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Profitability tailwinds coming back finally

Bajaj Auto’s (BJAUT) Q1FY23 EBITDA margin came in at 16.2% (down 92bps QoQ) vs our estimate of 15.6% (consensus: 15.4%), with gross margin down 25bps QoQ amidst adverse input material costs. Price hikes (~2% QoQ), higher premium model mix and better USD realisation supported ASP (up 5% QoQ) despite underrecoveries against commodity inflation (up 3% QoQ). Improving exports QoQ, tailwinds of RM cost pass-through and favourable FX in Q2FY23 are likely to balance the negative impact from higher energy costs and higher mix of low margin domestic 2W models ahead. Securing sourcing of ECU from additional supplier would drive wholesales in coming 3-4 months amidst lean inventory and pre-festive season demand. We look forward to the upcoming launches of Dominar refresh and the customer feedback on new variants of Pulsar amidst 2W market recovery with festive season setting from H2FY23E. BJAUT is gradually ramping up its Chetak portfolio with the new capacity and also planning entry into B2B e-2W segment down the line. Maintain HOLD with revised DCF-based target price of Rs3,778 (implied 14x FY24E core EPS; previous TP: Rs3,507).

Key takeaways from earnings call:

* Production in Q1 was impacted by ~20-30% due to shortage of ECU supply by a key vendor resulting in depleted inventory situation both in domestic and export markets. BJAUT has secured supplies from an additional supplier from Q2 and is confident of sprucing up volumes in the coming months with pre-festive season months imminent.

* As against cost inflation of ~300bps in Q2, blended price hikes of ~2%, favourable currency moves and higher sales of spares aided BJAUT in controlling the gross margin from declining much. For Q1, cost inflation will go down to ~1.5% QoQ led by energy cost for conversion with operating leverage and favourable currency movement combined to comfort margin. Improved supply of ECUs would potentially push supplies of lower-end domestic 2Ws, thus acting as a hurdle to gross margin improvement. BJAUT is not planning to pass on currency benefits in the export markets barring plans to push 3Ws in select markets other than pushing higher cc bikes in select export markets; INR/USD realised rate moved from Rs75.5 to Rs77.4 QoQ.

* Export market inventory is seeing depletion from the elevated level due to limited supply. Macro concerns in certain export markets led by volatility and limited availability of currency can pose temporary hurdle to retail demand along with regulatory hurdles in those markets. Revival in demand from Asian markets like the Philippines and Malaysia is likely to mitigate the current risk to demand in African markets like Egypt and Nigeria

* Company does not expect domestic 3W volumes returning closer to FY19 levels anytime soon as ‘work from home’ is continuing in key markets like Bengaluru along with rising fuel costs impacting earnings of 3W owners. Post recent improvement in ECU supply and depleted system inventory, there can be a few months of surge in volumes but it should thereafter stabilise around ~20k-22k units/month in general. E-3Ws are undergoing live product trials in Delhi and Pune markets. Products would get formally launched across markets, once technical issues are fully resolved.

* Chetak is doing retails of ~6k units a quarter and BJAUT is aiming to double it in the next couple of quarters given that the new EV-dedicated plant with 0.5mn units annual capacity is ready. Currently BJAUT is selling Chetak in 27 cities, which would eventually move to 100 in a year’s time and through 43 dealership outlets (including a few exclusively for BJAUT EVs). Company is looking forward to enter the B2B e-2W portfolio soon, both in export and domestic markets.

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