The business provides limited upside at the current levels. Hence, we advise investors to wait for any weakness in stock prices to accumulate.
Eicher Motors (EML) has been one of the biggest wealth creators in the Indian market. Its flagship product, Royal Enfield (RE) is arguably India’s most respected and sought after brand in the mid-sized two-wheeler (2W) segment, continues to maintain its mojo.
The company, yet again, posted a very strong set of numbers in the final quarter of FY18. The company continues to cruise smoothly on the back of strong demand, improved realisation and operational efficiencies. Growth is, however, constrained by capacity. Despite our high comfort on the business, the valuation leaves little room for comfort. We would advise investors to capitalise on dips to build positions in the stock.Quarter in a nutshell
Amid all the disruptions that took place in the Indian automobile industry in FY18, RE continues to cruise smoothly. It registered its best ever-quarterly volume and realisation growth of 27 percent and five percent year-on-year (YoY). Consequently, EML posted its highest ever net quarterly income from operations at Rs 2,528 crore, a growth of 34 percent over the corresponding period of last year.
In an environment where the industry is struggling to cope up with rising raw material prices, EML has been able to maintain its margin due to improved realisation and cost efficiencies. Hence, the earnings before interest, tax, depreciation and amortisation (EBITDA) margin witnessed a marginal 50bps YoY uptick at 31.5 percent.Strong showing by VECV
With an overall pick-up in demand for commercial vehicles (CV), Volvo Eicher CV (VECV) witnessed a 30 percent YoY growth in topline on the back of 33 percent growth in volumes. However, realisations witnessed a three percent YoY decline due to discounts prevailing within the industry. The company could maintain its overall market share in the CV segment.
EBITDA margin witnessed a significant 130bps YoY increase due to better price management and focus on cost reductions. However, the management indicated that the market continues to be highly competitive with heavy discounts continuing.
The moot question is whether the stock is worthy of investment at current premium valuations given the capacity constraints?Capacity constraints getting phased out
Low capacity has been EML’s Achilles heel for long. Despite huge capacity additions for Royal Enfield, which has increased from 60,000 units in CY11 to 675,000 units in FY17, constrains still persist.
EML expanded its capacity to 825,000 units in FY18 by commencing production from its new Chennai plant in August 2017. The management expects to raise capacity to 950,000 units by FY19. Despite aggressive capacity addition, growth is still constrained by capacity. The company has earmarked Rs 800 crore for expansion next fiscal.New launches to grow mid-weight segment
Recently, the company 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. They will be launched in the market this year. Further, the company has launched the Himalayan Sleet + Explorer Kit and the Thunderbird X in Q4 FY18, which are also seeing strong response from customers.Exports to provide the next leg of growth
The next leg of growth for EML will accrue from the export market. The management continues to focus on those markets. RE is expanding its footprint in the South Asian region by opening its first store in Bali, Indonesia. In October last year, RE forayed into Vietnam, the fourth biggest motorcycle market in the world, and opened its first store. The company opened its first exclusive store in Argentina as well. With these additions, the company now has 36 exclusive stores in export markets, up from 26 stores as at the end of June 2017, and has over 540 multi-brand dealers.
For newly launched products, the management expects strong traction in developed markets such as Europe and the US and in developing markets such as Colombia, Indonesia, etc.Competition heating up
Bajaj Auto’s Dominar is seeing strong traction in the premium bike segment and the recent addition of Triumph in the premium segment would also pose competition to RE. Other players in the two-wheeler segment such as Hero MotoCorp and TVS Motor also have plans to launch premium bikes soon. With competition clearly heating up, investors ought to take note of the same.Expensive valuations
On the back of strong business growth and brand, the company deserves a premium valuation. However, capacity-constraints led earnings growth cap is behind the steep valuation.
Using sum of the parts valuation (SoTP), we value the RE business at 30 times (a premium valuation multiple compared to peers) and VEVC at 15 times FY20e earnings. The business provides limited upside at the current levels. Hence, we advise investors to wait for any weakness in stock prices to accumulate.
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