be tough to pass on cost increases. Secondly, the ramp up in electric vehicles would lead to pressure on profitability as this business is margin dilutive. Thirdly, with competition intensifying, more so in the premium segment, there could be a spike in advertisement and promotion expenses.
It is worth noting here that Bajaj and Hero’s two-wheeler volumes for the first five months of FY24 are still about 16% and 36% lower than pre-covid levels of FY19 for the same period, respectively. Eicher’s volume is just 4% ahead of the pre-covid levels aided by the ongoing premiumization trend. Against this backdrop, the sharp run up in share prices seems unjustified. In a report last week, analysts from Kotak Institutional Equities highlighted that their reverse valuation analysis of Eicher, Hero and TVS suggests that the market is pricing in strong volume growth for Eicher and TVS (13% CAGR each for Eicher and TVS) over FY23-39. CAGR is compound annual growth rate. “We have assumed a steady increase in Ebitda per vehicle for this exercise, and any disappointment in profitability will further intensify the required ask rates," they said in a report on 20 September. Ebitda is earnings before interest, depreciation, and amortization; a key profitability measure.
Thus, going ahead, all eyes will be on how volumes pan out. Currently, shares of Hero, Bajaj Auto, Eicher, and TVS trade at 16x, 18x, 22x and 29x their respective FY25 estimated earnings, showed Bloomberg data.
Meanwhile, electric two-wheelers are gaining traction post the subsidy cut from 1 June. In August, the share of electric two-wheelers was 5%, according to Vahan, which is roughly the same level seen before subsidies were slashed. “The recovery in electric two-wheeler penetration suggests that electrification trend is structural and not entirely incentive dependent, which is comforting," said Rakesh.
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