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Margin bottom not yet in sight, lacks imminent triggers

About the stock:

Bajaj Auto (BAL) is the second largest motorcycle manufacturer and largest 3-W OEM domestically (FY21 market share at 18%, 50.6%, respectively).

* Exports comprised ~52% of FY21 volumes; >125 cc motorcycles constituted ~28% of FY21 volumes with Pulsar 125 enjoying good success

* Strong b/s with ~| 20,000 crore surplus cash on books, history of >20% return ratios & one of the highest dividend yields among Nifty stocks

Q1FY22 Results:

BAL reported steady Q1FY22 results under the circumstances.

* Net sales were down 14% QoQ to | 7,386 crore, decline being volume-led

* EBITDA margins fell 257 bps QoQ to 15.2% on higher RM, employee costs

* Consequent standalone PAT at | 1,061 crore was lower by 20.3% QoQ

What should investors do?

BAL’s stock price has outperformed the Nifty Auto index in the past five years, having grown at ~8% CAGR (~| 2,700 in July 2016).

* We downgrade from BUY to HOLD on margin pressures, EV transition risk.

Target Price and Valuation: We value BAL at | 4,350 on SOTP basis (22x PE on FY23E standalone EPS, 2x P/B on KTM investment; earlier target price | 4,500)

Key triggers for future price performance:

* We expect volume, net sales CAGR of 13.3%, 19.4% over FY21-23E (2-W CAGR 12.4%, 3-W CAGR 21.4%) aided by low base, pent-up demand

* Under-recovery of cost increases, elevated employee costs to pressurise margins over medium term; margins seen stabilising ~16% by FY23E

* Revised dividend distribution policy (up to 90% payout for surplus funds in excess of | 15,000 crore) to ensure high dividend yield in future

* Well charted transition strategy encompassing switch to electrification

Alternate Stock Idea:

In our auto OEM coverage we also like M&M.

* Focused on prudent capital allocation, UV differentiation & EV proactiveness

* BUY with a target price of | 1,000

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