30 August 2010India | Automobiles | Initiating CoverageCommercial Vehicle IndustryHeavier the merrier                     ...
Commercial Vehicle Industry                                                                                               ...
30 August 2010India | Automobiles | Initiating Coverage                                                    Price: `70Ashok...
Ashok Leyland                                                                                                             ...
Ashok Leyland                                                                                        30 August 2010     Fi...
Ashok Leyland                                                                                                             ...
Ashok Leyland                                                                                                             ...
Ashok Leyland                                                                                                             ...
30 August 2010India | Automobiles | Initiating Coverage                                                                   ...
Eicher Motors                                                                                     30 August 2010About EIM ...
Eicher Motors                                                                        30 August 2010About AB Volvo’s India ...
Eicher Motors                                                                            30 August 2010Exhibit 16. Valuati...
Eicher Motors                                                                                                             ...
Eicher Motors                                                                                                             ...
Eicher Motors                                                                       30 August 2010    Royal Enfield can be...
Eicher Motors                                                                                  30 August 2010Exhibit 22. E...
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
Commercial vehicle industry initiation report[1]
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Commercial vehicle industry initiation report[1]

  1. 1. 30 August 2010India | Automobiles | Initiating CoverageCommercial Vehicle IndustryHeavier the merrier Pramod Kumar pramod.kumar@jmfinancial.in Tel: (91 22) 6630 3019 Expect MHCV to witness volumes CAGR of 18% till FY13: MHCV volume Mitakshi Ashar mitakshi.ashar@jmfinancial.in growth has a long-term correlation with 1.5x the industrial production (IIP) Tel: (91 22) 6630 3079 growth (see exhibit 1); however, in the initial years of an up-cycle the growth is much higher than the long-term correlation. We expect the MHCV segment to see volumes CAGR of 18% till FY13 compared to a 19% CAGR over the last cycle between FY01-FY08. Recommendations Tonnage/volume growth at 1.3x: In the last cycle, the tonnage/volume Company Ashok Eicher Leyland Motors growth used to be around 1x; it is currently c.1.3x (see exhibit 1) driven by Rating BUY BUY strong demand for heavy tonnage vehicles. Improving highway network, Bberg Ticker AL IB EIM IB revival of the industrial capex cycle, government thrust on infrastructure and TP (`) 91 1,677 better operating economics are driving demand for higher tonnage trucks. CMP (`) 70 1,093 Upside/Downside (%) 31.0 53.4 Hub and Spoke model driving tonnage polarisation: While higher tonnage Source: Bloomberg, JM Financial trucks are becoming prevalent on highways the smaller trucks (sub 1 tn) are rapidly replacing intermediate tonnage trucks for providing last mile Relative Performance connectivity. This polarisation is squeezing the intermediate segment (see AL EIM SENSEX exhibit 2). Entry regulations in many cities are putting the intermediate trucks 5.50 at further disadvantage. 5.00 4.50 Several entry barriers favour incumbents: The MHCV industry has several 4.00 3.50 entry barriers, like reach in terms of sales and service with the latter being 3.00 very critical. Mapping truck routes across the country and ensuring service 2.50 2.00 and spare availability on these routes is critical for success. This is a big 1.50 advantage for incumbents as creating reach is very time and resource 1.00 1-Apr- 1-Jun- 1-Aug- 1-Oc t- 1-Dec - 1-Feb- 1-Apr- 1-Jun- 1-Aug- intensive. We expect serious competition from new players like Mahindra- 09 09 09 09 09 10 10 10 10 Navistar and Daimler, but that is still 2-3 years away, giving enough window of opportunity for incumbents to scale up their R&D. Source: Bloomberg, JM Financial Pricing strong in MHCV and weak in LCV: The MHCV industry has seen price increase (excluding excise) of c.8% since Oct’09 despite moderate increase in commodity prices. Ashok Leyland (AL) and Eicher Motors (EIM) have been the biggest beneficiaries of the benign pricing environment. In FY10, AL’s operating profit was 94% of FY08 levels despite volumes being 77% of FY08 levels. Increasing competition in the small truck market (where reach is not as critical as in the MHCV space) is leading to lower margins for incumbents. TTMT has refrained from increasing prices of Ace despite increase in excise duty and commodity pressure resulting in lower profits. AL and EIM to outperform industry growth: We are initiating coverage on AL and EIM, which derive complete/bulk of their earnings from CVs. AL and EIM will outperform the industry growth with a volume CAGR of 25% and 30%. We initiate with BUY on AL and EIM with TP of `91.2 and `1,677: We believe heavier is merrier in the medium-term due to limited competition and strong cyclical demand. We are initiating coverage on AL and EIM, which derive complete/bulk of their earnings from CVs, with BUY rating and target price of `91.2 (upside of 31%) and `1,677 (upside of 53%) respectively. We have delved deeper into EIM as it not widely tracked, and according to us, is a stock for keeps. JM Fiancial Research is also available on: Bloomberg - JMFR <GO>, Thomson Publisher & Reuters. Please see important disclosure at the end of the report JM Financial Institutional Securities Private Limited
  2. 2. Commercial Vehicle Industry 30 August 2010Exhibit 1. Growth in IIP and MHCV volumes, tonnage/volume trend 125 100 14 Volume growth MHCV IIP Tonnage growth X Tonnage/Volume 1.3x 80 100 12 60 75 10 40 1.1x 50 1.2x 8 1.0x 1.0x % 20 1.1x % % 6 25 0 0.6x 1.1 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 1QFY11 1.2x 4 0 -20 1QFY11 QoQ FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 1QFY11 -40 2 -25 -60 0 -50Source: SIAM, JM FinancialExhibit 2. Hub and Spoke driving tonnage polarisation 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% 1QFY11 1QFY11 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 < 3.5 3.5-5 5-7.5 7.5-12 12-16.2 16.2-25 > 25 7.5-12 12-16.2 16.2-25 > 25Source: SIAM, JM FinancialExhibit 3. Freight Index on a steady rise 174 173 172 171 170 Apr-10 Aug-10 Jun-09 Jul-09 May-09 Jan-10 Jun-10 May-10 Oct-09 Nov-09 Feb-10 Sep-09Source: TCI, JM FinancialJM Financial Institutional Securities Private Limited Page 2
  3. 3. 30 August 2010India | Automobiles | Initiating Coverage Price: `70Ashok Leyland | AL IN BUY Target: `91.2 (Mar’11) Pantnagar a game changer Pramod Kumar pramod.kumar@jmfinancial.in Tel: (91 22) 6630 3019 Pantnagar to bring in significant cost advantage: This is the only MHCV Mitakshi Ashar plant in a tax haven zone giving AL a significant cost advantage (100% excise mitakshi.ashar@jmfinancial.in exemption for 10 years, 100% income tax exemption for the first 5 years and Tel: (91 22) 6630 3079 30% over the following 5 years). We estimate this plant to bring in additional benefits of `595mn and atleast `1.2bn for FY11 and FY12. Pantnagar will also Key Data act as a beach-head to increase its reach in the North India market. Market cap (bn) ` 92.7 / US$ 2.0 Shares in issue (mn) 1,330 Huge operating leverage: We expect AL’s capacity utilisation to be c.58% in Diluted share (mn) 1,330 FY11 and c.67% in FY12, bringing in huge operating leverage. The improvement in utilisation will be driven by ramp-up at the Pantnagar plant, 3-mon avg daily val (mn) ` 359.7 / US$ 7.7 which with 50,000 units will account for 33% of overall capacity. AL’s existing 52-week range 74.2 / 34.3 capacity of 150,000 units will hold good till FY14-FY15 driving up RoEs. Sensex/Nifty (20-08-2010) 18,402/5,531 `/US$ 46.7 Financing arm to increase market acceptance: The recently launched captive financing arm will be able to finance over 4,000 trucks in FY11 and a Daily Performance much higher number in the future, improving AL’s acceptance amongst Ashok Leyland customers. 80 180% 160% 70 140% 60 Entry into LCV and CE business to reduce cyclic trend further: AL’s 50 120% 100% portfolio will be less cyclical FY12 onwards as the JVs start commercial 40 80% 60% launches. By mid-2011, LCVs from Nissan JV and CEs from the John Deere JV 30 20 40% will be launched. 10 20% 0% 0 -20% Expect FY10-FY12E revenue and earnings CAGR of 30% and 40%: Volume Jan-09 Mar-09 Jul-09 Sep-09 Jan-10 Mar-10 Jul-10 May-09 Nov-09 May-10 and realisation CAGR of 25% and 3.3% will drive strong revenue growth. Ashok Leyland Relative to Sensex (RHS) Earnings growth will be driven by 37% CAGR in operating profits. Bulk of the tax haven benefits will be back-ended in FY11. Expect EPS of `4.8 and `6.2. % 1M 3M 12M Absolute -1.8 14.5 98.3 Pantnagar and financing arm to boost marketshare: We expect AL’s MHCV Relative* -4.7 3.2 75.7 marketshare to increase by at-least 280 bps by FY12 driven by Pantnagar and * To the BSE Sensex the financing arm. Shareholding Pattern (%) Investment in JVs valued at `5.4 per share (1x FY12E BV) 1QFY11 1QFY10 Promoters 38.6 38.6 Initiate with BUY and TP of `91.2, 31% upside: AL currently owns 17.2mn FII 13.6 10.2 IndusInd Bank shares which are worth `2 per share (after 30% discount). In 19.4 19.7 DII addition, investment in the key JVs are worth `5.4 per share (1x FY12E BV). Public / others 28.3 31.5 We value the standalone business at `83.8 (13.5x FY12 EPS or 8.6x EV/EBITDA), taking the target price to `91.2 (18% above consensus).tExhibit 4. Financial Summary (` mn)Y/E March FY08 FY09 FY10 FY11E FY12ENet sales 77,426 59,811 72,447 101,493 121,304Sales growth (%) 0 -22.8 21.1 40.1 19.5EBITDA 8,077 4,560 7,596 11,242 14,258EBITDA (%) 10.4 7.6 10.5 11.1 11.8Adjusted net profit 4,694 1,900 4,237 6,345 8,254EPS (`) 3.5 1.4 3.2 4.8 6.2EPS growth (%) 0 -59.5 123.0 49.8 30.1ROCE (%) 19.7 7.5 9.1 13.7 17.3ROE (%) 22.1 6.8 11.8 16.3 19.2PE (x) 19.8 48.8 21.9 14.6 11.2Price/Book value (x) 4.4 2.7 2.5 2.3 2.0EV/EBITDA (x) 11.3 23.9 14.0 8.8 6.5 JM Financial Research is also available on: Bloomberg - JMFR <GO>, Thomson Publisher & Reuters.Source: Company data, JM Financial. Note: Valuations as of 20/08/2010 Please see important disclosure at the end of the report JM Financial Institutional Securities Private Limited
  4. 4. Ashok Leyland 30 August 2010 Pantnagar plant a game changer: This is the only MHCV plant in a tax haven zone giving AL a significant cost advantage (100% excise exemption for 10 years, 100% income tax exemption for the first 5 years and 30% over the following 5 years). The company is expected to save `35,000 on each of the 17,000 odd trucks to be rolled out in FY11 from this plant. In FY12, we expect volumes of 30,000 units from this plant and the benefits to be over `40,000 per truck. This would mean `595mn and atleast `1.2bn in terms of additional benefit in FY11 and FY12. Pantnagar will also act as a beach-head to increase its reach in the North India market. Huge scope for marketshare gains in non-South markets: While AL enjoys a strong 45-46% share of the South HCV market its presence in other geographies has been much below its potential. Its share in the key North and West markets is c.26% and c.18%, and in the smaller east market its a meager 10%. Geographical distance is one of the reason for lower share in these markets. However, with commissioning of the Pantnagar plant, AL is very close to the North and East markets, leading to shorter time-to-market and lower logistical costs. This coupled with the captive financing arm will ensure that AL increases its marketshare considerably in the North and West markets, helping it outpace industry growth over the next few years.Exhibit 5. Region-wise marketshare and tonnage wise marketshare trend 50% 35 33 33 46% 29 29 29 30 28 > 16 tn 40% 26 26 25 24 25 21 21 30% 20 26% % 15 20% 18% 10 10% 6 4 5 10% 5 3 0 0% 7.5-12 tn 12-16.2 tn 16.2-25 tn >25 tn North South East West FY08 FY09 FY10 YTDFY11Source: Company, JM Financial Huge operating leverage: With the commissioning of the Pantnagar plant, AL has a capacity of around 150,000 units, of which it will be utilising only c.58% in FY11. This gives the company a huge operating leverage going forward. This, along with the tax benefits, should help it protect margins despite commodity pressure.Exhibit 6. Installed capacity and capacity utilisation 100 150 75 Thousands units 100 50 % 50 25 - 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E FY12E Installed Capac ity Capac ity UtilisationSource: Company, JM FinancialJM Financial Institutional Securities Private Limited Page 4
  5. 5. Ashok Leyland 30 August 2010 Financing arm to increase acceptance amongst customers: AL has been at a disadvantage, a significant one in a downturn, vis-a-vis Tata Motors due to lack of a captive financing arm. Since virtually all CVs sold are financed, presence of a captive financing arm considerably improves customer acceptance. The recently launched captive financing arm will be able to finance over 4,000 trucks in FY11 and a much higher number in the future as the book size increases, improving AL’s acceptance amongst customers.Exhibit 7. Trend in dependence of Tata Motors on Tata Motors Finance 110 45 105 40 Units 000s 100 35 % 95 30 90 25 85 20 FY07 FY08 FY09 FY10 CVs financed % of domestic CVsSource: Company, JM Financial Entry into LCV and CE business to reduce cyclic trend further: AL being a pure MHCV player is weighed down by the cyclical nature of the MHCV segment. Comparatively, the LCV segment is much more stable and has gradually grown bigger than the MHCV segment in terms of volumes (see exhibit 8). ALs JV with Nissan will roll out its LCVs by mid-2011. By early 2011, its entry in the construction equipment (CE) business with John Deere will also open up a non-cyclical stream of revenue with limited capex. In addition, JVs with Albonair and Alteams will also start contributing significantly.Exhibit 8. MHCV and LCV growth trends 375 120 Thousands 300 80 225 40 % 150 - 75 0 (40) FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11E LCV MHCV LCV Grow th % MHCV Grow th %Source: Company, JM FinancialJM Financial Institutional Securities Private Limited Page 5
  6. 6. Ashok Leyland 30 August 2010 Entry into sub 3.5tn market; better late than never: The sub 3.5tn cargo segment has seen a CAGR of 38% since FY03 with bulk of that growth coming after launch of Tata Ace in May 2005. AL, due to its limited presence in the LCV segment (less than 2% of its volumes), missed this opportunity. However, the JV with Nissan will enable the company to participate in this fast growing segment. The JV will be launching products between the 2.5tn-5tn segment, with the first product targeted for launch in mid-2011. Nissan’s LCV expertise coupled with AL’s wide reach will enable the JV to quickly ramp-up volumes.Exhibit 9. Volume and growth trend in LCV (sub 1 tonne cargo) 225 80 150 Th u n s o sa d 50 % 75 20 0 -10 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 1QFY11 Volume Grow th %Source: Company, JM Financial Key JVs valued at `5.4 per share: Key JVs contribute around `5.4 per share based on a 1x FY12 price/book multiple to the estimated investments.Exhibit 10. Details of Key JVs Total Investment Company Description FY10/FY12E (` mn) Status Nissan Motors JV to develop, manufacture and distribute LCVs under both 748 / 5,888 Rollout in Feb 2011 brands; JV has three separate companies - A vehicle manufacturing company, AL: Nissan- 51:49 - Powertrain manufacturing company, AL:Nissan- 49:51 - A technology development company, 50:50 JV John Deere (JD) A 50:50 JV to manufacture and market Construction 292 / 792 Rollout by Feb 2011 Equipment under both brands. Initially rollout Backhoes and four-wheel drive loaders Automotive A 50:50 JV to design, develop infotronics products and 50 / 50 200-230 cr in FY11 Infotronics services for automotive customers Ashley Alteams India A 50:50 JV to produce high Pressure Die Casting aluminum 250 / 500 Went on stream in January Pvt Ltd components for telecom & automotive sectors 2010 Per share book value (`) 1 / 5.4Source: Company, JM ResearchJM Financial Institutional Securities Private Limited Page 6
  7. 7. Ashok Leyland 30 August 2010Key assumptionsExhibit 11. Volumes and realisation assumption (Units) FY10 FY11E YoY (%) FY12E YoY (%) Volumes 63,933 87,623 37.1 100,235 14.4 MDV Passenger 18,452 21,322 15.6 23,257 9.1 MDV Goods 44,384 64,851 46.1 75,181 15.9 LCV 1,097 1,450 32.2 1,797 23.9 Domestic 57,959 80,301 38.5 91,553 14.0 MDV Passenger 16,405 18,866 15.0 20,186 7.0 MDV Goods 40,742 60,298 48.0 69,946 16.0 LCV 812 1,137 40.0 1,421 25.0 Export 5,974 7,322 22.6 8,682 18.6 MDV Passenger 2,047 2,456 20.0 3,071 25.0 MDV Goods 3,642 4,553 25.0 5,235 15.0 LCV 285 314 10.0 376 20.0 Realisations (`) 1,133,172 1,158,290 2.2 1,210,190 4.5Source: JM FinancialValuations AL currently owns 17.2mn shares in IndusInd Bank which are worth `2 per share (after 30% discount). In addition, investments in key JVs are valued at `5.4 per share (1x FY12E BV). AL deserves a higher multiple than its historic average due to the tax haven plant and new forays like LCV, CE which will make the business less cyclical. We value the standalone business at `83.8 (13.5x FY12 EPS or 8.6x EV/EBITDA), taking the target price to `91.2. At the current price the stock is trading at 11.2x FY12E EPS. We initiate coverage with a BUY rating. Please see exhibit 27 on page 22 for Global CVs comparable table.Key risks Key downside risks are: a) Lower than estimated volumes from Pantnagar plant, b) Drastic slowdown in industrial growth, c) Sharp increase in diesel prices, and d) sharp increase in interest rates. Higher than estimated ramp-up at Pantnagar is the key upside riskExhibit 12. AL 1 yr fwd P/E 120 20x 17x 80 14x 11x 40 8x 5x 0 A pr-03 A pr-05 A pr-07 A pr-09 A ug-04 A ug-06 A ug-08 A ug-10 Dec-03 Dec-05 Dec-07 Dec-09Source: Bloomberg, JM FinancialJM Financial Institutional Securities Private Limited Page 7
  8. 8. Ashok Leyland 30 August 2010Financial TablesProfit & Loss (` mn) Balance Sheet (` mn)Y/E March FY08A FY09A FY10A FY11E FY12E Y/E March FY08A FY09A FY10A FY11E FY12ENet sales (Net of excise) 77,426 59,811 72,447 101,493 121,304 Share capital 1,330 1,330 1,330 1,330 1,330Growth (%) -22.8 21.1 40.1 19.5 Other capital 0 0 0 0 0Other operational income 0 0 0 0 0 Reserves and surplus 19,937 33,349 35,946 39,432 44,054Raw material (or COGS) 57,647 44,442 52,041 75,402 90,426 Networth 21,267 34,680 37,277 40,763 45,385Personnel cost 6,289 5,797 6,749 8,119 9,098 Total loans 8,875 19,581 22,039 20,977 19,591Other expenses (or SG&A) 5,412 5,011 6,062 6,729 7,522 Minority interest 0 0 0 0 0EBITDA 8,077 4,560 7,596 11,242 14,258 Sources of funds 30,142 54,261 59,316 61,740 64,976EBITDA (%) 10.4 7.6 10.5 11.1 11.8 Intangible assets 0 0 0 0 0Growth (%) -43.6 66.6 48.0 26.8 Fixed assets 29,424 49,389 60,186 64,396 68,707Other non-op. income 576 496 704 321 408 Less: Depn. and amort. 14,169 15,398 17,691 20,249 23,059Depreciation and amort. 1,774 1,784 2,041 2,426 2,677 Net block 15,256 33,991 42,496 44,147 45,648EBIT 6,880 3,271 6,259 9,137 11,990 Capital WIP 5,292 9,983 5,615 5,600 5,600Add: Net interest income -497 -1,187 -811 -1,400 -1,800 Investments 6,099 2,635 3,262 8,151 11,080Pre tax profit 6,382 2,084 5,448 7,737 10,190 Def tax assets/- liability -2,538 -2,634 -3,845 -4,845 -5,845Taxes 1,688 185 1,211 1,393 1,936 Current assets 28,753 31,656 41,397 47,898 54,834Add: Extraordinary items 0 0 0 0 0 Inventories 12,239 13,300 16,382 23,635 26,587Less: Minority interest 0 0 0 0 0 Sundry debtors 3,758 9,580 10,221 6,952 8,308Reported net profit 4,694 1,900 4,237 6,345 8,254 Cash & bank balances 4,514 881 5,189 6,641 8,024Adjusted net profit 4,694 1,900 4,237 6,345 8,254 Other current assets 0 0 0 0 0Margin (%) 6.1 3.2 5.8 6.3 6.8 Loans & advances 8,241 7,895 9,605 10,670 11,914Diluted share cap. (mn) 1,330 1,330 1,330 1,330 1,330 Current liabilities & prov. 22,719 21,369 29,608 39,211 46,342Diluted EPS (`.) 3.5 1.4 3.2 4.8 6.2 Current liabilities 19,267 18,689 25,921 35,137 41,488Growth (%) NA -59.5 123.0 49.8 30.1 Provisions and others 3,452 2,681 3,687 4,074 4,854Total Dividend + Tax 2,337 1,556 2,327 2,724 3,502 Net current assets 6,033 10,287 11,789 8,687 8,492Source: Company, JM Financial Others (net) 0 0 0 0 0 Application of funds 30,142 54,262 59,316 61,740 64,975 Source: Company, JM FinancialCash flow statement (` mn) Key RatiosY/E March FY08A FY09A FY10A FY11E FY12E Y/E March FY08A FY09A FY10A FY11E FY12EReported net profit 4,694 1,900 4,237 6,345 8,254 BV/Share (`) 16.0 26.1 28.0 30.6 34.1Depreciation and amort. 1,037 1,229 2,292 2,558 2,810 ROCE (%) 19.7 7.5 9.1 13.7 17.3-Inc/dec in working cap. 2,949 -6,521 1,881 5,233 2,042 ROE (%) 22.1 6.8 11.8 16.3 19.2Others 0 0 0 0 0 Net Debt/equity ratio (x) -0.1 0.5 0.4 0.2 0.0Cash from operations (a) 8,680 -3,392 8,410 14,136 13,105 Valuation ratios (x)-Inc/dec in investments -3,888 3,464 -627 -4,889 -2,929 PER 19.8 48.8 21.9 14.6 11.2Capex -6,140 -24,656 -6,429 -4,195 -4,311 PBV 4.4 2.7 2.5 2.3 2.0Others 601 -1,366 925 -679 -463 EV/EBITDA 11.3 23.9 14.0 8.8 6.5Cash flow from inv. (b) -9,427 -22,558 -6,130 -9,763 -7,703 EV/Sales 1.2 1.8 1.5 1.0 0.8Inc/-dec in capital 209 13,069 687 -135 -130 Turnover ratios (no.)Dividend+Tax thereon -2,337 -1,556 -2,327 -2,724 -3,502 Debtor days 18 58 51 25 25Inc/-dec in loans 2,471 10,706 2,457 -1,062 -1,386 Inventory days 58 81 83 85 80Others 569 96 1,211 1,000 1,000 Creditor days 110 145 164 157 157Financial cash flow ( c ) 911 22,316 2,029 -2,921 -4,018 Source: Company, JM FinancialInc/-dec in cash (a+b+c) 164 -3,633 4,308 1,452 1,384Opening cash balance 4,349 4,514 881 5,189 6,641Closing cash balance 4,514 880 5,189 6,641 8,025Source: Company, JM FinancialJM Financial Institutional Securities Private Limited Page 8
  9. 9. 30 August 2010India | Automobiles | Initiating Coverage Price: `1,093 BUYEicher Motors | EIM IN Target: `1,677 (Mar’11)This one is for keeps Pramod Kumar pramod.kumar@jmfinancial.in Tel: (91 22) 6630 3019 JV with AB Volvo a game changer: The JV with AB Volvo (VECV, which Mitakshi Ashar accounts for 85% of consolidated earnings) will increase their presence mitakshi.ashar@jmfinancial.in Tel: (91 22) 6630 3079 (currently 3%) in the `250bn domestic HCV market and also grow as a major sourcing hub for Volvo. Key Data Huge upsides from engine deal; will lead to other sourcing opportunities: Market cap (bn) ` 29.3 / US$ 0.6 AB Volvo recently chose VECV as its manufacturing hub for 85,000 Euro 3,4,5 Shares in issue (mn) 26.8 and 6 engines. Apart from the additional source of revenues (JMFe `12bn in Diluted share (mn) 26.8 CY13 assuming first year exports of 40,000 units) this will give VECV a huge 3-mon avg daily val (mn) `123.2 / US$ 2.6 technology lead over domestic peers. This deal, according to us, is a 52-week range 1150 / 420 precursor to outsourcing of other parts to the JV. Sensex/Nifty (20-08-2010) 18,402/5,531 `/US$ 46.7 Success of JV crucial for AB Volvo: Unlike the developed world, emerging markets have come out stronger from the slowdown, growing beyond the pre- Daily Performance crisis highs. Success in emerging markets is crucial and a lot of that depends on the way VECV grows. AB Volvo expects Asia to be its largest market by 1200 Eicher Motors 200% 2015 with 60% of the demand coming from India and China. 1000 150% 800 Royal Enfield in a sweet spot: RE is seeing an unprecedented demand for its 100% 600 new launches and is enjoying a waiting period of several months. Cult brand 400 50% equity and lack of competition gives RE tremendous pricing power. Expect 200 0% volumes of c.57,000 units in CY10 and c.72,000 units in CY11, resulting in 0 -50% operating profit of `663mn (up 70%) for CY10 and `1bn (up 51%) for CY11. Jan-09 Mar-09 Jul-09 Sep-09 Jan-10 Mar-10 Jul-10 May-09 Nov-09 May-10 Eicher Motors Relative to Sensex (RHS) VECV operating profit to witness 98% CAGR in CY09-CY11: We expect VECV’s operating profit, including the discounted value of the engine deal, to % 1M 3M 12M be at `5,1bn in CY11. Absolute 13.2 32.4 153.8 Relative* 10.2 21.0 131.2 Net cash of `518/share in CY11 * To the BSE Sensex Initiate with BUY and TP of Rs1,677, 53% upside: Our CY11E based per Shareholding Pattern (%) share value of the standalone and VECV operating business works out to `332 1QCY10 1QCY09 (15x CY11E EPS) and `829 (13x CY11 EPS). These along with the cash of `515 Promoters 55.7 55.9 take the SOTP to `1,677. Alternatively, the stock is available 8.7x our CY11E FII 11.0 11.1 consolidated EPS of Rs125 (including the engine deal) and at our TP of DII 10.5 6.7 Rs1,677 it would trade at Rs13.4x. BUY for an upside of 53%. Public / others 22.9 26.3 Exhibit 13. Financial Summary (Consolidated) (` mn) Y/E March CY09 CY10E CY11E Net sales 29,386 42,794 52,542 Sales growth (%) 71.1 45.6 22.8 EBITDA 1,593 4,027 5,545 EBITDA (%) 5.4 9.4 10.6 Adjusted net profit 981 2,319 3,053 EPS (`) 36.7 86.9 114.4 EPS growth (%) 355.3 136.6 31.7 ROCE (%) 11.6 25.3 29.0 ROE (%) 6.0 13.1 14.6 PE (x) 29.8 12.6 9.6 Price/Book value (x) 1.8 1.5 1.3 JM Financial Research is also available on: EV/EBITDA (x) 17.6 6.8 4.8 Bloomberg - JMFR <GO>, Thomson Publisher & Reuters. Source: Company data, JM Financial. Note: Valuations as of 20/08/2010 Please see important disclosure at the end of the report JM Financial Institutional Securities Private Limited
  10. 10. Eicher Motors 30 August 2010About EIM EIM is promoted by the Delhi-based Vikram Lal group. Automobile segment remains the core focus of the group, with business interest in other areas like management consultancy, engineering solutions and exports of food products. Mr S Sandilya (Chairman), Mr Siddhartha Lal (MD & CEO), Mr Vinod Aggarwal (CEO of VECV) and Mr R L Ravichandran (CEO of Royal Enfield) hold the key positions of the company. The core management team has vast experience in various functional areas within and outside the Eicher Group. Currently, the Indian promoter holds 55.9% and Volvo owns 8.5% stake.EIM structureExhibit 14. EIM Structure Eicher Motors Ltd Motorc y c le (Roy al Enfield) VE Commerc ial Vehic les LTD 100% standalone business (VECV) 54.4% subsidiary Eic her Engineering Solutions (EES) (USA, 100% subsidiary ) Hoff Automotiv e Design (China, 100% subsidiary of EES) Hoff Tec hnology Serv ic e (China, 100% subsidiary of EES)Source: Company, JM FinancialManufacturing facilityExhibit 15. EIM product profile Product profile Location Annual Capacity (units) Motorcycles (Royal Enfield) Thiruvottiyur, Chennai (TN) 60,000 (being expanded) CV (Trucks, Buses and Chassis) , Automotive Pithampur (MP) 48,000 gears (for Exports) Automotive gears (for Domestic tractors and CV Thane, Mumbai - sector) Automotive gears (transmission gears and Dewas (MP) - safts)Source: CompanyJM Financial Institutional Securities Private Limited Page 10
  11. 11. Eicher Motors 30 August 2010About AB Volvo’s India operations Sweden-based AB Volvo is the world’s second largest producer of heavy trucks. Volvo entered India in 1997 to meet the rising demand for luxury buses. As the company sells only fully built buses it entered into a JV with local coach builder, JAICO Automobiles, for manufacturing buses. The manufacturing facility is located at Hoskote, near Bangalore with monthly production capacity of 200 plus vehicles. After establishing itself as a synonym for luxury buses the company started selling high tonnage trucks for mining application. Volvo is offering FM and FH range of heavy duty trucks (49tn-150tn) in the Indian market, catering to construction, mining, petroleum and other similar heavy load areas.Rationale behind the JV Despite being present in the country for ten years Volvo was not able to make much impact in the truck segment due to lack of India specific products which are low on power, tonnage and price. Incidentally, the company faced the same problem in other emerging markets where the requirement is for cheaper trucks. With growth stagnating in developed markets and lack of emerging market specific products the company decided to partner EIM. The bus business of Volvo was kept out of VECV as it already had a JV with JAICO. However, the after sales business for buses was merged into VECV.Volvo – Eicher Alliance In Jul’08, EIM formed a joint venture company, VECV, with Volvo. VECV comprises EIM’s CV, component and engineering solution businesses and the Volvo Group’s Indian truck sales and services (buses and trucks) operations.Key highlights of the joint venture• EIM and Volvo hold 54.4% and 45.6% respectively in the JV company (VECV). VECV is jointly managed by EIM and Volvo with shared management and equal representation rights on the board. VECV is a subsidiary of EIM.• The CV business of EIM along with related components and design services business was transferred to VECV at an enterprise value of US$506mn.• Volvo invested a total of US$350mn in VECV (with US$275mn cash and its Indian truck dealer and service network worth US$75mn).• Volvo acquired 8.1% stake in EIM from EML promoters.• Post acquisition of stake in EIM, Volvo’s economic ownership in VECV is 50%.JM Financial Institutional Securities Private Limited Page 11
  12. 12. Eicher Motors 30 August 2010Exhibit 16. Valuation of the deal US$ mn Enterprise value of CV business along with components and engineering and design business of Eicher motors 506 Amount paid by Volvo for 45.6% stake 350 Divided as Cash 275 Value for dealership and after sales network of Volvo India (20 in numbers) 75 Value of JV taking value of Volvos stake 768 Value of Eicher Motors stake of 54.4% (A) 418 Value of Eicher motors business for JV (B) 506 Cash received by Eicher Motors from JV (B-A) 89Source: Company JV with AB Volvo a game changer: The JV with AB Volvo (VECV, which accounts for 85% of consolidated earnings) will increase their presence (currently 3%) in the `250bn domestic HCV market and also grow as a major sourcing hub for AB Volvo. EIM on its own had limited technology and financial resource to take on the quasi duopoly of Tata Motors and Ashok Leyland in the HCV market. AB Volvo also wanted to participate more meaningfully in the fast growing Indian market. JV with EIM gave AB Volvo a complementary product portfolio, a strong manufacturing base and a management which was ready to take them on-board as equal partners rather than as a minority partner providing technology. Huge upsides from engine deal: AB Volvo recently announced VECV as a global manufacturing hub for 85,000 Euro 3,4,5 and 6 medium duty engines, thanks to the compatibility of the partners and VECV’s efficient operations. With this deal AB Volvo will be bringing in its latest technology to India. Of these 85,000 engines, VECV will do the final assembly of 55,000 Euro 3 and 4 engines and export bulk of them to AB Volvo. Another 30,000 engines for Euro 5 and 6 will be exported to AB Volvo in the base form. This deal not only throws up an additional source of revenue (c. `12bn in CY13 and increasing in subsequent years) but also gives VECV a huge lead over domestic competition in terms of engine technology. With the Euro 6 engine, VECV will be ready to meet the Indian emission norms beyond 2020. Engine deal a precursor to more sourcing: Sourcing of the most critical part from the JV is, according to us, a precursor to bigger sourcing opportunities which will also result in deployment of huge surplus cash. We expect large outsourcing announcements over the next two years. Success of JV very crucial for AB Volvo: Since Jul’08, when the JV was formalised, AB Volvo’s global business has taken a big hit due to the meltdown in the developed world. Revenue fell from US$46.7bn in 2008 to US$28.7bn in 2009 as demand collapsed in Europe and America. However, India and other emerging markets have come out stronger from the slowdown, growing beyond the pre-crisis highs. Increasing its presence in these markets is very crucial for AB Volvo and a lot of it will depend on the success of VECV. AB Volvo expects Asia to be its largest market by 2015 with 60% of the demand coming from India and China.JM Financial Institutional Securities Private Limited Page 12
  13. 13. Eicher Motors 30 August 2010Exhibit 17. Geographical break-up of sales of AB Volvo 100% 8 9 9 5 14 18 80% 19 21 60% 40% 20% 0% CY03 CY04 CY05 CY06 CY07 CY08 CY09 1HCY10 Europe North Americ a S outh Americ a Asia Other marketsSource: Company Volvo’s technology and Eicher’s reach, a great combination: Amongst all the recent JVs in the truck market VECV is best placed to quickly ramp up its marketshare. While AB Volvo brings in its expertise in R&D, production, sales and after sales, EIM brings a wide product portfolio, a strong reach and understanding of the market. The JV has already launched the new line of HCVs under the VE Series (Value Enhanced) which has resulted in monthly HCV volumes improving from 100 units to 300 units.Exhibit 18. Segment wise presence of all the players Key players tonnage < 3.5 3.5-5 5-7.5 7.5-12 12-16.2 16.2-25 >25 TT 26.4-35 TT > 35 AMW - - - - - - Y - Y Ashok Leyland - - Y Y Y Y Y Y Y Force Motors Y Y Y - - - - - - Hino Motors - - - - - Y - Y - M&M / Navistar Y Y Y - - - Y - - MAN Force - - - - Y Y - - Y Mercedes-Benz - - - - - - Y - - Piaggio Vehicles Y - - - - - - - - Swaraj Mazda - Y Y - - - - - Tata Motors Y Y Y Y Y Y Y Y Y VECV - - Y Y Y Y Y - YSource: Company Bridging the gap between Indian and European trucks: We expect VECV to launch a new platform of trucks priced between the existing Indian HCVs and the European trucks. The current 49tn Indian CV costs around `2mn while a European truck costs around `6mn. Launching a truck in the mid-segment will result in greater volumes, and according to us, VECV is best placed to outperform its peers here. There is a bigger scope for such development in the bus segment where AB Volvo is a synonym for luxury buses. Government’s focus on improving the quality of public transportation and network bodes very well for the luxury bus segment, especially, if prices could be made more affordable. AB Volvo bringing in the best talent and practises: AB Volvo has tapped its global network to bring in the best of the talent into VECV. The plant head deputed to VECV was handling the Nissan Diesel plant in Japan, one of the best in the world. Similarly AB Volvo executives have been deputed in areas like marketing, services, spares and quality.JM Financial Institutional Securities Private Limited Page 13
  14. 14. Eicher Motors 30 August 2010 Vision 2015: 15% of HCV market share against current 3%: The management has set itself a target to achieve atleast 15% of the HCV market share in India compared with under 3% currently. In the process, the company wants to reach the 100,000 units sales milestone compared with 25,164 units in CY09, implying a target CAGR of 26%.Exhibit 19. Management vision for 2015 50 35 Thousands 45 43 30 30 40 35 25 30 30 20 % 25 20 15 20 15 10 15 10 10 10 6 4 5 5 - 0 Bus MCV HCV 2008 2015E 2015E minimum marketshare (RHS)Source: Company Negative working capital; sales to core capital employed and net fixed assets over 7.5x: The total capital employed at the consolidated level stood at `17.8bn for CY09, of which c. `14bn was surplus cash and cash equivalent, implying capital employed (net of surplus cash) to be a mere `3.8bn. Similarly, net fixed assets stood at `3.8bn, implying a sales/net fixed assets turnover of 7.8x. VECV is not only much better placed than its peers, Tata Motors and Ashok Leyland, but is also comparable to the two wheeler players. Exhibit 20. Trend in consolidated working capital 2,400 1,526 1,600 826 906 800 Rs mn 89 0 Mar-09 Mar-10 Jun-09 Dec-08 Sep-09 Dec-09 -800 -924 -1,600 -1,347Source: CompanyJM Financial Institutional Securities Private Limited Page 14
  15. 15. Eicher Motors 30 August 2010 Royal Enfield can be a big opportunity: We believe, Royal Enfield is operating much below its potential and can surprise hugely on the upside going forward. Cult brand equity, lack of competition and successful new launches are resulting in an unprecedented demand for its bikes. Its latest offering Classic 350 and 500 have a waiting period of over 5 months. The company is in the process of ramping up production to meet demand and aims to sell 100,000 units/year by 2013 with the existing portfolio, implying a CAGR of 18% for CY09-CY13E. We expect the recent launches in the superbike segment (Kawasaki Ninja, the cheapest bike costing around `300,000) and the proposed launch of Harley Davidson (Harley) will lead to significant growth in lifestyle biking. Harley will create huge aspirational demand for lifestyle bikes but will be out of reach for many customers due to the steep prices (ranges from `0.7mn to `3.5mn). This bodes well for Royal Enfield due to its low pricing (Classic 500, the most expensive bike in the portfolio, costs around `150,000) and near Harley experience.Exhibit 21. Classic 500Source: JM Financial Expect volume CAGR of 30.5% for VECV and 17.6% for standalone: We expect VECV and standalone volumes to grow by 30% and 18% between CY09- CY11E.JM Financial Institutional Securities Private Limited Page 15
  16. 16. Eicher Motors 30 August 2010Exhibit 22. EIM growth and volumes trend 90 70 72 60 75 50 60 57 Units 000s 52 40 % 45 40 33 30 30 21 20 15 10 - 0 CY09 CY10E CY11E VECV Standalone VECV YoY Standalone YoYSource: Company, JMFinancial Revenue CAGR much higher at 35% and 31% driven by mix: We estimate VECV’s realisations to see CAGR improvement of 3.4% over CY09-CY11E driven by ramp-up in HCV business. The standalone motorcycle business is expected to grow realisations by a whopping 11.1% during the same time with the launch of Classic range. Operating profits to post CAGR of 80.8% and 60.3%: Strong volume growth, mix improvement and benefits of operating leverage will result in operating margins at VECV to improve from 5.2% in CY09 to 9.3% in CY11, translating into an operating profit growth of 80.8% to `4.3bn. On the standalone side, launch of Classic is driving stupendous mix improvement, leading to operating margins expanding from 10.3% in CY09 to 15.5% in CY11E. Here, we expect operating profit to grow by 60.3% to `1bn in CY11. Cash accretion to continue despite huge capex: We expect the current cash/share to increase from `352 to `518 in CY11 driven by strong business growth. Even in CY12, when bulk of the `2.8bn for the engine facility will be invested in VECV, the cash levels are expected to improve due to strong operational cash flow. VECV is expected to generate over `3bn of free cash flow in CY11 itself, much more than the total investment in the engine facility.JM Financial Institutional Securities Private Limited Page 16

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