Eicher Motors Q2 FY20: Weak numbers, wait for a correction to accumulate

Highlights
–  Subdued demand led to a significant decline in volumes
– Operating margins under pressure due to negative operating leverage
– Business outlook for company weak in medium term but in positive in the long run
– Advise investors to wait for weakness in stock price to accumulate for the long-term

Amid weakness in two-wheeler sales, Eicher Motors Ltd (EML) (CMP: Rs21,640; Mcap: Rs59,203 crore) posted a weak set of Q2 numbers. It reported a sharp decline in volumes and net revenue. Operating margin continued to be under pressure due to negative operating leverage (refers to fixed costs being expensed over a smaller base of sales).

Though the medium-term outlook continues to be weak, the long term outlook looks promising. That optimism is due to its dominant position in the bikes segment of engine capacity with a displacement of above 250cc, focus on the new Twin bikes and distribution network expansion. We advise investors to wait for weakness in its stock price to accumulate for the long term.

Quarter in a nutshell

Key highlights

Royal Enfield’s sales volume fell by 22.2 percent YoY. Volumes hit a speedbump due to subdued customer sentiments in two-wheeler (2W) as well as rise in total cost of ownership due to mandatory long-term insurance, and regulatory safety requirements.

Realisations, however, witnessed a significant YoY increase of 17 percent led by price increase due to ABS implementation, multiple price hikes, a favourable product mix and higher exports. Improved realisations helped Eicher arrest the fall in net revenue compared to volumes, falling by 9 percent YoY.

Royal Enfield’s Ebitda margin (earnings before interest, tax, depreciation and amortisation) declined by 557.4 bps during the quarter, attributable chiefly to negative operating leverage.

On the back of weak commercial vehicle (CV) demand in India, Volvo Eicher CV’s (VECV) performance was very poor. It saw a significant decline of 39.2 percent YoY in volumes. Realisation, however, grew by 11 percent, leading to a 32.4 percent decline in its net operating revenue. Its EBITDA margin declined by 376 bps, also due to negative operating leverage.

OutlookIndustry outlook – Sluggish in near term, positive for long term

Royald Enfield’s volumes have declined for some time now, owing to myriad challenges facing the two-wheeler industry. Factors such as an increase in the total cost of ownership, driven by mandatory long-term insurance and implementation of ABS and CBS are the main challenge. The management indicated that walk-ins are still very weak and highlighted subdued consumer sentiments.

The management indicated they have taken steps to revive demand. They are giving customers more options to choose from, and have started increasing reach in semi-urban areas through studios which are yielding positive results. In October 2019, the company saw growth in its wholesale numbers on YoY basis. Also, the management remains optimistic on the back of strong traction coming in from 650cc Twins.

In terms of VECV market, domestic commercial vehicle market continues to face challenges on the back of weakening macroeconomic environment leading to muted sentiments. The industry continues to face issues due to liquidity problems, financing challenges and slowdown in economic activity. This was aggravated by the lagged impact of new axle load norms in the CV segment.

We expect demand to remain weak  in the short term but longer term, the 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.

New products to drive volumes

Recently, the company had launched two new motorcycles – the Interceptor 650 roadster and the Continental GT 650. These launches are part of Royald Enfield’s aim to lead and expand the mid-weight (250-750cc) motorcycle segment globally.  These models have done well both in India and abroad. It also unveiled two new ‘Nought Tea GT’s’ version 2.0 at the Bike Shed Festival UK, in October 2019.  To give customers more options, it launched the Classic 350 in new colours, with single-channel ABS, which is receiving a good response from customers.

Network expansion – to target under-penetrated areas

To improve penetration further, Royald Enfield has been ramping up distribution, not just in India but also abroad. In the domestic market, the company continues to focus on distribution network. It has added dealers in new and under-penetrated areas and now has 500 small stores in Tier-2 and Tier-3 cities.

In international markets, in the quarter gone by, it added six new stores across geographies.

Valuation

After the recent rally, the stock price has risen 42 percent from its 52-week levels thereby making valuations expensive. Our sum of the parts valuation (SOTP) implies the presence of downside risk. Therefore, we advise investors to wait for weakness in the share price to accumulate and with an eye on the long term.

Risks

Upside risk is there if sustained revival in wholesale volumes is there and there is easier liquidity for the financing.

Source: Moneycontrol

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