change in stance tvsl in equity november 21, 2016...

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Get-off or go downhill TVS Motor (TVSM) had a stellar run in recent years (22% EBITDA CAGR; FY13-16) due to strong product cycle (Jupiter, Victor). Market share should stagnate from FY18 due to average franchise (high cost base, patchy launches), no major gaps in portfolio now and rising competition in scooters. In the near term, cash crunch and weak exports pose challenges. Over FY18-19, margins would improve only marginally given: 1) high cost structure and no support from pricing (weak brand); 2) high marketing spends. Small category size and Royal Enfield’s dominance imply limited potential for domestic 250-500cc bikes. Premium valuations do not factor in lower RoIC vs peers and growth moderation from FY20 as market share and margins peak.

Competitive position: MODERATE Changes to this position: NEUTRAL Limited scope for further market share gains in domestic 2Ws

We expect TVSM’s domestic motorcycle market share to stagnate from FY18 given no major product gaps now and weak franchise (high cost base, lack of innovation, patchy launches). Rising competition would hit TVSM’s market share in domestic scooters (down 184bps YoY; Apr-Oct 2016). Market share in domestic 2Ws (ex-mopeds) would improve only 15bps over FY18-19. Near term volume deceleration; margin gains to be modest

The Government’s demonetisation would moderate TVSM’s volume growth to 13.4% in 2HFY17 (vs. 23.2% in 1HFY17). We expect only modest EBITDA margin gain over FY18 (70bps to 8.2%) and FY19 (54bps to 8.8%) vs management target of double-digit by FY18-end. Our belief stems from TVSM’s high cost structure but lack of adequate pricing power and high competitive intensity that would keep marketing spends elevated. Limited volumes in domestic 250-500cc; BMW exports potential built in

Upsides to earnings from TVSM’s 250-500cc segment (~64k by FY25) will be limited given small category size, well-entrenched presence of Royal Enfield and potential competition from Bajaj, KTM and Honda. Our estimates fully capture in BMW export potential (15% net earnings accretion by FY22) as our volume projections are higher than BMW’s own expectations. Driving ahead of fundamentals; SELL

Our core business valuation (ex-BMW exports; `267 of `335 SoTP) at 15x Oct 2018 net earnings is similar to Bajaj and Hero’s multiples and TVSM’s five-year average. Current valuation of 19x FY18 net earnings implies 17% premium to peers and 25% to five-year average despite significant RoIC gap with peers and earnings growth moderation from FY20 as market share/margin gains moderate. Key risks: Commodity prices, exports recovery.

CHANGE IN STANCE TVSL IN EQUITY November 21, 2016

TVS Motor Company

SELL

Automobile

Recommendation Mcap (bn): `172/US$2.6 6M ADV (mn): `816/US$12.2 CMP: `360 TP (12 months): `335 Downside (%): 7

Flags Accounting: AMBER Predictability: AMBER Earnings Momentum: GREEN

Catalysts

EBITDA margin to moderate in 2HFY17 (53bps lower vs. QFY17) due to higher commodity prices/lower revenues.

Market share gains to moderate in FY18 (only 10bps ex-mopeds) due to rising competition in scooters and limited gains in motorcycles

Performance (%)

Source: Bloomberg, Ambit Capital Research

80100120140160

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-

16

Sep-

16

TVSM SENSEX index

Research Analysts

Ashvin Shetty, CFA

+91 22 3042 3285

[email protected]

Gaurav Khandelwal, CFA

+91 22 3042 3132

[email protected]

Ritu Modi

+91 22 3042 3292 [email protected]

Key financials (Standalone including exports to BMW)

Year to March FY15 FY16 FY17E FY18E FY19E

Net Revenues (` mn) 1,00,888 1,12,439 1,27,580 1,59,179 1,85,264

EBITDA (` mn) 6,489 7,507 9,574 13,251 16,427

Adjusted PAT (` mn) 3,997 4,385 5,925 8,248 10,395

Diluted EPS (`) 8.41 9.2 12.5 17.4 21.9

RoE (%) 26% 24% 28% 32% 33%

P/E (x) 44.0 40.1 29.7 21.3 16.9

EV/EBITDA (x) 28.5 24.6 19.3 13.9 11.2

Source: Company, Ambit Capital research

TVS Motor Company

November 21, 2016 Ambit Capital Pvt. Ltd.

Limited scope for market share gains in domestic 2Ws TVSM’s market share revival in the last three years was led by plugging key product loopholes (launch of Victor in the executive bike segment and four stroke mopeds) and capitalising on Honda’s scooter capacity shortfall (leading to Jupiter’s runaway success). Though product gaps are now largely filled, TVSM remains a relatively weak franchise (high cost structure, lack of innovation, patchy launch cycle). Hence, TVSM’s market share in domestic motorcycles would stagnate from FY18. Also, the domestic scooter segment is witnessing increased competition (especially from Honda) impacting TVSM’s market share (down 184bps YoY in April-Oct 2016. We estimate only 15bps market share gain in domestic 2Ws (ex-mopeds) over FY18/FY19 vs 270bps over FY14-17.

Market share revival was led by plugging of portfolio gaps

TVSM consistently lost market share in domestic motorcycles and scooters from FY08 to 1HFY14. This resulted in TVSM’s market share in overall domestic 2Ws (ex-mopeds) coming down from 14.6% in FY07 to 7.3% in FY14.

However, the company witnessed some revival in market share in the last three years, gaining 200bps in domestic 2Ws (excluding mopeds) over FY15 to 1HFY17. During this period, TVSM gained market share across both domestic motorcycle and scooter segments. In domestic motorcycles, TVSM’s market share improved by ~220bps led by new launches (Victor, new Star City and Apache 200). Similarly, successful response to Jupiter (launched in September 2013) meant TVSM’s market share improved from a low of 12.7% in FY14 to 15.4% in FY16. Jupiter’s success can be attributed to: (i) filling an important gap (unisex scooter) in the scooter portfolio; (ii) capitalising on Honda Activa’s supply/capacity shortfall; and (iii) strong growth momentum in the domestic scooter industry.

Exhibit 1: TVSM has witnessed some revival in market share over last three years

Source: SIAM, Ambit Capital research

However, market share could stagnate from FY18

We expect TVSM’s market share gain to continue in 2HFY17 (up 70bps YoY excluding Mopeds) as it benefits from incremental volumes from products launched at the beginning of FY17 (Victor, Apache 200). However, we build in only 10bps gain in FY18 and no market share gain thereafter. The key reasons are:

A) TVS comes across an average franchise in our IBAS framework

TVSM comes across as a relatively average franchise under our IBAS framework driven by lack of product innovations, patchy launch frequency compared to peers, and high cost structure.

0%

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35%

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 1HFY17

Motorcycle market share Scooter market share Two-wheeler (including mopeds) market share

Victor discontinued Victor re-

launched and Apache RTR 200

Apache 160 launched

Apache 180RTR launched

Star City+

l h

TVS-BMW agreement signed; Jupiter l h d

Wego launched

Scooty Zest

TVS Motor Company


Exhibit 2: TVS has moderate to weak scores on all IBAS parameters

Hero Bajaj Honda TVSM

Innovation

Brands/Reputation

Architecture

Strategic Asset

Overall

Source: Company, Ambit Capital research Note: =Strong, =Moderate and =Weak

Innovation - lacks peers’ innovative strength

a) TVS lacks innovation capabilities of peers

The Indian 2W industry has a high product concentration, with the top 5 motorcycle brands accounting for nearly 55% of the domestic motorcycle market and the top 3 scooter brands constituting 67% of the total scooter sales in the industry. We find that most of the products which have tasted success in the Indian 2W industry have been those which came in with a substantially improved technology (for instance, four stroke Splendor vs the then prevailing two stroke motorcycle) or innovative products for the market (Pulsar, Activa).

We find that TVSM has been historically slow compared to peers in introducing innovative products in the market except for low-cc female-oriented scooters in 1996. On the other side, its peers have been at the forefront of introducing innovative or technologically break-through products in the market (refer exhibit 3 below).

Exhibit 3: Key factors underpinning successful 2W brands

Brand Company Launch year

Share in overall 2W market (1HFY17)

Key success factors

Splendor Hero Honda (now Hero MotoCorp)

1994 14%

Four stroke motorcycle - high mileage compared to the existing two stroke motorcycles. Legendary brand campaign - Fill it -shut it-

forget it emphasising mileage Known for durability and longevity - high

resale value.

Activa Honda 2001 16% Pioneered gearless scooter in India

Targeted towards both male and female population.

Pulsar Bajaj 2003 3%

Created the affordable premium (150cc) bike market in India. Much more stylish and powerful compared to

then existing commuter bikes.

Classic 350 Royal Enfield 2010 2%

Substantial improvement over existing RE bikes (mileage, durability) Significant pricing gap with Harleys

Rejuvenated/grew the leisure biking segment in India.


b) Patchy launch cycle compared to peers

The company’s frequency of product introductions has lagged that of its main peers; i.e. Hero, Bajaj and Honda. This has also been one of the key reasons for TVSM’s market share getting adversely impacted historically.

TVS Motor Company


Exhibit 4: TVSM’s motorcycle launch frequency has lagged peers

Year Hero MotoCorp Bajaj Auto TVS Motor

FY12 Impulse Discover 125, Discover 150, Avenger 220 DTS-I

Apache RTR 180ABS

FY13 Ignitor, Passion X-Pro KTM Duke 200, Kawasaki Ninja 650R, Pulsar 200 NS, Discover 125 ST

Phoenix 125cc

FY14 Splendor iSmart Boxer 150

FY15 Splendor Pro Classic; Passion Pro TR Pulsar AS 200; Pulsar RS 200 TVS StaR City

FY16 Passion Pro; Xtreme Sports V 15; Pulsar AS 150; CT100; CT100B

TVS Victor; TVS Apache RTR 200

FY17 Splendor iSmart 110; Achiever 150

Total number of launches since CY05

9 14 5


c) Absolute R&D spends lower than peers

While TVSM’s R&D spends as a percentage of sales is in-line with that of domestic peers, absolute R&D spends are significantly lower. On the other hand, Honda’s global R&D spends in its motorcycle division at 4.2% of revenues for 2015 was head and shoulders above the domestic players.

Brand: Moderate to weak in key 2W segments Going by market share data, TVSM has the lowest brand presence in domestic motorcycles. In the domestic scooters space, TVSM is the third-largest player but has significantly lower market share than market leader Honda. Both these sub-segments account for nearly 77% of total domestic 2W industry by value size. On the other hand, TVSM’s franchise strength is the strongest in those sub-segments where the market value size is relatively smaller, for instance mopeds. 150-200cc premium bike is the only sub-segment where both TVSM’s market share and segment value size are both respectable levels.

Exhibit 5: TVSM is strongest in sub-segments with relatively low market size

Source: Ambit Capital research, Company. Size of the bubble represents segment value

Architecture: High cost base a big disadvantage A comparative common-size analysis of the income statement indicates that Bajaj Auto has the lowest cost base in the industry (amongst top players) while TVSM has the highest. This enables Bajaj to price its products cheaper in the industry. Similarly, while TVSM has the highest cost base, we have not seen any significant cost reduction measures forthcoming from the company. Some of it peers have embarked on aggressive cost reduction measures. For instance, Hero has implemented a margin transformation program (known as ‘Leap’ since May 2013 involving cost savings across material costs, outbound logistics, marketing expenditure etc. This program resulted in cost savings to the tune of `2.6bn (0.90% of sales) for Hero in FY16. We believe a high cost base is a big disadvantage for TVSM especially in a rising competitive environment.

0 1 2 3 4 5 6

TVSM

's' f

ran

chis

e s

tren

gth

TVSM’s absolute R&D spends lag that of peers

FY2016 R&D

expense (` bn)

R&D expense as a % of revenue

TVS Motor 2.3 1.8% Hero MotoCorp* 10.4 3.6%

Bajaj Auto 3.3 1.4% Honda 2W (Globally)^ 48.4 4.2%

Source: Ambit Capital research, Company. Note: ^for Honda R&D spend of CY2015 has been considered. *Hero MotoCorp R&D expenditure includes expenditure on Jaipur R&D center commissioned in CY2016.

Strong

Weak

? Moderate

TVSM’s strong franchise has the lowest market size

TVSM has moderate to weak franchise in biggest segments

TVS Motor Company


Exhibit 6: Bajaj has the lowest cost base; TVSM has the highest

As % of net revenues TVSM Bajaj Auto Hero MotoCorp TVSM cost as against average cost of

Bajaj Auto and Hero MotoCorp

FY14 FY15 FY16 FY14 FY15 FY16 FY14 FY15 FY16E FY14 FY15 FY16E

Raw material costs 71.3% 72.3% 71.4% 68.2% 68.1% 65.9% 72.1% 71.6% 67.5% 1.1% 2.5% 4.7%

Employee expenses 6.0% 5.8% 5.9% 3.6% 3.9% 4.0% 3.7% 4.3% 4.6% 2.4% 1.7% 1.6%

Power & fuel 1.0% 0.9% 0.8% 0.5% 0.5% 0.5% 0.5% 0.6% 0.4% 0.5% 0.4% 0.3%

Advertising/marketing 6.8% 5.6% 6.4% 1.4% 1.6% 1.9% 2.0% 2.4% 2.5% 5.1% 3.6% 4.1%

Packing & freight 3.8% 4.1% 3.6% 1.6% 1.8% 1.5% 2.9% 3.1% 3.0% 1.6% 1.6% 1.3%

R&D expenses 1.4% 1.4% 1.4% 0.6% 0.7% 0.7% 0.4% 0.5% 1.0% 0.9% 0.9% 0.6%

Others 3.8% 4.0% 3.9% 6.6% 3.1% 3.8% 9.6% 4.7% 5.3% -4.3% 0.1% -0.7%

EBITDA margin 6.0% 5.9% 6.7% 21.6% 20.3% 21.7% 14.0% 12.8% 15.5% -11.8% -10.7% -11.9%


Strategic assets: Not much difference between players

Having a widespread sales and service network is certainly an advantage for a company, especially in the rural areas and for the economy/executive bike segments. While Hero has a definite edge over peers in terms of distribution/service network, there is no significant gap between the top four players in terms of distribution/service (unlike significant divergence that we find in case of Maruti and other players in the domestic passenger vehicle industry).

Exhibit 7: Hero has the largest number of dealer outlets, but Honda’s not far behind

Player No. of touch points No. of dealers

Hero MotoCorp 6,000+ 800

Bajaj Auto 4,000 675

Honda 4,800 768

TVSM 3,000 900


B) What next? Product portfolio gaps now largely filled in motorcycles

TVSM has had a strong product launch cycle in domestic motorcycles over the last two years. The launch of new Star City with better/more features and new colour offerings in Apache 160/180 cc helped market share gains in FY15 and FY16 (~120bps). In FY17, TVSM had two major offerings, viz. Victor in the highest volume executive motorcycle segment and Apache 200 in the premium motorcycle space. Both these launches accelerated market share gains to 8% in April-October 2016 (up 115bps YoY). However, with these launches, TVSM has now filled key portfolio gaps across economy, executive and premium segments (<250cc). With competition remaining intense in motorcycles (peers launching new motorcycles consistently) and low hanging fruits in product launches captured, market share gains in domestic motorcycles from FY18 will be limited.

C) Rising competition in scooters

Since April 2016, TVSM’s market share in domestic scooters has witnessed moderation, declining by 184bps YoY to 13.5% in April-October 2016. As a result, TVSM’s domestic scooter volume growth has moderated to 9% YoY and significantly lagged industry’s 24% growth. Our channel checks suggest that TVSM’s market share has been impacted by increased availability of Honda Activa (after commissioning of Honda’s Gujarat plant) and, to a lesser extent, from Hero’s new scooter launches (Maestro Edge and Duet). With rising competitive intensity in domestic scooters due to Honda’s renewed focus on the segment and both Yamaha and Hero also targeting the space in a big way, TVSM’s market share would remain under pressure. As a result, we estimate market share of 13.9% for FY18 and FY19 (a decline of ~142bps over FY16 levels.

With Victor and Apache 200 launches, TVSM has now filled key portfolio gaps across economy, executive and premium segments (<250cc)

With rising competitive intensity in domestic scooters from Honda’s refocus; and both Yamaha and Hero targeting the space in a big way, we estimate TVSM’s market share would remain under pressure.

TVS Motor Company


D) Moped segment to witness structural decline

TVSM is the only player now in mopeds as other players such as Bajaj Auto exited the segment in the last decade on account of the segment’s flagging volumes. The share of mopeds in the domestic 2W space has been consistently declining from 6% in FY10 to 4.4% in FY16 (volume CAGR of 4%). However, TVSM recently launched four stroke moped in January 2016, which has led to some demand rejuvenation. The segment’s volumes grew by 28% YoY in April-October 2016. However, our channel checks as well as interaction with the industry experts suggest this growth rate is unlikely to sustain as base effect catches up in FY18 and rising options in entry-level motorcycles pose headwinds to category growth. As a result, after factoring in 24% growth in FY17 (up 28% in April-October 2016), we expect only 6% growth in FY18 and 4% in FY19.

Market share gains to be limited in FY18/19

As discussed, we expect TVS market share in motorcycles to stagnate in FY18 due to limited product gaps/continuing high competitive intensity. In scooters, we see market share to remain under pressure due to rising focus of Honda and other players on the segment. As a result, we expect TVSM’s market share in domestic 2Ws (excluding mopeds) to witness only 20bps increase in FY18 (vs. 260bps over FY14-17). In fact, due to declining share of mopeds, we expect TVSM’s market share may witness a decline in FY19 (by 10bps).

Exhibit 8: We expect TVSM’s market share gains to moderate from FY18

Market share FY15 FY16 FY17E FY18E FY19E

Motorcycle 6.2% 6.7% 7.9% 8.0% 8.0%

Scooters 15.2% 15.4% 13.9% 13.9% 13.9%

Mopeds 100.0% 100.0% 100.0% 100.0% 100.0%

Domestic 2Ws 15.2% 15.6% 16.4% 16.5% 16.3%


Our channel checks as well as the interactions with the industry experts suggest moped segment would structurally exhibit weak growth as increasing options in the entry level motorcycles poses headwinds to its growth.

TVS Motor Company


Demand growth to decelerate in 2HFY17; build in modest margin improvement We expect significant impact on near-term volumes (Nov-Dec 2016 domestic industry volumes down 18% YoY) due to cash crunch arising from the recent demonetisation move by Indian Government. Despite 17% growth in revenues and benign commodity prices, TVSM witnessed limited EBITDA margin improvement in 1HFY17 (up 20bps YoY). We see only modest EBITDA margin gains over FY18 (by 70bps to 8.2%) and FY19 (54bps to 8.8%), versus management target of a double-digit gain by FY18-end. Our belief stems from TVSM’s high cost structure but lack of adequate pricing power and high competitive intensity which would keep marketing spends elevated.

We expect TVSM’s volume growth to decelerate to 13% in 2HFY17 (vs 23% in 1HFY17) Domestic 2W Industry demand to be impacted by cash crunch

Around 60-65% of domestic 2Ws are bought with cash. This ratio is particularly high in rural areas. As a result, the recent Government decision of banning the old `500/1,000 notes could impact cash availability and thereby demand, particularly in November and December 2016. Feedback from our dealer interaction indicates demand could decline by 25-30% YoY in Nov-Dec 2016 before somewhat normalising in 4QFY17. So, we now expect domestic 2W industry volumes (including mopeds) to grow at a muted 2% YoY over Nov-Mar 2017 compared to around 16% growth in Apr-Oct 2016. This implies that our FY17 domestic Motorcycle industry volumes are downgraded by 3%.

Exhibit 9: TVSM’s volumes would get impacted in 2HFY17 because of cash crunch

Particulars FY16 1HFY17 2HFY17 FY17 FY18

Domestic Motorcycle industry growth 0% 13% 1% 7% 10%

TVS Motorcycle market share 6.7% 7.7% 8.1% 7.9% 8.0%

TVS Motorcycle volumes growth 7% 33% 20% 26% 12%

Domestic Scooter industry growth 12% 27% 6% 16% 15%

TVS Scooter market share 15.4% 13.1% 14.8% 13.9% 13.9%

TVS Scooter volumes growth 13% 11% 1% 5% 15%

Domestic two-wheeler (ex-moped) industry growth 3% 17% 2% 10% 12%

TVS two-wheeler (ex-moped)market share 9.4% 9.5% 10.4% 9.9% 10.1%

TVS two-wheeler (ex-moped)volumes growth 10% 22% 10% 15% 13%

Domestic Moped industry growth -4% 26% 22% 24% 6%

TVS Moped market share 100.0% 100.0% 100.0% 100.0% 100.0%

TVS Moped volumes growth -4% 26% 22% 24% 6%

Domestic two-wheeler (incl. moped) industry growth 3% 18% 3% 10% 11%

TVS two-wheeler (incl. moped)market share 13.4% 13.7% 15.1% 14.4% 14.3%

TVS two-wheeler (incl. moped)volumes growth 5% 23% 13% 18% 11%


Export markets continue to be challenging for TVSM/industry

Demand in key export markets continue to be weak due to sharp currency depreciation and restricted availability of foreign exchange. While TVSM’s 2W export volumes declined by 12% in 1HFY17, the decline has been sharper for 3W volumes at 45%. The management commentary from both TVSM and Bajaj Auto indicates that demand remains uncertain in the key export markets at least for the next six months owing to issues surrounding foreign currency availability and macro headwinds from lower crude oil prices. As a result, we expect the aggregate volumes of export 2Ws and 3Ws to witness flat volumes YoY over November-March 2017.

Our dealer interactions indicate that demand could decline by 25-30% in November-December 2016 due to cash crunch

TVS Motor Company


Limited margin improvement; large gap with peers to persist

TVSM’s margin has witnessed only limited gains (up 20bps YoY) despite strong revenue growth and benign RM prices: TVSM’s EBITDA margin expansion was limited in FY16 (6.8% up from 6.1% in FY15); margin gains accelerated in 1HFY17 with EBITDA margin at 7.6%, up 80bps YoY. A significant part of this margin gain was due to changes in accounting arising from IND-AS adoption. On a like-a-like comparison with the restated accounts of 1HFY16, the EBITDA margin is up only 20bps YoY. While RM costs as a percentage of sales moderated by only 10bps, ‘other expenses' declined just 10bps despite strong revenue growth of 17%.

We build in only limited margin improvement over FY17-19

We build in EBITDA margin of 7.5% for 2HFY17, which is similar to 7.5% for 1HFY17 but down from 8.1% in 2QFY17. This moderation is due to lower revenue growth and higher raw material costs. For FY18 and FY19, we build in a further improvement of ~70bps (to 8.2%) and 54bps (to 8.8%) respectively on the back of operating leverage benefits from revenue growth (15% CAGR over FY17-19). While we have built in margin improvement, it is significantly lower than the management target of double-digit EBITDA margin by 4QFY18. Key reasons slower improvement in margin and large gap with peers:

A high cost structure but no commensurate pricing power

A comparative common-size analysis of income statement indicates that Bajaj Auto has the lowest-cost base in the industry (amongst top players) while TVSM has the highest (exhibit 6 on page 5). At the same time, TVSM’s higher costs are not recovered through any pricing advantage over peers. This is unlike Hero MotoCorp, which is able to price its bike Splendor (~10% premium) much above similar bikes of peers. To some extent, this is on account of the weaker brands of TVSM. As a result, TVSM neither commands the lowest cost structure of Bajaj Auto nor does it enjoy the pricing power of Hero MotoCorp.

Exhibit 10: Hero’s splendor brands commands ~10% pricing premium vs. peers

Model Hero MotoCorp Bajaj Auto TVS Motor

Splendor Pro Platina Sport City+

Engine capacity (cc) 100 100 110

FY16 volumes (mn units ) 2.5 0.28 0.23

Price (`) (on-road Delhi) 54,789 47,471 50,233


Advertising/promotion spends to remain elevated

TVSM’s advertisement and promotion spends totaled ~6.4% of revenues in FY16 (vs 5.6% in FY15). This is significantly higher compared to that of the peers Bajaj Auto (1.9%) and Hero MotoCorp (2.5%). TVSM’s marketing spends are higher even after adjusting for lower sales volumes compared to the above peers. The key reason for this is weaker brand positioning which necessitates higher spends. Furthermore, rising competitive intensity will keep marketing expenses elevated. As a result, while we build in a moderation in advertisement/promotion spends (due to operating leverage); we do not expect it to go down significantly as a percentage of sales and remain much higher than the peers.

Exhibit 11: Are TVSM’s higher marketing spends due to weaker brand perception?

As a % of sales Advertisement Other Marketing Total Remarks

FY13 2.8% 3.6% 6.4% FY14 3.5% 3.3% 6.8% FY15 2.5% 3.0% 5.6%

FY16 2.8% 3.5% 6.4%

FY16 advertisement and marketing expenditure includes one-off expenditure related to auto expo and dealer conferences at ~`550mn or 0.5% of sales.

FY17E 2.4% 2.9% 5.3% FY18E 2.2% 2.8% 5.0% FY19E 2.1% 2.6% 4.7% Source: Company, Ambit Capital research

TVS Motor Company


Limited volumes in domestic 250-500cc segment; BMW exports factored in Given RE’s success and technological association with a strong brand like BMW, investors are expecting a long runway of growth for TVSM. However, our analysis suggests domestic 250-500cc segment is unlikely to contribute meaningfully to TVSM’s volumes (3% by FY2025) given small category share (2.1 mn units by FY2025), well-entrenched presence of Royal Enfield (which will continue to dominate, leaving little room for non-RE players) and potential competition from players like Bajaj Auto, Honda and KTM which are also vying for the space. We are already building in BMW export benefits in our estimates, yielding 15% net earnings accretion by FY22.

Limited volumes for TVSM in domestic 250-500 cc segment Domestic 250-500 cc bike segment, sans Royal Enfield, is negligible with limited volumes/successes

Excluding RE, volumes of this segment stood at only 9k units in FY16 with one model, Bajaj KTM Duke 390, accounting for 7.1k units. Moreover, over the last four years, players such as Mahindra, Yamaha and Kawasaki have launched products in 250-500cc motorcycle segment. However, none of these players have been able to cross volumes of more than 1k units in any year.

RE’s success in this segment will be difficult to replicate

Within the 250-500 cc sub-segment, RE has witnessed stupendous success in the last 6-7 years with its volumes increasing from a mere 50K units in CY10 to 307k units by 1HFY17. However, RE’s success has been driven by a combination of several factors (discussed below) which we believe would be difficult to replicate. While these factors are now generally well known, we touch upon the same briefly below:

Highly differentiated brand with cult/legacy: RE has a long standing history in India and has developed a cult following over the years given its dominant presence on the roads (retro styling, thud), usage by the Indian Army and strong heritage associated with Himalayan rides. While the brand tasted limited success over a large part of its history, it has found widespread acceptability in the recent years helped by significant product improvement (such as introduction of unit construction engine which generates more power and consumes less fuel) and introduction of Classic 350.

Social perks of owning an RE: An important part of owning an RE is the access it gives to bike riding and other social clubs. Over the years, this has become one of the biggest selling propositions for RE, something which Harley Davidson created in North America.

Strong pull created by rival brands: The entry of global leisure motorcycle makers like Harley Davidson and Triumph amongst others raised the interest levels for leisure biking in India. But at the same time, the price points of these motorcycles rendered them unaffordable to vast majority of the consumers. This also helped create demand for the more affordable RE bikes.

Potential competition from Honda, Bajaj, KTM and others in mid-segment

TVSM will have to contend with other players trying to enter or increase their focus in this segment. The first to enter would be Bajaj Auto through a 400 cc bike in January 2017. KTM continues to focus on the segment with its new 390cc bike, likely to be introduced in CY2017. While Honda and Yamaha are currently not focusing on this segment, these players have strong global premium portfolio which can be adapted to and introduced in India. Possibility of Harley Davidson and Ducati introducing mid-segment bikes cannot be ruled out. For instance, in 2014, Harley Davidson launched its Street750 Motorcycle (750cc, `542k ex-showroom Delhi), which was around 40% cheaper in comparison to its then cheapest model Iron 883 (883cc, `885k ex-showroom Delhi).

Excluding Royal Enfield, 250-500cc is non-existent in India

Source: Ambit Capital research, SIAM

TVS to contend with Honda and KTM in 250-500 cc motorcycles; latter have well-priced products and strong brands

Model CC ` in '000

Mahindra MOJO 295 177

Honda CBR 250R 250 178

Kawasaki Ninja 300 296 403

KTM 390 Duke 373 403

KTM RC390 373 237

Source: Ambit Capital research, Company

Bajaj, KTM and Honda will also vie for market share in mid-segment bikes

0%

1%

2%

3%

0

5

10

FY14 FY15 FY16 Ytd- Sep2016

Non-RE >250-500cc volumes (in '000)Share in >250-500cc segment

TVS Motor Company


Exhibit 12: Recent move by the peers in the 250-500c sub-segment

Bajaj Bajaj would be launching a 400c bike in the 250-500ccc segment in 2HFY17. Further, it would be upgrading the whole range of Pulsar motorcycles in Q4FY17.

KTM KTM unveiled 2017 version of 390 Duke at the EICMA motorcycle show in Milan. The new range has reworked body/design, with aggressive styling inspired by the Super Duke. It will be launched in CY17.


Lack of BMW co-branding makes a difference

As per our interaction with management, the TVS variant of the jointly developed bikes would not carry any branding of BMW (also corroborated by the concept bike showcased in Delhi Auto Expo). BMW branding could have lent significant aspirational value to the bike.

250-500cc domestic segment to contribute only 3% of TVSM volumes by FY25

We estimate that the ‘150cc and above’ segment’s penetration is 25% amongst households with income of `500k p.a. and above. We forecast a similar penetration for the 250cc and above segment by FY25, resulting in an 18% volume CAGR over FY16-25. We estimate that RE would grow at 17% CAGR over FY16-25. This would leave only ~303K units for the non-RE players in this segment. In line with its current market share in the 150-200 cc segment, we build in ~20% market share for TVSM (ex-RE) to arrive at 64k units for TVSM in the 250-500 cc segment by FY25. Thus, the domestic 250-500cc segment would contribute only 3% of TVSM’s total volumes by FY25.

Exhibit 13: Domestic 250-500 cc motorcycles unlikely to be a big contributor to TVSM volumes

(No. of units) FY18 FY20 FY25

250-500cc industry volumes (excluding Royal Enfield) 87,000 1,20,233 3,02,910

TVS volumes in 250-500 cc segment 24,000 31,740 63,840

TVS market share in 250-500 cc segment 27.6% 26.4% 21.1%

250-500cc segment contribution to TVSM’s total volumes 2.4% 2.6% 3.3%

Source: Ambit Capital research, SIAM

Exports to BMW – more than adequately built into our estimates We have already built in benefits from exports of 250-500cc motorcycles to BMW Motoradd in our estimates for TVSM. These estimates are worked out as below:

Globally, the mid-segment market is close to 1.2 mn units and is dominated by Royal Enfield with about 40% market share (other players being KTM, Honda, Yamaha). Led by increasing volumes of RE, increasing focus of BMW, KTM and other players, we estimate this segment’s volumes to double (2.4 mn units) by FY22 (implying CAGR of 13% over FY15-22).

BMW currently has around 14% market share in the >500cc motorcycle market (1.0mn units). We estimate that BMW can capture around 7% market share in the <500cc motorcycle segment by FY22 (lower market share than in >500cc segment due to competition from players like Royal Enfield). Consequently, we expect BMW Motoradd’s sales in the <500cc motorcycle segment to touch around 162k units by FY22 as it introduces a series of products in this category.

Overall, this will lead to 162k units for BMW by FY22. This is equal to the BMW’s current volumes in the >650cc category.

We estimate exports to BMW exports would contribute 15% to TVSM’s net earnings by FY22

http://www.carandbike.com/ktm-bikes

http://www.carandbike.com/ktm-bikes/390-duke

TVS Motor Company


Exhibit 14: TVSM’ exports to BMW – key estimates

FY18 FY19 FY20 FY21 FY22

Volumes (units) 50,000 80,000 110,000 137,500 162,250

YoY 60% 38% 25% 18%

Average selling price (`) 200,000 202,000 204,020 206,060 208,121

YoY 1% 1% 1% 1%

Revenues (` mn) 10,000 16,160 22,442 28,333 33,768

YoY 62% 39% 26% 19%

EBITDA (` mn) 1,000 1,616 2,244 2,833 3,377

EBITDA margin 10.0% 10.0% 10.0% 10.0% 10.0%

EBITDA (`/bike) 20,000 20,200 20,402 20,606 20,812

Post-tax profit (` mn) 750 1,212 1,683 2,125 2,533

Contribution to TVSM’s net earnings 9% 12% 13% 14% 15%

Source: Ambit Capital research

Can BMW exports surprise? We think not

BMW Motoradd’s 2020 target implies lower volumes than our expectations

BMW has targeted ~200k volumes by FY20. Even if BMW’s>500cc segment volumes remain at 1HCY16 levels (annualised), the 2020 target implies volumes of 39k units in the sub-500cc segment. This is in fact lower than 137k units that we have built in our TVSM estimates for FY2021 as shown in exhibit above.

China unlikely to be a big market for BMW’s sub500 cc bikes

The >250cc motorcycle market in China is very small with annual volumes of 610k units in FY13. This is just 7% of the overall ICE motorcycle market volume and 1% of the total two-wheeler market in China (including Electric Vehicle). Moreover, BMW’s market share is relatively low with volumes of only 2.4k units in 1HCY2016 (<1% market share). As a result, we do not expect significant volumes for BMW’s mid-segment bikes in China.

TVS Motor Company


Key assumptions and changes in estimates We downgrade our domestic 2W industry volumes for FY17/FY18 by 3%. But this is offset by upgrades to scooter and moped industry volumes (recent better-than-expected volume trends more than offset demonetisation impact). Also, TVSM’s market share performance in domestic motorcycles has beaten our expectations. So, we upgrade our domestic 2W volume forecasts for TVSM for FY17 by 1%. However, weaker export volume trends and muted outlook make us downgrade export volume estimates for FY17/FY18 by 4/8%, resulting in marginal downgrades to total volume estimates. This, along with weaker product mix (lower share of export 3Ws), result in 2% downgrade to FY17/FY18 revenues. At EBITDA level, our estimates are unchanged as better-than-expected 2QFY17 performance offsets revenue downgrade. This, together with higher ‘other income’ in recent quarters, results in small upgrades at the net earnings level.

Exhibit 15: Key assumptions and estimates (ex-BMW exports)

Particulars FY16 FY17E FY18E Remarks

Volumes

Motorcycles (domestic) volume growth 7% 26% 12%

FY17E growth led by market share gains arising from new launches (Victor, Apache 200) and industry volume recovery (up 7% vs. 0% in FY16). We expect volume growth to taper down in FY18 as market share stagnates.

Motorcycles (exports) volume growth 4% -4% 20%

We expect tepid export performance in FY17 due to macroeconomic challenges at TVS’ key export destinations. FY18 export volume growth to benefit from low base of FY17.

Scooters (domestic + exports) volume growth 15% 6% 17%

Scooter volume growth in FY17 impacted by market share losses arising from increased availability of Honda Activa (after commissioning of its Gujarat plant in February 2016).

Mopeds (domestic + exports) volume growth -3% 24% 6% Moped volumes in FY17 are expected to benefit from good response to four-

stroke mopeds launched in January 2016.

3Ws (dom. + exports) volume growth 2% -35% 35%

Export 3W volume in FY17 is expected to be weak on account of macro-economic challenges in key export destinations. Volume growth to recover in FY18 helped to a significant extent by low FY17 base

Total volumes 5% 14% 13%

Income statement

Revenues (` mn) 1,12,439 1,27,580 1,49,179 We expect revenue to witness 14% CAGR over FY16-18E led by volume growth. YoY growth 11% 13% 17%

EBITDA (` mn) 7,507 9,574 12,251 EBITDA margin improvement in FY17 on account of lower commodity prices and lower marketing spends (FY16 had one-offs). We expect modest improvement in FY18 arising from operating leverage benefits. EBITDA margin 6.7% 7.5% 8.2%

Adjusted PAT (` mn) 4,385 5,925 7,498 We expect interest costs to moderate on the back of reduction in debt levels. As a result, the net earnings growth is likely to be higher than the EBITDA growth.

Adjusted PAT margin 3.9% 4.6% 5.0%

Adjusted EPS (`) 9.2 12.5 15.8

Adjusted EPS YoY growth 10% 35% 27%

Balance sheet

Work cap days (ex-cash) – closing 4 4 4

Working capital levels is expected to largely remain stable over FY16-18. Work cap days (ex-cash) – average 8 4 4

CFO (` mn) 8,457 7,422 9,226 CFO generation in line with EBITDA performance. CFO in FY16 benefited from decline in ‘short term loans and advances’.

Capex (` mn) 3,984 3,827 4,475 Capex estimate in line with the management guidance.

Inv. in Indonesia and other entities (Gross, before sale of investments)

1,670 1,250 - We expect fund infusion of `750mn into TVS Motor services and `500mn in TVS Indonesia in FY17. No fund infusion thereafter.

FCF (` mn) (ex-sale of investments) 2,804 2,346 4,750 Stable capex and lower investments to result in healthier FCF generation in

FY18.

Net debt (` mn) 8,916 5,362 1,619 We expect net debt levels to come down in FY17E and FY18E on the back of positive FCF generation


TVS Motor Company


Exhibit 16: Change in estimates (ex BMW exports)

Particulars New estimates Old estimates Change (%, bps)

Remarks FY17E FY18E FY17E FY18E FY17E FY18E

Volumes Domestic 2Ws (‘000 units) 2,610 2,891 2,578 2,888 1% 0% Downgrade to domestic motorcycle industry volume

estimate (due to currency demonetisation) is offset by (i) higher than expected moped volumes in 1HFY17; and (ii) Higher than expected market share in motorcycle in recent months. This results in marginal upgrades to our FY17 domestic 2W volume estimates.

YoY growth 18% 11% 17% 12% 144 (125)

Export 2Ws (‘000 units) 359 441 370 472 -3% -7% Exports volumes continue to remain sluggish due to macro-economic challenges in TVSM’s key export destinations (mainly Africa). As a result, we have downgraded our FY17/18 export volume estimates.

YoY growth 0% 23% 3% 28% (318) (454)

3Ws (Domestic +Exports) (‘000 units) 72 98 86 109 -16% -11% Similarly, muted performance in recent months and

sluggish outlook make us downgrade our 3W export volume estimates. YoY growth -35% 35% -22% 27% (1,231) 782

Total volumes (‘000 units) 3,041 3,430 3,034 3,469 0% -1% Overall, our FY17 volumes estimates remain

unchanged and FY18 volume estimates get downgraded marginally. YoY growth 14% 13% 13% 14% 26 (155)

Income statement

Revenues (` mn) 1,27,580 1,49,179 1,29,867 1,51,818 -2% -2% Revenue downgrade arising from weaker product mix (lower share of 3Ws). YoY growth 13% 17% 15% 18% (203) (151)

EBITDA (` mn) 9,574 12,251 9,576 12,254 0% 0% No changes to EBITDA despite revenue downgrades – due to higher than expected margin performance in 2QFY17. EBITDA margin 7.5% 8.2% 7.4% 8.1% 13 14

PBT (` mn) 7,900 10,272 7,439 10,079 6% 2% We have revised upward our other income estimates and revised downwards our tax rate estimates in-line with recent quarterly estimates. This results in our PAT estimates for FY17/FY18 getting upgraded by 8%/2%.

PAT (` mn) 5,925 7,498 5,468 7,370 8% 2%


Exhibit 17: Ambit vs consensus (ex-BMW exports)

Particulars Ambit Consensus Divergence Comments

Revenues (` mn)

FY17E 1,27,580 1,29,990 -2%

Our estimates for FY17/FY18 are marginally lower than consensus as we factor in near term weakness in demand arising from government’s currency demonetisation move.

FY18E 1,49,179 1,49,279 0%

FY19E 1,69,104 1,68,175 1%

EBITDA (` mn)

FY17E 9,547 9,997 -4%

FY18E 12,251 12,608 -3%

FY19E 14,811 15,091 -1%

EPS (`)

FY17E 12.5 12.8 -2%

FY18E 15.8 16.7 -6%

FY19E 19.3 20.3 -5%


TVS Motor Company


Valuations at premium to better peers We marginally upgrade our SOTP-based valuation by 2% to `335/TVSM share. The valuation (`267/share) implied for the core standalone business (ex-BMW exports) is 15x October 2018 net earnings, in-line with the multiples commanded by Bajaj Auto and Hero MotoCorp and TVSM’s own five-year historical average. The current FY18 valuation for the core standalone business at 16.7x is at a 5% premium to peers and 20% premium to its own past five-year average. This appears expensive given significant RoIC gap with peers and difference in earnings growth (to peers) to close from FY20 as TVSM’s market share and margin gains peak. Limited scope of surprises and gradual appreciation of limited opportunity from BMW exports will bring down multiples.

Standalone core business (ex-BMW) upgraded by 1% to `267/TVSM share

As discussed earlier, we maintain our earlier estimates for FY17/FY18 EBITDA. Net earnings, on the other hand, are upgraded by 2-8% due to higher ‘other income’ as per recent quarterly trends. Using a WACC of 15% and terminal growth of 5%, our revised DCF-based valuation for the standalone business (November 2017) is `267/share, 1% higher than our last published estimates. The increase in the valuation is mainly on account of roll-forward of DCF to November 1, 2017 (instead of September 1, 2016 earlier). The revised valuation implies 9.6x October 2018 EBITDA and 15x October 2018 net earnings.

Exhibit 18: FCF profile


Exhibit 19: DCF assumptions [` mn]

Present value of cash flows 62,579

Present value of Terminal Value 69,537

Total Enterprise value 1,32,116

Less: Net debt of standalone entity 5,372

Value to Equity 1,26,744

Fully Diluted equity shares 475

Fair value per dil. Share for standalone business 267


Our valuation implies similar multiples as peers with TVSM’s higher earnings growth offset by its lower return ratios

Our implied multiple for TVSM is 14.9x October 2018 net earnings. This is somewhat similar (only marginal discount) to the valuation multiples implied by our target prices for Hero MotoCorp and Bajaj Auto.

a) Over FY19-27, we expect TVSM to record EBITDA CAGR of 12%. This is higher than 8%/9% we build in for Hero MotoCorp and Bajaj Auto. We have not built in any market share gain for TVSM post FY18 and no margin gain post FY2020. The higher net earnings CAGR for TVSM is driven by favourable industry trends, i.e. higher growth in scooters which helps TVSM (given higher volume contribution from this segment at 31% of total volumes) compared to both Hero (13% contribution to total volumes) and Bajaj Auto (no presence). These favourable industry trends for TVSM also negate the impact of TVSM’s weaker franchise compared to Hero/Bajaj.

b) Our FY20-27 average RoE for TVSM at 25% lags Hero (30%) and Bajaj (33%). This somewhat offsets the earnings growth advantage of TVSM. At the same time, higher RoE does not bring in much valuation advantage for Hero/Bajaj given limited reinvestment opportunities as well as low capital intensity of the business (average FY16 P/B of Hero and Bajaj stands at 6.7x).

10%

15%

20%

25%

30%

35%

40%

45%

2,000 2,500 3,000 3,500 4,000 4,500 5,000 5,500 6,000 6,500 7,000 7,500 8,000

FY17

E

FY18

E

FY19

E

FY20

E

FY21

E

FY22

E

FY23

E

FY24

E

FY25

E

FY26

E

PVFF (LHS) (Rs mn) WACC (RHS) RoIC

TVS Motor Company


Exhibit 20: Our implied valuation for TVSM is at a marginal discount to peers

Particulars Average RoE Earnings CAGR

Implied multiple FY20-27 FY19-27

TVSM (standalone, ex-BMW) 25% 12% 14.9

Hero (standalone) 30% 8% 15.2

Bajaj (standalone) 33% 9% 15.4

Average Hero + Bajaj 32% 9% 15.3


No capital allocation in unrelated business since FY13; but TVS Indonesia continues be a drag

The company has stopped investing in unrelated businesses (not related to 2Ws such as housing and energy) since FY12. The investments since FY13 have been restricted to its Indonesian subsidiary and the 2W financing business (TVS Motor Services). Of this, while the financing entity is a profitable business, Indonesia has been a drag. It has recorded EBITDA loss of `442mn in FY16. However, in the recent 2QFY17 results conference call, management indicated that the Indonesian subsidiary has recorded an improvement in performance in 1HFY17, with its volumes growing by 55% YoY and EBITDA losses coming down sharply. We do not assign any value to TVSM’s investments into Indonesian 2W subsidiary (discussed in a later section).

Exhibit 21: Indonesian operations continues to be loss-making and funded from cash generated from Indian business

Particulars (` mn) Related/ unrelated

Equity stake held

Book value of Investments PBT

FY14 FY15 FY16 FY17E FY16

Indonesian 2W venture (TVS Motor Co. (Europe) B.V. + TVS Motor (Singapore) Pte. Ltd. + PT. TVS Motor Co. Indonesia)

Related 100% 5,240 5,490 6,179 6,679 (716)

Less: Impairment provision (1,247) (1,247) (1,247) (1,247)

Net Book value 3,993 4,242 4,932 5,432 (716)

Energy ventures

TVS Energy Ltd. Unrelated 5% 33 33 33 33 (1)*

Housing ventures

TVS Housing Ltd. Unrelated 100% 1 1 1 1 7

Emerald Haven Realty Ltd. Unrelated 49% 400 400 400 400 247*

Net Book value 401 401 401 401

Auto component ventures

Sundaram Auto Comp. Ltd. Related 100% 609 609 609 609 422

Engine technology

Pinnacle Engines Inc., USA Unrelated 117 117 117 117 NA

Net Book value 5,152 5,401 6,092 6,592 NA

Net Book value Per TVSM share 11 11 13 14 NA

As % of standalone net worth 36% 33% 31% 29%

Source: MCA21, Company, Ambit Capital research. * represents PBT for the year ended March 2015 (FY15)

Exports to BMW valued at `54/share

As discussed in earlier sections, we build in benefits from the TVS-BMW tie-up in our estimates for TVSM. We expect BMW Motoradd’s <500cc bike sales to touch 162k units by FY22. We build in an average realisation/bike of `200k for TVS exports to BMW and an EBITDA margin of 10%. The total investments made by TVSM towards BMW are close to Euro20mn, which is captured in our capex estimates for the standalone business. Using a WACC of 15% and terminal growth of 4%, our DCF-based valuation for the TVSM’s exports to BMW (November 1, 2017) is `54/share, implying 15x FY20 net earnings, in line with our last published valuation estimates.

TVS Motor Company


TVS Motor Services (`13/share vs `11 earlier) and Sundaram Auto Components (`1/share)

TVSM has infused `1bn in TVS Motor Services in FY16. We expect further fund infusion of `0.75 bn in FY17, which would result in cumulative investment of `6.2bn as at FY17-end. We do not expect any further infusion into TVS Motor Services. Given TVS Motor Services is profitable, we assign a valuation of 1x end-FY17 book value to the equity investment made by TVSM in TVS Motor Services, which amounts to `13/TVSM share. We also assign `1/TVSM share for TVSM’s investment in Sundaram Auto Components Limited based on 1xFY17-end P/B.

Investment in Indonesia (NIL/TVSM share)

TVSM has made investments of `6.2bn (equity + preference) into the Indonesia business as at end-FY16 (before impairment provision of `1.2 bn). We expect a further infusion of `0.5bn in FY17 and no further equity infusion thereafter. Given that Indonesia subsidiaries continue to make losses, we are not assigning any value to the investments made by (and to be made by) TVSM into these entities. At 1.0x P/B (net of impairment), these investments would have accounted for `11/TVSM share as at end-FY17, which is not considered in our valuation estimate for TVSM.

Overall, we arrive at a one-year forward (November 1, 2017) SoTP-based valuation of `335/share, which implies 7% downside from current levels. We change our stance to SELL.

Exhibit 22: SoTP valuation for TVSM at `335/share (vs. `330 earlier)

Segment Methodology Implied multiple Value (`/TVSM share)

(x) New Old Change

Core business FCF 15 x Oct 2018 earnings 267 264 1%

BMW exports FCF 15 x FY20 net earnings 54 54 1%

Investments - TVS Motor Services + Sundaram Clayton

P/B 1.0x FY17 P/B 14 12 20%

Total 335 330 2%


Relative valuation: TVSM trading at a significant premium to peers

TVSM (standalone, including BMW) is trading at 20.7x FY18 net earnings, which is at a premium to the multiples commanded by peers (average of 16.2x for Bajaj and Hero). On FY18 EV/EBITDA, TVSM (standalone, including BMW) trades at 13.5x FY17 EBITDA, which is a significant premium to average of 10.6x for Hero and Bajaj. Whilst we expect TVSM’s EBITDA growth (25% CAGR over FY16-19) to be ahead of peers Hero MotoCorp (12%) and Bajaj Auto (10%) and RoIC is significantly lower (FY17 RoIC at 28% vs ~110% average for Bajaj Auto and Hero MotoCorp). As a result, we believe TVSM should trade in-line with peers.

Exhibit 23: TVSM trading at significant premium to domestic and global peers

Company Mcap EV/EBITDA (x) P/E (x) CAGR (FY16-18) EBITDA Margin (%) RoE (%)

US$ mn FY16 FY17 FY18 FY16 FY17 FY18 Sales EBITDA EPS FY16 FY17 FY18 FY16 FY17 FY18

Indian 2Ws TVS* 2,688 24.6 19.3 13.9 40.1 29.7 21.3 19 33 37 6.7 7.5 8.3 24 28 32

Bajaj Auto* 11,775 13.6 12.7 11.2 21.5 19.6 17.0 11 10 12 21.7 21.7 21.4 31 30 32

Hero MotoCorp* 9,374 12.6 11.1 10.0 18.9 16.7 15.3 10 13 11 15.5 16.3 16.3 44 41 38

Median (ex-TVS) 13.1 11.9 10.6 20.2 18.1 16.2 10 11 12 18.6 19.0 18.9 37 35 35

Global 2W’s Honda 50,524 6.3 6.9 6.6 9.8 10.6 9.9 (2) (2) (0) 8.3 10.7 11.4 8 8 8

Suzuki 18,462 5.1 5.0 4.5 15.3 13.8 15.0 2 7 1 10.9 12.4 13.2 9 12 11

Harley 10,610 12.2 13.0 12.2 16.4 15.5 14.2 1 0 7 22.6 23.5 25.4 30 39 39

Yamaha 7,951 6.3 7.3 6.7 13.0 14.2 11.6 (2) (3) 6 9.5 10.1 10.8 13 12 14

Median 6.3 7.1 6.7 14.2 14.0 12.9 (1) (1) 4 10.2 11.6 12.3 11 12 13

Source: Bloomberg, Company, Ambit Capital research. *Multiples and return ratios computed on Ambit estimates, Bloomberg estimates used for other companies

TVS Motor Company


Cross-cycle valuation: Trading at significant premium to five-year average

On cross-cycle EV/EBITDA, TVSM (standalone) is trading at a significant premium to its five-year average EV/EBITDA. Similarly, on a cross-cycle P/E comparison, TVSM (standalone) is trading at a premium of 66% to the five-year average. We believe the last five-year average multiple adequately captures the improvement in the business prospects of TVSM. Hence, the multiple implied by our fair valuation for the standalone business is 15x one-year forward net earnings, in line with the five-year historical average.

Exhibit 24: Trading at a 55% premium to five-year average one-year forward P/E…

Source: Ambit Capital research, Bloomberg Note: P/E bands arrived at using Bloomberg estimates for respective periods

Exhibit 25: … and 52% premium to five year average one-year forward EV/EBITDA

Source: Ambit Capital research, Bloomberg Note: P/E bands arrived at using Bloomberg estimates for respective periods

Improving consolidated return ratios

The consolidated return ratios of TVSM have improved over the last 3-4 years with post-tax RoCE improving from 8.1% in FY13 to 18.4% in FY16. This improvement has been driven by: (i) Improved business performance of the standalone business- standalone post tax RoCE has improved from 8.1% in FY13 to 18.4% in FY16; and (ii) capital employed in low return subsidiaries has also declined due to sale of investments in TVS Energy Limited in FY14.

Exhibit 26: TVS’s return ratios have been improving from FY13…


Exhibit 27: …in line with improvement in standalone performance and sales of interments in TVS Energy


4

8

12

16

20

24

28

Nov-11 Aug-12 May-13 Jan-14 Oct-14 Jul-15 Apr-16

TVS 1-yr fwd P/E

Average 1-yr fwd P/E of Bajaj Auto and Hero MotoCorp

Average TVS 1-yr fwd P/E

2

6

10

14

18

Nov-11 Aug-12 May-13 Jan-14 Oct-14 Jul-15 Apr-16TVS 1-yr fwd EV/EBITDA

Average 1-yr fwd EV/EBITDA of Bajaj Auto and Hero MotoCorp

Avg TVS 1-yr fwd EV/EBITDA

0%

5%

10%

15%

20%

25%

-20%

0%

20%

40%

60%

80%

100%

FY11 FY12 FY13 FY14 FY15 FY16

EBITDA growth RoCE (post-tax)

0%

2%

4%

6%

8%

10%

12%

14%

16%

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

FY11 FY12 FY13 FY14 FY15 FY16

Earnings growth RoE

TVS Motor Company


Exhibit 28: Explanation for our flags

Segment Score Comments

Accounting AMBER

In FY15, TVSM’s accounting score is lower than sector average accounting score, mainly due to increase in “loans and advances” (28 days in FY15 at the end of as against 22 days at the end of FY14) which impacted working capital position of the company. This trend reversed in FY16 (21 days at the end of FY16). Hence, we rate TVS’s accounting score in line with peers.

Predictability AMBER Given that automobile companies publish their volume numbers on a monthly basis, generally no significant positive/ negative surprises are seen in revenues. However, the margins tend to be less predictable and are generally the source for actual results coming in above/below consensus expectations.

Earnings momentum GREEN Bloomberg shows marginal upgrades to consensus numbers in recent weeks.


TVS scores low on our forensic framework but high in greatness framework

TVS scores low on our forensic framework given high miscellaneous expenditure as a percentage of total revenues, low/volatile cash yield and high CAGR in auditor remuneration. Further, the accounting ratio is declining for the last five years due to a continuous decline in cash yield, increase in contingent liability as a percentage of net worth, increase in miscellaneous expenditure as a percentage of total revenues, and increase in volatility of non-operating income. However, as highlighted in the earlier section, TVSM’s FY15 accounting score was impacted due to increase in “loans and advances”. This trend reversed in FY16. Hence, we believe TVSM’s accounting score would have improved in FY16 from FY15.

TVSM scores ‘Good’ on our greatness framework. In comparison to peers, TVS has maintained balance sheet discipline, pricing discipline and has consistently improved its sales, EBITDA and CFO.

Exhibit 29: TVSM scores low in our forensic framework…

Source: Ambit ‘HAWK’, Ambit Capital research

Exhibit 30: …but high in our greatness framework

Source: Ambit ‘HAWK’, Ambit Capital research

TVS Motor Company


Key catalysts and risks Key catalysts Moderation in EBITDA margin

Our EBITDA margin estimates for 2HFY17 at 7.5% are 53bps lower in comparison to 2QFY17 because of: (i) negative impact of lower volumes due to currency denomination impact and (ii) rising commodity prices (the landed steel price increased by 20% from the lows of Q4FY16 (we expect gross margin to be 30bps lower in 2HFY17 over 2QFY17).

Market share gains to slow down

Market share gain for TVS will slow down because of: (i) lower market share in domestic scooters; (ii) limited market share gains in domestic motorcycle segment as portfolio gaps appear limited; and (iii) structural decline in the category share of mopeds in the overall two-wheeler market. We expect market share to stagnate in FY18/19 as compared to 260bps market share gain in FY14-17.

Key risks Commodity price correction

As discussed earlier, commodity prices of steel and aluminum have increased sharply in the last two quarters. We have also this built this into our estimates. Any significant decline in the commodity prices presents key risk to our EBITDA margin and PAT estimates for FY17/18.

Exhibit 31: Sensitivity of Target Price to EBITDA margin

Average EBITDA margin FY17 and FY18 Earnings CAGR FY16-18

SoTP Valuation (`)

Upside/ Downside (+/-)

Current estimates (7.9%) 31% 335 -7%

8.4% 35% 357 -1%

8.9% 40% 378 5%

9.4% 44% 399 11%


Faster-than-expected recovery in exports market

TVS export volumes in the recent months have been impacted due to macro-economic challenges in its key export destinations like Nigeria due to the sharp fall in crude prices. We have built in 8% decline in the export volumes in FY17 and 20% volume growth in FY18 (on low base). Higher-than-expected recovery in the exports volumes poses a risk to our revenue, EBITDA and PAT estimates for FY17/18.

Exhibit 32: Sensitivity of target price to export volumes

FY16-18 exports volumes CAGR Earnings CAGR FY16-18

SoTP valuation (`)

Upside/ Downside (+/-)

Current estimates (7%) 31% 335 -7%

10% 33% 340 -5%

13% 35% 344 -4%

16% 38% 348 -3%

19% 40% 353 -2%


TVS Motor Company


Balance sheet (Standalone including exports to BMW)

Year to March (` mn) FY15 FY16 FY17E FY18E FY19E

Shareholders' equity 475 475 475 475 475

Reserves and surplus 15,979 18,893 22,554 27,974 34,973

Total net worth 16,454 19,368 23,029 28,449 35,449

Debt 9,705 9,244 7,892 7,892 7,892

Deferred tax liability 1,528 1,757 1,757 1,757 1,757

Total liabilities 27,686 30,369 32,678 38,097 45,097

Net block 13,296 15,929 16,874 18,114 19,546

CWIP 999 400 400 400 400

Investments (non-current) 10,125 11,857 13,107 13,107 13,107

Cash & cash equivalents 54 309 2,510 6,886 12,714

Debtors 5,039 5,787 6,566 8,192 9,535

Inventory 8,197 8,260 9,372 11,693 13,609

Loans & advances 8,313 7,077 7,955 9,788 11,302

Total current assets 21,602 21,432 26,403 36,560 47,161

Total current liabilities 18,356 19,257 24,114 30,091 35,125

Net current assets 3,246 2,175 2,289 6,468 12,036

Total assets 27,686 30,369 32,678 38,097 45,097


Income statement (Standalone including exports to BMW)


Revenues 1,00,888 1,12,439 1,27,580 1,59,179 1,85,264

% growth 27% 11% 13% 25% 16%

Operating expenditure 94,399 1,04,931 1,18,006 1,45,927 1,68,838

EBITDA 6,489 7,507 9,574 13,251 16,427

% growth 36% 16% 28% 38% 24%

Depreciation 1,533 1,897 2,882 3,235 3,641

EBIT 4,956 5,610 6,691 10,016 12,786

Interest expenditure 274 462 331 284 284

Non-operating income 326 513 1,539 1,539 1,693

Adjusted PBT 5,008 5,661 7,900 11,272 14,195

Tax 1,010 1,276 1,975 3,023 3,800

Adjusted PAT 3,997 4,385 5,925 8,248 10,395

YoY growth 66% 10% 35% 40% 26%

Diluted EPS (`) 8.4 9.2 12.5 17.4 21.9

Dividend per share (`) 1.9 2.5 4.0 5.0 6.0


TVS Motor Company


Cash flow statement (Standalone including exports to BMW)


PBT 4,562 5,660 7,900 11,272 14,195

Depreciation 1,533 1,898 2,882 3,235 3,641

Others 11 175 (1,208) (1,256) (1,409)

Tax (1,407) (1,458) (1,975) (3,023) (3,800)

Change in working capital (3,851) 2,182 (177) (369) (305)

CFO 848 8,457 7,422 9,859 12,322

Capex (net) (4,052) (3,984) (3,827) (4,475) (5,073)

Investments (1,183) (1,712) (1,250) 0 0

Others 302 500 1,539 1,539 1,693

CFI (3,538) (2,936) - (2,936) -

Net borrowings 4,424 (480) (1,352) - -

Interest paid (285) (461) (331) (284) (284)

Dividend paid (831) (2,065) - (2,263) (2,829)

CFF 3,308 (3,006) (1,683) (2,547) (3,113)

Net change in cash 619 2,514 5,739 4,376 9,209

Free cash flow (4,453) 2,804 2,845 5,384 7,249


Ratio analysis (Standalone including exports to BMW)

Year to March (%) FY15 FY16 FY17E FY18E FY19E

EBITDA margin (%) 6.4% 6.7% 7.5% 8.3% 8.9%

EBIT margin (%) 4.9% 5.0% 5.2% 6.3% 6.9%

Net profit margin (%) 4.0% 3.9% 4.6% 5.2% 5.6%

Net debt: equity (x) 0.59 0.46 0.23 0.04 -0.14

RoCE (%) 28% 25% 28% 34% 39%

RoIC (%) 28% 25% 28% 37% 44%

RoE (%) 26% 24% 28% 32% 33%


Valuation parameters (Standalone including exports to BMW)

Year to March FY15 FY16 FY17E FY18E FY19E

EPS (`.) 8.4 9.2 12.5 17.4 21.9

Diluted EPS (`.) 8.4 9.2 12.5 17.4 21.9

Book value per share (`.) 34.6 40.8 48.5 59.9 74.6

Dividend per share (`.) 1.9 2.5 4.0 5.0 6.0

P/E (x) 44.0 40.1 29.7 21.3 16.9

P/BV (x) 10.7 9.1 7.6 6.2 5.0

EV/EBITDA (x) 28.5 24.6 19.3 13.9 11.2

EV/EBIT (x) 1.8 1.6 1.3 0.9 0.7


TVS Motor Company


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected] Pramod Gubbi, CFA Head of Equities (022) 30433124 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected] Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected] Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected] Achint Bhagat, CFA Cement / Home Building (022) 30433178 [email protected] Anuj Bansal Mid-caps (022) 30433122 [email protected] Aditi Singh Economy / Strategy (022) 30433284 [email protected] Ashvin Shetty, CFA Automobile (022) 30433285 [email protected] Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected] Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 [email protected] Dhiraj Mistry, CFA Consumer (022) 30433264 [email protected] Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected] Karan Khanna, CFA Strategy (022) 30433251 [email protected] Mayank Porwal Retail (022) 30433214 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected] Paresh Dave, CFA Healthcare (022) 30433212 [email protected] Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected] Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected] Rahil Shah Banking / Financial Services (022) 30433217 [email protected] Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected] Ravi Singh Banking / Financial Services (022) 30433181 [email protected] Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected] Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected] Ritu Modi Automobile (022) 30433292 [email protected] Sagar Rastogi Technology (022) 30433291 [email protected] Sudheer Guntupalli Technology (022) 30433203 [email protected] Sumit Shekhar Economy / Strategy (022) 30433229 [email protected] Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected] Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7886 2740 [email protected] Dharmen Shah India / Asia (022) 30433289 [email protected] Dipti Mehta India (022) 30433053 [email protected] Krishnan V India / Asia (022) 30433295 [email protected] Nityam Shah, CFA Europe (022) 30433259 [email protected] Parees Purohit, CFA UK (022) 30433169 [email protected] Punitraj Mehra, CFA India / Asia (022) 30433198 [email protected] Shaleen Silori India (022) 30433256 [email protected]

Singapore

Praveena Pattabiraman Singapore +65 6536 0481 [email protected] Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola – CEO Americas +1(646) 793 6001 [email protected] Hitakshi Mehra Americas +1(646) 793 6002 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected] Sharoz G Hussain Production (022) 30433183 [email protected] Jestin George Editor (022) 30433272 [email protected] Richard Mugutmal Editor (022) 30433273 [email protected] Nikhil Pillai Database (022) 30433265 [email protected]

TVS Motor Company


TVS Motor (TVSL IN, SELL)

Source: Bloomberg, Ambit Capital research

050

100150200250300350400450

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Dec

-15

Feb-

16

Apr

-16

Jun-

16

Aug

-16

TVS Motor Co Ltd

TVS Motor Company


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

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TVS Motor Company


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