Two-Wheelers - FMCG Model At A Discount - PINC Sector Update

The Indian two-wheeler industry has undergone a complete makeover over the last two decades with entry of Japanese manufacturers. The geared scooters, which used to dominate the industry, have been totally replaced by fuel efficient and stylish motorcycles. In the last couple of years the industry seems to be entering a maturing phase with rationality in players' behaviour and improvement in profitability. This evolvement of the two-wheeler industry is on the line of FMCG industry. Two-wheelers has attained a status of essentials due to the need for personal mobility and inadequate public transportation system in the country. Despite an overall household penetration level of45%, the industry continues to grow in double digits due to demand from under penetrated rural markets and shortening replacement cycle. Indian two-wheeler industry has lots of similarity to FMCG business and despite that they trade at a significant discount to the companies in FMCG industry.

Branding is the key: Branding plays a major role in product differentiation in an industry where there are marginal differences in the products based on technology and features.

Low capex requirement: Two-wheeler industry like FMCG, is low on capex requirement and due to this, companies have impressive cash accruals which they are using to reward the shareholders through dividends.

Negative working capital: Vendors are important part of the business and besides raw materials they also provide working capital to the business. Due to this, two-wheeler industry works on negative working capital like their counterparts in FMCG sector.

High return ratios: Low capex requirement, negative working capital coupled with high dividend payout provide high return on equity for the two-wheeler industry.

Wide differential in valuations: Despite a lot of similarities in the business model, there is a wide gap in valuations of two-wheeler companies as compared to FMCG industry. While FMCG companies have been trading at a multiple of 22-23x one year forward P/E ratio, two-wheeler stocks are trading in the range of 15-16x one year forward P/E ratio. We believe that this differential will gradually narrow down with two-wheeler industry moving up on the valuation matrix. Our top picks in the sector are Hero Honda and Bajaj Auto.

Source : Equity Bulls

Keywords