Two Wheelers

Industry Risk
Structural Risk Financial Risk

3.4
3.1 4.6

Industry Risk Evaluation

April 2010

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Two-Wheelers: April 2010

Two Wheelers
INDUSTRY RISK EVALUATION

CONTENTS
Background of the product Industry Overview Executive Summary Structural Risk
Demand Supply and Competition Factors of Production Government Policies and regulations

3 4 6 7
7 8 8 9

Financial Risk

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Two-Wheelers: April 2010

Background
Industry Risk Evaluation assesses the risk of the industry on various critical parameters that impact the cash flows and debt repayment capabilities of the industry in the next 2 3 years. The broader parameters selected for evaluation of risk include demand, supply, competition, factors of production, Government policies and regulations and the financial structure of the industry. The score is given to various parameters on the scale of 1 to 5, whereby 1 indicating the highest risk and 5 indicating lowest risk. The risk on each of the broader parameter is evaluated considering various important sub-parameters. The risks on various parameters are quantified by assigning a score to each parameter and the final risk score for the industry is derived by aggregating the scores multiplied by the respective weight-age given to each parameter. The selection of parameters and weight-age assigned to each of them is based on the extent to which they affect the cash flows and debt servicing ability of the industry. Scores on these parameters reflect the extent of positive or negative impact on cash flows and the degree of variability in cash flows.

Score
1 2 3 4 5

Risk Scale
High Marginally High Medium Marginally Low Low

DISCLAIMER
Industry Risk Evaluation is a product of CARE Research, an independent division of Credit Analysis & REsearch Limited [CARE]. CARE Research has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Research operates independently of ratings division and this report does not contain any confidential information obtained by ratings division, which they may have obtained in the regular course of operations. The opinion expressed in this report cannot be compared to the rating assigned to the company within this industry by the ratings division. The opinion expressed is also not a recommendation to buy, sell or hold an instrument. CARE Research is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE (including all divisions) has no financial liability whatsoever to the user of this product. This report is for the information of the intended recipients only and no part of this report may be published or reproduced in any form or manner without prior written permission of CARE Research.

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Industry Overview
Indian Two Wheeler Industry evolved with the introduction of imported bullets and metal bodied geared scooters. In 1955, Automobile Products of India (API) started manufacturing scooters in India for the first time. Subsequently, with the easing of industrial policies, foreign players entered India in collaboration with local players. Honda Motors, Yamaha, Suzuki and Kawasaki entered into joint venture with Hero, Escorts, TVS and Bajaj respectively for manufacturing motorcycles in India. Piaggio entered into a technical collaboration with LML in for manufacturing scooters. Suzuki collaborated with TVS for a pie in the scooter market and so did Honda with Kinetic. Over a period of time, the traditional metal bodied geared scooters were increasingly replaced by motorcycles on the back of improved technology, better fuel economy and style quotient. Of late, the colourful gearless scooters are witnessing faster growth in sales. Gearless scooters are preferred by youngsters and female population for short trips on account of style, lighter weight and hassle free commutation. The recent addition to the industry is the electric scooters, which is at a nascent stage and has limited target market. At present motorcycles dominate the market, followed by gearless scooters. Mopeds garner very low share. In terms of competition, the industry is dominated by Hero Honda, followed by Bajaj Auto and TVS Motors. Honda Motorcycles and Scooters is the leader in gearless scooter segment. Customer reach through large distribution network and making spare parts easily available at cheaper prices is one of the key success factors of the industry. Raw material cost forms the important cost head. Though the industry, being relatively more consolidated than the fragmented auto component industry, has strong bargaining power vis--vis the component suppliers, the industry hardly has any say on the prices of global commodities like steel, aluminium and rubber, the key inputs. The industry is not subject to rigid Government regulations. In fact, the boost is given to the automobile industry on account of its employment generation capabilities, especially during the economic down-cycle for pushing domestic consumption and job opportunities that would result into economic revival.

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Current State of the industry The Indian two-wheeler sales grew by 25.2 per cent in 2009-10. The domestic sales increased by 26.4 per cent from 7.4 million units in 2008-09 to 9.4 million units in 2009-10. Similarly, exports grew by 13.5 per cent from 1 million units in 2008-09 to 1.1 million units in 2009-10. The high growth in domestic sales came on a low base in 2008-09, in which the sales grew by merely 2.6 per cent from 7.2 million units in 2007-08. Hero Honda leads the market, followed by Bajaj Auto, TVS Motor Company and Honda Motorcycle & Scooter India with sub-twenty per cent shares. Hero Honda has been gaining market share at the cost of Bajaj Auto and TVS Motor Company in the last three years. Smaller players continue to remain insignificant in the overall industry. However, Bajaj Auto is the market leader in exports with 63.6 per cent share in Indias two-wheeler exports in 2009-10.

Market Share of key players in domestic sales (in %)

Player Hero Honda Bajaj Auto TVS Motor Company Honda Motorcycle & Scooter India Yamaha Suzuki Motorcycle India Others 2007-08 45 23 16 12 2 1 1 Source: SIAM; CARE Research 2008-09 49 17 15 14 2 2 1 2009-10 48 19 14 13 2 2 1

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Executive Summary

SCORE 3.4

The industry risk of the Indian two-wheeler industry is Medium on CAREs Industry Risk Evaluation Model. The score is driven by healthy demand outlook, reasonably high entry barriers and minimal regulatory interference from the Government. However, the industry has limited say in the prices of key inputs like steel, aluminium and rubber, though it enjoys good bargaining power with the component suppliers. With the global economic recover under-way, the commodity prices have bounced back and are likely to inch up further. A very sharp up-move in the prices of inputs could adversely impact the profitability and hence the cash flows of the industry. Nevertheless, currently the low gearing and strong coverage ratios translate into Low risk on the financial parameters for the industry.

PARAMETERS STRUCTURAL RISK (A)

Demand Supply and Competition Factors of Production Government Policies and Regulations

WEIGHTAGE 80%
30% 30% 30% 10%

SCORE 3.1
3.0 4.0 2.0 4.0

Medium
Medium Marginally Low Marginally High Marginally Low

FINANCIAL RISK (B) OVERALL RISK (A + B)

20% 100%

4.6 3.4

Low Medium

It may be noted that the score on Structural Risk is for the industry as a whole and the score on Financial Risk is based on the financials of sample companies. Hence, the Financial Risk can vary from company to company.

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Two-Wheelers: April 2010

STRUCTURAL RISK

Medium

3.1

Demand

3.0

CARE Research expects domestic two-wheeler sales to grow from 9.4 million units in 2009-10 to 13.4 million units in 2013-14, a compounded annual growth rate (CAGR) of 9.5 per cent. Increasing income levels and lower penetration, especially in smaller cities and rural areas, would drive the sales growth. Approximately 68 per cent of Indian households affording two-wheelers already own one. But, if looked granularly, only 34 - 36 per cent of the affording households in smaller cities and rural areas own a twowheeler, suggesting humungous opportunity. The capturing of this opportunity depends on the ability of two-wheeler manufacturers to expand their distribution network in such areas.

Two-wheeler exports are expected to grow at strong CAGR of 22.3 per cent from 1.1 million units to 2.5 million units during the same period. Low cost advantage would help India driving its export growth.

The short term demand outlook remains relatively strong, with domestic sales expected to grow by 14 15 per cent, while exports expected to register 18 20 per cent growth.

The score on demand is constrained on account of the sensitivity of demand to interest rate and economic cycle. Around 60 70 per cent of two-wheelers are purchased by Indian consumers on finance. The availability and cost of finance is based on liquidity in the system, actions of the financers and trend in delinquencies of two-wheeler loans. Nevertheless, the industry is not cyclical in nature as such.

The industry faces minimal threat from alternate modes of commutation like cars and public transport (buses and trains). The price differential of two-wheeler and car has narrowed, but running costs of car is still much higher than a two-wheeler. Likewise, people are more tilted towards easily maneuverable twowheeler over the uncomfortable and crowded public transport.

Supply and Competition

4.0

The two-wheeler industry is dominated by four players Hero Honda, Bajaj Auto, TVS Motors and Honda Motorcycles and Scooters India (HMSI). Nevertheless, there is stiff competition amongst them. The

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Herfindahl-Hirschman Index (HHI) for the industry stands at approximately 31 per cent. There is hardly any import threat to the industry.

Market Share of key players in various segments of two-wheeler industry

Key Players Hero Honda Bajaj Auto TVS Motors HMSI Total of above Motorcycles (78%) 58% 24% 7% 6% 96% Scooters (16%) 14% Negligible 20% 51% 85% Mopeds (6%) Nil Nil 100% Nil 100% Two-wheelers (100%) 48% 19% 14% 13% 94%

Source: SIAM, CARE Research

The industry is not a strictly regulated one and is relatively scalable business. The industry is also not very capital intensive. However, the requirement of strong distribution network is critical for garnering significant market share. Similarly, intellectual property in terms of engine and other technology is also very critical. These two factors form significant barriers to entry, which protect the interests of the existing players. Hence the industry risk related to barriers of entry is assessed marginally low. The most of the two-wheeler customers are brand-conscious which too translates into an entry barrier for new players.

Factors of production

2.0

Raw materials form an important cost component of the industry. Though the consolidated structure of the industry affords it healthy bargaining power vis--vis fragmented component suppliers, the players hardly have any say in the prices of global commodities like steel, aluminium and rubber, the key inputs for the industry. The availability of the inputs is not a concern but their prices are cyclical and volatile. With the global economic recovery under-way, the prices of commodities have started looking up and are further expected to inch northwards.

The industry is marginally capital intensive, but on account of healthy financial profile, the availability of capital is not very challenging. The industry is to an extent dependent on technology in terms of engine system, fuel system, etc. But the life cycle of the technology is relatively high and does not face

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obsolescence in short period of time. However, the availability of land for expansions is a challenge for the industry.

Government Policies and Regulations

4.0

The two-wheeler industry is not rigidly regulated by the Government. There are no specific statues relating to the industry. There are neither scalability barriers nor any price controls on the industry from the Government. However, the industry has to comply with the vehicle pollution norms, which keep on getting stricter and involve capital costs.

The industry is to an extent important to the economy, not because of its direct but indirect contribution to GDP through employment opportunities and consumption of steel and aluminium. Accordingly, it gets boost from the Government during economic down cycles for pushing up the domestic consumption and job opportunities that would result into economic revival.

Government allows 100 per cent foreign direct investment in the sector. This may bring in additional competition, but creating dealer network and brand name remains a challenge for the new entrant.

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FINANCIAL RISK

Low

4.6

Key Financial Aggregates of sample companies

Rs. Billion Total Income EBIDTA Interest Costs Net Cash Accruals Networth Debt Long Term Debt Average Capital Employed Source: Prowess, CARE Research 2004-05 107.0 16.1 0.1 6.4 21.7 3.9 1.8 22.4 2005-06 123.4 18.2 0.2 8.1 27.8 5.7 3.1 29.5 2006-07 142.3 16.1 0.4 7.3 32.8 8.0 4.5 37.1 2007-08 143.6 17.2 0.2 7.9 38.1 8.0 4.0 43.4 2008-09 168.9 21.7 0.7 11.1 46.1 9.8 3.8 51.0 CAGR (%) 12.1 7.7 61.1 14.9 20.7 26.2 21.3 22.8

Key Ratios of sample companies

EBIDTA Margins RoCE Gearing Interest Coverage LT Debt / NCA % % times times times 2004-05 15.0 n.a. 0.2 156.8 0.3 2005-06 14.8 61.6 0.2 76.1 0.4 2006-07 11.3 43.3 0.2 38.3 0.6 2007-08 12.0 39.7 0.2 87.7 0.5 2008-09 12.8 42.5 0.2 31.4 0.3 Average 13.2 46.8 0.2 78.1 0.4

Source: Prowess, CARE Research

Other financial information of sample companies

Material Cost to Income Power Cost to Income Employee Cost to Income Debtor Days Creditor Days Inventory Days Current Ratio Contingent Lia. / Networth % % % days days days times % 2004-05 70 1 4 17 38 16 0.5 12 2005-06 70 1 4 19 34 19 0.7 11 2006-07 73 1 4 22 28 18 0.8 15 2007-08 73 1 4 18 31 20 0.7 8 2008-09 72 1 4 18 28 15 0.7 8 Average 72 1 4 19 32 18 0.7 11

Source: Prowess, CARE Research

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List of Companies in the sample

1. Hero Honda Motors Limited 2. TVS Motor Company Limited It may be noted that the score on Financial Risk is based on the financials of sample companies. Hence, the Financial Risk can vary from company to company.

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Two-Wheelers: April 2010