Eicher Motors: Weak Q4 earnings, but stock fairly valued; hold

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Highlights:- Significant decline in volume numbers after multiple macroeconomic challenges - Operating margin continues to remain under significant pressure - Business outlook for the company is weak in the short term, positive for the long term  --------------------------------------------------

Eicher Motors (EML) posted an in-line set of numbers amid concerns over volume growth, impacted by substantial cost inflation because of mandatory long-term insurance and implementation of anti-lock braking system (ABS).

Margin also continues to be under pressure due to higher promotional spend and cost associated with installation of ABS.

We continue to like the company on the back of its dominant position in bikes with engine displacement of above 250cc, outperformance of the sub-segment and positive outlook on the back of customers’ shift towards premium products. The valuation, however, seems to be at fair levels.

Quarter in a nutshell

Key highlights Royal Enfield's (RE) registered a quarterly volume decline of 13.7 percent YoY. Volume growth hit a speed bump on subdued customer sentiment in the auto sector, led by a rise in total cost of ownership due to mandatory long-term insurance and regulatory safety requirements. The demand in flood-affected Kerala is yet to reach its previous levels.

Realisation, however, rose 14.4 percent YoY led by price increase following ABS implementation and a favourable product mix. Improved realisation helped the company arrest the fall in net revenue, which declined 1.2 percent YoY.

Earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted 450 bps, primarily on account of expenses involved in the launch of twin bikes and higher raw material cost associated with the installation of ABS.

Volvo Eicher Commercial Vehicles (VECV) witnessed a nine percent annual decline in its volume. Realisation, however, grew 6.3 percent, leading to 3.3 percent decline in its net operating revenue. EBITDA margin witnessed a 100 basis points (100 bps=1 percentage point) contraction due to higher discounting.

Industry outlook – sluggish in the near-term RE is facing demand softness after a very long time, buffeted by multiple challenges faced by the two-wheeler industry. The industry continues to operate in a tough environment because of factors such as increase in total cost of ownership, driven up by mandatory long-term insurance and implementation of ABS and CBS (combi brake system).

The management indicated the drop in enquiry post Diwali due to price hikes and highlighted the subdued consumer sentiment. The management, however, continues to be optimistic and has set the production target at 950 thousand units in FY20.

When it comes to VECV, the domestic CV market continues to face challenges from a weakening macroeconomic environment, leading to muted sentiment. Subdued market sentiment is on account of liquidity problem, financing issues and slowdown in economic activities.

This was, further, aggravated by the lag impact of new axle load norms in the CV segment. We expect demand to remain weak  in the short term, but the long-term growth outlook remains promising on the back of economic growth, rising income levels, lower penetration, government’s thrust on increasing rural income and focus towards infrastructure and construction.

Twin 650cc -- mid-weight segment in focus After a lull of no meaningful launches, the company has come out with two new motorcycles: the Interceptor 650 roadster and the Continental GT 650. These launches are part of RE’s aim to lead and expand the mid-weight (250-750cc) motorcycle segment globally.

Network expansion – under-penetrated areas holds centre stage To improve penetration further, RE has been ramping up its distribution network not just in India but also abroad. In the domestic market, the company continues to focus on distribution network and added 37 new dealers in the quarter gone by, taking the dealership count to 915. The company has added dealers in new and under-penetrated areas.

In international markets, the company started its first exclusive store in Seoul and has 42 exclusive across 14 countries. The management plans to double these in 1.5-2 years.

Valuation: At a fair level Sum of the parts valuation (SoTP) suggests that the stock is trading at a fair valuation.

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