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.
Eicher Motors (EML) has been 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-wheelers (2W) segment, continues to maintain its mojo.
EML, yet again, has posted a very healthy set of numbers for the quarter ended September 2017. Albeit our high interest in the business, the valuation leaves little room for comfort and we would advise investors to capitalize on dips to build position in the stock.
Quarter in a nutshell
Amid all disruptions taking place in Indian automobile industry, RE continues to cruise smoothly. RE registered the best ever quarterly volume with a growth of 22 percent (YoY) that contributed to the highest ever net quarterly income from operations at Rs 2,167 crore, a growth of 23.5 percent over the corresponding period last year. The EBITDA margin witnessed marginal uptick of 60bps and came at around 31.5 percent.Decent show by VECV
With the overall pick-up in the demand for commercial vehicles (CV), Volvo Eicher CVs witnessed a 19 percent growth in the topline on the back of 12 percent growth in volumes and 6 percent in realization. Despite the growth in the volume, the company lost its market share from 13.6 percent last year to 13 percent.
Its EBITDA margin witnessed a significant increase of 200bps due to better price management and focus on material cost reductions. However, the management indicated that the market continues to be highly competitive with heavy discounts continuing.
The moot question is that whether the stock is worthy of investment at current premium valuations?Capacity constraints
The Achilles' heel for EML is capacity. 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 has commenced production in August 2017. The management expects to take the capacity to 900,000 units by FY19.New launches – to grow mid-weight segment
Recently, the company has unveiled two new motorcycles - the Interceptor 650 roadster and the Continental GT 650 cafe racer at the EICMA Motor Show in Milan, Italy. These launches are part of RE’s aim to lead and expand the mid-weight (250-750cc) motorcycle segment globally. The management believes that these two bikes along with the existing portfolio will help grow this segment.Exports - to provide the next leg of growth
The next leg of growth for EML is to come from export markets and the management continues to focus on those markets. During the quarter, RE continued to expand its footprint in the South Asian region by opening its first store in Bali, Indonesia. In October RE forayed into Vietnam, the fourth biggest motorcycle market in the world, and opened its first store. With these additions, the company now has 30 exclusive stores in export markets up from 26 stores as of June 2017 and has presence in more than 600 multi-brand dealers.
In fact, for the newly launched products, the management expects to get strong traction in the export markets both in developed markets such as Europe and US and in developing markets such as Colombia and Indonesia, etc.Competition 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 and TVS also have plans to launch premium bikes soon. Hence, competition is clearly heating up. Investors ought to take note of the intensified competition.Expensive valuationsOn 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 valued at the current price level. We advise investors to wait for any weakness in stock prices to accumulate.
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