Moneycontrol
Aug 10, 2017 03:42 PM IST | Source: Moneycontrol.com

Eicher Motors' steep valuation should give pause to investors. Better to wait it out

Riding on the strength of Royal Enfield, Eicher Motors has yet again posted a healthy set of numbers for the quarter ended June 2017. But after the dream performance and an equally impressive run for the stock, should you be chasing it now?

Eicher Motors' steep valuation should give pause to investors. Better to wait it out

Nitin Agrawal

Moneycontrol Research

Eicher Motors will go down as one of the biggest wealth creators in the Indian markets. Its flagship product the Royal Enfield (RE), arguably India’s most respected and sought-after brand in the mid-sized two-wheeler (2W) segment, continues to maintain its mojo. Riding on the strength of RE, Eicher Motors (EIM), yet again, posted a very healthy set of numbers for the quarter ended June 2017, unfazed by structural changes in the industry. But after the dream performance and an equally impressive run for the stock, should you be chasing it now?

Quarter in a nutshell

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RE continues to be strong

Amid all disruptions taking place in the Indian automobile industry, RE continues to cruise smoothly. RE volume was up 24.8 percent (YoY) that contributed to the 28.4 percent increase in standalone topline. EBITDA margin was down by 58.3 bps on account of a rise in the raw material prices.

Poor show by VECV

The overall commercial vehicle (CV) industry was impacted by the transition to BS IV norms and GST implementation and Volvo Eicher CV (VECV) was no exception. VECV witnessed 15.7 percent decline in the topline on the back of 27.9 percent fall in the volume. Apart from this, VECV lost market share in almost all segments on the back of supply issues as competitors took advantage of VECV’s supply constraints.

The moot question that beckons our attention is if the stock is worthy of investment at current premium valuations?

Capacity Constraints

Eicher has been steadily adding capacity for Royal Enfield that has increased from 60,000 units in CY11 to 675,000 units in FY17. The capacity addition has reduced the waiting time from 12 months to 2 months. Despite aggressive capacity addition, the company’s growth is still constrained by it. Eicher plans to expand its capacity to the level of 825,000 units in FY18 from its new plant in Chennai that will commence production by August 2017. The management expects to take the capacity to 900,000 units by FY19.

RE – Extremely strong brand

Royal Enfield has become a very strong brand amongst the youth in India. The growth in the volume has been extraordinary over the years, clocking 51 percent compounded growth over FY11-17. RE’s market share in premium segment also increased rapidly from 15.8 percent in FY12 to 45.3 percent in FY17. Going forward, volume growth for RE would be limited by capacity.

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Dealer expansion to drive growth

The company continues to expand its dealer network for better reach. RE currently has around 700 dealerships to cater to customers’ need, up from 110 dealerships in CY11. Expanding dealership should propel growth in the coming years.

Competition is heating up

Bajaj Auto’s Dominar has already started gaining traction in the premium bike segment and the recent addition of Triumph by Bajaj in the premium segment would give competition to RE. Other players in the two wheeler segment such as Hero MotoCorp also has plans to launch a premium bike soon. Hence competition is clearly heating up. Investors ought to take note of the intensified competition.

VECV – business to regain normalcy

The management indicated that though VECV reported a poor show in 1Q18, business should come back to normalcy. It indicated that there are no structural issues on the demand front and the volume should pick up as soon as the overall industry recoups from GST-led disruption.

Valuation

On the back of strong business growth and brand, the company deserves a premium valuation. However, the outperformance of the stock has rendered the valuation too steep. Following a Sum of the Parts valuation (SOTP), we value the RE business at 30 times, (a premium valuation multiple compared to peers) and VEVC business at 15 times FY19 projected earnings. Our analysis suggests that the business is fairly priced at the current level. We advise investors to wait for any weakness in stock prices to accumulate.

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