Macquarie - Bajaj Auto

Macquarie Research report on Bajaj Auto:

Initiate with an Outperform; value in the parts

We initiate coverage on Bajaj Auto with a non-consensus Outperform rating and a target price of Rs 2,453. While the core two-wheeler business remains weak, the non-core business areas – investment and insurance – provide a strong base. We value the core business on a DCF basis at Rs 1,216 per share. Together with the insurance business (Rs 546 per share) and fair value of investments (Rs 868 per share) at a target price of Rs 2,453, the stock provides share price upside of 17%.

Core business remains weak…

While Bajaj is better-placed than its peers, the core domestic two-wheeler business is likely to face strong pressure in the short-to-medium term. Increasingly intense and even irrational pricing competition coupled with a strong commodity cycle will sustain pressure on operating profitability. While growth in the three-wheeler business could stabilise, we believe exports could be a major sales driver in the future. We estimate that the core business earnings will grow at a CAGR of 13% between FY07–10.

…but is available cheaply

Net the value of insurance, investments and a holding company discount, the imputed value of the core business at current market prices is Rs 869 per share. This would imply a FY09E core earnings multiple of less than 8.3x. This is well below Bajaj’s historical trading band and is based on our earnings estimates, which are 10% below consensus. Our DCF-based target price of Rs 1,216 for the core business would imply a valuation of 12x FY09E core earnings – well below Bajaj’s recent trading band.

Insurance provides strong value

Our value for the insurance business of Rs 546 per share is significantly ahead of the Street; we believe the profitability of the general insurance business is being undermined by the market. On the appraisal valuation method, Bajaj’s life insurance business is valued at an NBAP of 17x FY08E – well below the valuations we assign to its peers like ICICI Prudential (ICICI Pru: 29x FY08E). The stake sale by ICICI Pru has provided a strong valuation benchmark for Bajaj’s insurance business.

Key risks and potential catalysts

Apart from the macroeconomic factor, key risks for Bajaj Auto include strongerthan- expected margin pressure in the automobile segment, a faster-thanexpected decline in the three-wheeler market and a decline in the value of investments. Key catalysts include the listing/stake sale of ICICI Pru, which has provided a market valuation to the insurance business; success of the new motorcycle to be launched in 2H FY08 and a gain in two-wheeler market share.