Commercial vehicle industry initiation report[1]

30 August 2010

India | Automobiles | Initiating Coverage

Commercial Vehicle Industry

Heavier the merrier Pramod Kumar
pramod.kumar@jmfinancial.in
Tel: (91 22) 6630 3019

Expect MHCV to witness volumes CAGR of 18% till FY13: MHCV volume Mitakshi Ashar
mitakshi.ashar@jmfinancial.in
growth has a long-term correlation with 1.5x the industrial production (IIP) Tel: (91 22) 6630 3079
growth (see exhibit 1); however, in the initial years of an up-cycle the growth
is much higher than the long-term correlation. We expect the MHCV segment
to see volumes CAGR of 18% till FY13 compared to a 19% CAGR over the last
cycle between FY01-FY08. Recommendations

Tonnage/volume growth at 1.3x: In the last cycle, the tonnage/volume Company
Ashok Eicher
Leyland Motors
growth used to be around 1x; it is currently c.1.3x (see exhibit 1) driven by
Rating BUY BUY
strong demand for heavy tonnage vehicles. Improving highway network,
B'berg Ticker AL IB EIM IB
revival of the industrial capex cycle, government thrust on infrastructure and TP (`) 91 1,677
better operating economics are driving demand for higher tonnage trucks. CMP (`) 70 1,093
Upside/Downside (%) 31.0 53.4
Hub and Spoke model driving tonnage polarisation: While higher tonnage
Source: Bloomberg, JM Financial
trucks are becoming prevalent on highways the smaller trucks (sub 1 tn) are
rapidly replacing intermediate tonnage trucks for providing last mile Relative Performance
connectivity. This polarisation is squeezing the intermediate segment (see
AL EIM SENSEX
exhibit 2). Entry regulations in many cities are putting the intermediate trucks 5.50
at further disadvantage. 5.00
4.50

Several entry barriers favour incumbents: The MHCV industry has several 4.00
3.50
entry barriers, like reach in terms of sales and service with the latter being 3.00

very critical. Mapping truck routes across the country and ensuring service 2.50
2.00
and spare availability on these routes is critical for success. This is a big 1.50

advantage for incumbents as creating reach is very time and resource 1.00
1-Apr- 1-Jun- 1-Aug- 1-Oc t- 1-Dec - 1-Feb- 1-Apr- 1-Jun- 1-Aug-
intensive. We expect serious competition from new players like Mahindra- 09 09 09 09 09 10 10 10 10

Navistar and Daimler, but that is still 2-3 years away, giving enough window
of opportunity for incumbents to scale up their R&D. Source: Bloomberg, JM Financial

Pricing strong in MHCV and weak in LCV: The MHCV industry has seen
price increase (excluding excise) of c.8% since Oct’09 despite moderate
increase in commodity prices. Ashok Leyland (AL) and Eicher Motors (EIM)
have been the biggest beneficiaries of the benign pricing environment. In
FY10, AL’s operating profit was 94% of FY08 levels despite volumes being
77% of FY08 levels. Increasing competition in the small truck market (where
reach is not as critical as in the MHCV space) is leading to lower margins for
incumbents. TTMT has refrained from increasing prices of Ace despite
increase in excise duty and commodity pressure resulting in lower profits.

AL and EIM to outperform industry growth: We are initiating coverage on
AL and EIM, which derive complete/bulk of their earnings from CVs. AL and
EIM will outperform the industry growth with a volume CAGR of 25% and 30%.

We initiate with BUY on AL and EIM with TP of `91.2 and `1,677: We
believe heavier is merrier in the medium-term due to limited competition and
strong cyclical demand. We are initiating coverage on AL and EIM, which
derive complete/bulk of their earnings from CVs, with BUY rating and target
price of `91.2 (upside of 31%) and `1,677 (upside of 53%) respectively. We
have delved deeper into EIM as it not widely tracked, and according to us, is a
stock for keeps. JM Fiancial Research is also available on:
Bloomberg - JMFR <GO>, Thomson Publisher & Reuters.

Please see important disclosure at the end of the report

JM Financial Institutional Securities Private Limited

Commercial Vehicle Industry 30 August 2010

Exhibit 1. Growth in IIP and MHCV volumes, tonnage/volume trend
125
100 14 Volume growth
MHCV IIP
Tonnage growth X Tonnage/Volume 1.3x
80 100
12

60 75
10

40 1.1x
50 1.2x
8 1.0x
1.0x
%

20 1.1x

%

%
6 25
0
0.6x 1.1
FY96

FY97

FY98

FY99

FY00
FY01

FY02

FY03

FY04

FY05

FY06
FY07

FY08

FY09

FY10

1QFY11
1.2x
4 0
-20

1QFY11 QoQ
FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

1QFY11
-40 2
-25

-60 0
-50

Source: SIAM, JM Financial

Exhibit 2. Hub and Spoke driving tonnage polarisation
100% 100%

80% 80%

60% 60%

40% 40%

20% 20%

0% 0%
1QFY11

1QFY11
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10
< 3.5 3.5-5 5-7.5 7.5-12 12-16.2 16.2-25 > 25 7.5-12 12-16.2 16.2-25 > 25

Source: SIAM, JM Financial

Exhibit 3. Freight Index on a steady rise

174

173

172

171

170
Apr-10

Aug-10
Jun-09

Jul-09
May-09

Jan-10

Jun-10
May-10
Oct-09

Nov-09

Feb-10
Sep-09

Source: TCI, JM Financial

JM Financial Institutional Securities Private Limited Page 2

30 August 2010

India | Automobiles | Initiating Coverage Price: `70

Ashok Leyland | AL IN BUY
Target: `91.2 (Mar’11)

Pantnagar a game changer Pramod Kumar
Tel: (91 22) 6630 3019
Pantnagar to bring in significant cost advantage: This is the only MHCV Mitakshi Ashar
plant in a tax haven zone giving AL a significant cost advantage (100% excise mitakshi.ashar@jmfinancial.in
exemption for 10 years, 100% income tax exemption for the first 5 years and Tel: (91 22) 6630 3079
30% over the following 5 years). We estimate this plant to bring in additional
benefits of `595mn and atleast `1.2bn for FY11 and FY12. Pantnagar will also Key Data
act as a beach-head to increase its reach in the North India market. Market cap (bn) ` 92.7 / US$ 2.0
Shares in issue (mn) 1,330
Huge operating leverage: We expect AL’s capacity utilisation to be c.58% in
Diluted share (mn) 1,330
FY11 and c.67% in FY12, bringing in huge operating leverage. The
improvement in utilisation will be driven by ramp-up at the Pantnagar plant, 3-mon avg daily val (mn) ` 359.7 / US$ 7.7
which with 50,000 units will account for 33% of overall capacity. AL’s existing 52-week range 74.2 / 34.3
capacity of 150,000 units will hold good till FY14-FY15 driving up RoEs. Sensex/Nifty (20-08-2010) 18,402/5,531
`/US$ 46.7
Financing arm to increase market acceptance: The recently launched
captive financing arm will be able to finance over 4,000 trucks in FY11 and a Daily Performance
much higher number in the future, improving AL’s acceptance amongst Ashok Leyland
customers. 80 180%
160%
70
140%
60
Entry into LCV and CE business to reduce cyclic trend further: AL’s 50
120%
100%
portfolio will be less cyclical FY12 onwards as the JVs start commercial 40 80%
60%
launches. By mid-2011, LCVs from Nissan JV and CEs from the John Deere JV 30
20
40%
will be launched. 10
20%
0%
0 -20%
Expect FY10-FY12E revenue and earnings CAGR of 30% and 40%: Volume

Jan-09

Mar-09

Jul-09

Sep-09

Jan-10

Mar-10

Jul-10
May-09

Nov-09

May-10
and realisation CAGR of 25% and 3.3% will drive strong revenue growth. Ashok Leyland Relative to Sensex (RHS)
Earnings growth will be driven by 37% CAGR in operating profits. Bulk of the
tax haven benefits will be back-ended in FY11. Expect EPS of `4.8 and `6.2. % 1M 3M 12M
Absolute -1.8 14.5 98.3
Pantnagar and financing arm to boost marketshare: We expect AL’s MHCV Relative* -4.7 3.2 75.7
marketshare to increase by at-least 280 bps by FY12 driven by Pantnagar and * To the BSE Sensex
the financing arm.
Shareholding Pattern (%)
Investment in JVs valued at `5.4 per share (1x FY12E BV) 1QFY11 1QFY10
Promoters 38.6 38.6
Initiate with BUY and TP of `91.2, 31% upside: AL currently owns 17.2mn FII 13.6 10.2
IndusInd Bank shares which are worth `2 per share (after 30% discount). In 19.4 19.7
DII
addition, investment in the key JVs are worth `5.4 per share (1x FY12E BV).
Public / others 28.3 31.5
We value the standalone business at `83.8 (13.5x FY12 EPS or 8.6x
EV/EBITDA), taking the target price to `91.2 (18% above consensus).t

Exhibit 4. Financial Summary (` mn)
Y/E March FY08 FY09 FY10 FY11E FY12E
Net sales 77,426 59,811 72,447 101,493 121,304
Sales growth (%) 0 -22.8 21.1 40.1 19.5
EBITDA 8,077 4,560 7,596 11,242 14,258
EBITDA (%) 10.4 7.6 10.5 11.1 11.8
Adjusted net profit 4,694 1,900 4,237 6,345 8,254
EPS (`) 3.5 1.4 3.2 4.8 6.2
EPS growth (%) 0 -59.5 123.0 49.8 30.1
ROCE (%) 19.7 7.5 9.1 13.7 17.3
ROE (%) 22.1 6.8 11.8 16.3 19.2
PE (x) 19.8 48.8 21.9 14.6 11.2
Price/Book value (x) 4.4 2.7 2.5 2.3 2.0
EV/EBITDA (x) 11.3 23.9 14.0 8.8 6.5 JM Financial Research is also available on:
Source: Company data, JM Financial. Note: Valuations as of 20/08/2010 Please see important disclosure at the end of the report


Ashok Leyland 30 August 2010

Pantnagar plant a game changer: This is the only MHCV plant in a tax haven
zone giving AL a significant cost advantage (100% excise exemption for 10
years, 100% income tax exemption for the first 5 years and 30% over the
following 5 years). The company is expected to save `35,000 on each of the
17,000 odd trucks to be rolled out in FY11 from this plant. In FY12, we
expect volumes of 30,000 units from this plant and the benefits to be over
`40,000 per truck. This would mean `595mn and atleast `1.2bn in terms of
additional benefit in FY11 and FY12. Pantnagar will also act as a beach-head
to increase its reach in the North India market.

Huge scope for marketshare gains in non-South markets: While AL enjoys
a strong 45-46% share of the South HCV market its presence in other
geographies has been much below its potential. Its share in the key North and
West markets is c.26% and c.18%, and in the smaller east market its a meager
10%. Geographical distance is one of the reason for lower share in these
markets. However, with commissioning of the Pantnagar plant, AL is very
close to the North and East markets, leading to shorter time-to-market and
lower logistical costs. This coupled with the captive financing arm will ensure
that AL increases its marketshare considerably in the North and West
markets, helping it outpace industry growth over the next few years.

Exhibit 5. Region-wise marketshare and tonnage wise marketshare trend
50% 35 33 33
46%
29 29 29
30 28
> 16 tn
40% 26 26
25 24
25
21 21
30% 20
26%
%

15
20% 18%
10
10% 6
4 5
10% 5 3

0
0% 7.5-12 tn 12-16.2 tn 16.2-25 tn >25 tn
North South East West
FY08 FY09 FY10 YTDFY11

Source: Company, JM Financial

Huge operating leverage: With the commissioning of the Pantnagar plant, AL
has a capacity of around 150,000 units, of which it will be utilising only c.58%
in FY11. This gives the company a huge operating leverage going forward.
This, along with the tax benefits, should help it protect margins despite
commodity pressure.

Exhibit 6. Installed capacity and capacity utilisation
100
150

75
Thousands units

100

50
%

50
25

- 0
FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

Installed Capac ity Capac ity Utilisation




Financing arm to increase acceptance amongst customers: AL has been at
a disadvantage, a significant one in a downturn, vis-a-vis Tata Motors due to
lack of a captive financing arm. Since virtually all CVs sold are financed,
presence of a captive financing arm considerably improves customer
acceptance. The recently launched captive financing arm will be able to
finance over 4,000 trucks in FY11 and a much higher number in the future as
the book size increases, improving AL’s acceptance amongst customers.

Exhibit 7. Trend in dependence of Tata Motors on Tata Motors Finance

110 45

105 40
Units '000s

100 35

%
95 30

90 25

85 20
FY07 FY08 FY09 FY10

CVs financed % of domestic CVs


Entry into LCV and CE business to reduce cyclic trend further: AL being a
pure MHCV player is weighed down by the cyclical nature of the MHCV
segment. Comparatively, the LCV segment is much more stable and has
gradually grown bigger than the MHCV segment in terms of volumes (see
exhibit 8). AL's JV with Nissan will roll out its LCVs by mid-2011. By early
2011, its entry in the construction equipment (CE) business with John Deere
will also open up a non-cyclical stream of revenue with limited capex. In
addition, JVs with Albonair and Alteams will also start contributing
significantly.

Exhibit 8. MHCV and LCV growth trends

375 120
Thousands

300
80

225
40
%

150

-
75

0 (40)
FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11E

LCV MHCV LCV Grow th % MHCV Grow th %




Entry into sub 3.5tn market; better late than never: The sub 3.5tn cargo
segment has seen a CAGR of 38% since FY03 with bulk of that growth coming
after launch of Tata Ace in May 2005. AL, due to its limited presence in the
LCV segment (less than 2% of its volumes), missed this opportunity. However,
the JV with Nissan will enable the company to participate in this fast growing
segment. The JV will be launching products between the 2.5tn-5tn segment,
with the first product targeted for launch in mid-2011. Nissan’s LCV expertise
coupled with AL’s wide reach will enable the JV to quickly ramp-up volumes.

Exhibit 9. Volume and growth trend in LCV (sub 1 tonne cargo)

225
80

150
Th u n s
o sa d

50

%
75
20

0 -10
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 1QFY11

Volume Grow th %


Key JVs valued at `5.4 per share: Key JVs contribute around `5.4 per share
based on a 1x FY12 price/book multiple to the estimated investments.

Exhibit 10. Details of Key JVs
Total Investment
Company Description FY10/FY12E (` mn) Status
Nissan Motors JV to develop, manufacture and distribute LCVs under both 748 / 5,888 Rollout in Feb 2011
brands; JV has three separate companies
- A vehicle manufacturing company, AL: Nissan- 51:49
- Powertrain manufacturing company, AL:Nissan- 49:51
- A technology development company, 50:50 JV
John Deere (JD) A 50:50 JV to manufacture and market Construction 292 / 792 Rollout by Feb 2011
Equipment under both brands. Initially rollout Backhoes
and four-wheel drive loaders
Automotive A 50:50 JV to design, develop infotronics products and 50 / 50 200-230 cr in FY11
Infotronics services for automotive customers
Ashley Alteams India A 50:50 JV to produce high Pressure Die Casting aluminum 250 / 500 Went on stream in January
Pvt Ltd components for telecom & automotive sectors 2010
Per share book value (`) 1 / 5.4
Source: Company, JM Research



Key assumptions
Exhibit 11. Volumes and realisation assumption
(Units) FY10 FY11E YoY (%) FY12E YoY (%)
Volumes 63,933 87,623 37.1 100,235 14.4
MDV Passenger 18,452 21,322 15.6 23,257 9.1
MDV Goods 44,384 64,851 46.1 75,181 15.9
LCV 1,097 1,450 32.2 1,797 23.9
Domestic 57,959 80,301 38.5 91,553 14.0
MDV Passenger 16,405 18,866 15.0 20,186 7.0
MDV Goods 40,742 60,298 48.0 69,946 16.0
LCV 812 1,137 40.0 1,421 25.0
Export 5,974 7,322 22.6 8,682 18.6
MDV Passenger 2,047 2,456 20.0 3,071 25.0
MDV Goods 3,642 4,553 25.0 5,235 15.0
LCV 285 314 10.0 376 20.0
Realisations (`) 1,133,172 1,158,290 2.2 1,210,190 4.5

Source: JM Financial

Valuations
AL currently owns 17.2mn shares in IndusInd Bank which are worth `2 per
share (after 30% discount). In addition, investments in key JVs are valued at
`5.4 per share (1x FY12E BV). AL deserves a higher multiple than its historic
average due to the tax haven plant and new forays like LCV, CE which will
make the business less cyclical. We value the standalone business at `83.8
(13.5x FY12 EPS or 8.6x EV/EBITDA), taking the target price to `91.2. At the
current price the stock is trading at 11.2x FY12E EPS. We initiate coverage
with a BUY rating. Please see exhibit 27 on page 22 for Global CVs
comparable table.

Key risks
Key downside risks are: a) Lower than estimated volumes from Pantnagar
plant, b) Drastic slowdown in industrial growth, c) Sharp increase in diesel
prices, and d) sharp increase in interest rates.

Higher than estimated ramp-up at Pantnagar is the key upside risk

Exhibit 12. AL 1 yr fwd P/E

120 20x
17x
80 14x
11x
40 8x
5x

0
A pr-03

A pr-05

A pr-07

A pr-09
A ug-04

A ug-06

A ug-08

A ug-10
Dec-03

Dec-05

Dec-07

Dec-09

Source: Bloomberg, JM Financial



Financial Tables
Profit & Loss (` mn) Balance Sheet (` mn)
Y/E March FY08A FY09A FY10A FY11E FY12E Y/E March FY08A FY09A FY10A FY11E FY12E

Net sales (Net of excise) 77,426 59,811 72,447 101,493 121,304 Share capital 1,330 1,330 1,330 1,330 1,330

Growth (%) -22.8 21.1 40.1 19.5 Other capital 0 0 0 0 0

Other operational income 0 0 0 0 0 Reserves and surplus 19,937 33,349 35,946 39,432 44,054

Raw material (or COGS) 57,647 44,442 52,041 75,402 90,426 Networth 21,267 34,680 37,277 40,763 45,385

Personnel cost 6,289 5,797 6,749 8,119 9,098 Total loans 8,875 19,581 22,039 20,977 19,591

Other expenses (or SG&A) 5,412 5,011 6,062 6,729 7,522 Minority interest 0 0 0 0 0

EBITDA 8,077 4,560 7,596 11,242 14,258 Sources of funds 30,142 54,261 59,316 61,740 64,976

EBITDA (%) 10.4 7.6 10.5 11.1 11.8 Intangible assets 0 0 0 0 0

Growth (%) -43.6 66.6 48.0 26.8 Fixed assets 29,424 49,389 60,186 64,396 68,707

Other non-op. income 576 496 704 321 408 Less: Depn. and amort. 14,169 15,398 17,691 20,249 23,059

Depreciation and amort. 1,774 1,784 2,041 2,426 2,677 Net block 15,256 33,991 42,496 44,147 45,648

EBIT 6,880 3,271 6,259 9,137 11,990 Capital WIP 5,292 9,983 5,615 5,600 5,600

Add: Net interest income -497 -1,187 -811 -1,400 -1,800 Investments 6,099 2,635 3,262 8,151 11,080

Pre tax profit 6,382 2,084 5,448 7,737 10,190 Def tax assets/- liability -2,538 -2,634 -3,845 -4,845 -5,845

Taxes 1,688 185 1,211 1,393 1,936 Current assets 28,753 31,656 41,397 47,898 54,834

Add: Extraordinary items 0 0 0 0 0 Inventories 12,239 13,300 16,382 23,635 26,587

Less: Minority interest 0 0 0 0 0 Sundry debtors 3,758 9,580 10,221 6,952 8,308

Reported net profit 4,694 1,900 4,237 6,345 8,254 Cash & bank balances 4,514 881 5,189 6,641 8,024

Adjusted net profit 4,694 1,900 4,237 6,345 8,254 Other current assets 0 0 0 0 0

Margin (%) 6.1 3.2 5.8 6.3 6.8 Loans & advances 8,241 7,895 9,605 10,670 11,914

Diluted share cap. (mn) 1,330 1,330 1,330 1,330 1,330 Current liabilities & prov. 22,719 21,369 29,608 39,211 46,342

Diluted EPS (`.) 3.5 1.4 3.2 4.8 6.2 Current liabilities 19,267 18,689 25,921 35,137 41,488

Growth (%) NA -59.5 123.0 49.8 30.1 Provisions and others 3,452 2,681 3,687 4,074 4,854

Total Dividend + Tax 2,337 1,556 2,327 2,724 3,502 Net current assets 6,033 10,287 11,789 8,687 8,492
Source: Company, JM Financial Others (net) 0 0 0 0 0

Application of funds 30,142 54,262 59,316 61,740 64,975

Cash flow statement (` mn) Key Ratios
Y/E March FY08A FY09A FY10A FY11E FY12E Y/E March FY08A FY09A FY10A FY11E FY12E

Reported net profit 4,694 1,900 4,237 6,345 8,254 BV/Share (`) 16.0 26.1 28.0 30.6 34.1

Depreciation and amort. 1,037 1,229 2,292 2,558 2,810 ROCE (%) 19.7 7.5 9.1 13.7 17.3

-Inc/dec in working cap. 2,949 -6,521 1,881 5,233 2,042 ROE (%) 22.1 6.8 11.8 16.3 19.2

Others 0 0 0 0 0 Net Debt/equity ratio (x) -0.1 0.5 0.4 0.2 0.0

Cash from operations (a) 8,680 -3,392 8,410 14,136 13,105 Valuation ratios (x)
-Inc/dec in investments -3,888 3,464 -627 -4,889 -2,929 PER 19.8 48.8 21.9 14.6 11.2

Capex -6,140 -24,656 -6,429 -4,195 -4,311 PBV 4.4 2.7 2.5 2.3 2.0

Others 601 -1,366 925 -679 -463 EV/EBITDA 11.3 23.9 14.0 8.8 6.5

Cash flow from inv. (b) -9,427 -22,558 -6,130 -9,763 -7,703 EV/Sales 1.2 1.8 1.5 1.0 0.8

Inc/-dec in capital 209 13,069 687 -135 -130 Turnover ratios (no.)
Dividend+Tax thereon -2,337 -1,556 -2,327 -2,724 -3,502 Debtor days 18 58 51 25 25

Inc/-dec in loans 2,471 10,706 2,457 -1,062 -1,386 Inventory days 58 81 83 85 80

Others 569 96 1,211 1,000 1,000 Creditor days 110 145 164 157 157

Financial cash flow ( c ) 911 22,316 2,029 -2,921 -4,018 Source: Company, JM Financial
Inc/-dec in cash (a+b+c) 164 -3,633 4,308 1,452 1,384

Opening cash balance 4,349 4,514 881 5,189 6,641

Closing cash balance 4,514 880 5,189 6,641 8,025


30 August 2010

India | Automobiles | Initiating Coverage
Price: `1,093
BUY
Eicher Motors | EIM IN Target: `1,677 (Mar’11)

This one is for keeps Pramod Kumar
Tel: (91 22) 6630 3019

JV with AB Volvo a game changer: The JV with AB Volvo (VECV, which Mitakshi Ashar
accounts for 85% of consolidated earnings) will increase their presence mitakshi.ashar@jmfinancial.in
Tel: (91 22) 6630 3079
(currently 3%) in the `250bn domestic HCV market and also grow as a major
sourcing hub for Volvo.
Key Data
Huge upsides from engine deal; will lead to other sourcing opportunities: Market cap (bn) ` 29.3 / US$ 0.6
AB Volvo recently chose VECV as its manufacturing hub for 85,000 Euro 3,4,5 Shares in issue (mn) 26.8
and 6 engines. Apart from the additional source of revenues (JMFe `12bn in Diluted share (mn) 26.8
CY13 assuming first year exports of 40,000 units) this will give VECV a huge 3-mon avg daily val (mn) `123.2 / US$ 2.6
technology lead over domestic peers. This deal, according to us, is a 52-week range 1150 / 420
precursor to outsourcing of other parts to the JV. Sensex/Nifty (20-08-2010) 18,402/5,531
`/US$ 46.7
Success of JV crucial for AB Volvo: Unlike the developed world, emerging
markets have come out stronger from the slowdown, growing beyond the pre- Daily Performance
crisis highs. Success in emerging markets is crucial and a lot of that depends
on the way VECV grows. AB Volvo expects Asia to be its largest market by 1200
Eicher Motors
200%
2015 with 60% of the demand coming from India and China. 1000 150%
800
Royal Enfield in a sweet spot: RE is seeing an unprecedented demand for its 100%
600
new launches and is enjoying a waiting period of several months. Cult brand 400
50%

equity and lack of competition gives RE tremendous pricing power. Expect 200 0%

volumes of c.57,000 units in CY10 and c.72,000 units in CY11, resulting in 0 -50%

operating profit of `663mn (up 70%) for CY10 and `1bn (up 51%) for CY11.

Jan-09

Mar-09

Jul-09

Sep-09

Jan-10

Mar-10

Jul-10
May-09

Nov-09

May-10
Eicher Motors Relative to Sensex (RHS)
VECV operating profit to witness 98% CAGR in CY09-CY11: We expect
VECV’s operating profit, including the discounted value of the engine deal, to % 1M 3M 12M
be at `5,1bn in CY11. Absolute 13.2 32.4 153.8
Relative* 10.2 21.0 131.2
Net cash of `518/share in CY11 * To the BSE Sensex

Initiate with BUY and TP of Rs1,677, 53% upside: Our CY11E based per Shareholding Pattern (%)
share value of the standalone and VECV operating business works out to `332 1QCY10 1QCY09
(15x CY11E EPS) and `829 (13x CY11 EPS). These along with the cash of `515 Promoters 55.7 55.9
take the SOTP to `1,677. Alternatively, the stock is available 8.7x our CY11E FII 11.0 11.1
consolidated EPS of Rs125 (including the engine deal) and at our TP of DII 10.5 6.7
Rs1,677 it would trade at Rs13.4x. BUY for an upside of 53%. Public / others 22.9 26.3

Exhibit 13. Financial Summary (Consolidated) (` mn)
Y/E March CY09 CY10E CY11E
Net sales 29,386 42,794 52,542
Sales growth (%) 71.1 45.6 22.8
EBITDA 1,593 4,027 5,545
EBITDA (%) 5.4 9.4 10.6
Adjusted net profit 981 2,319 3,053
EPS (`) 36.7 86.9 114.4
EPS growth (%) 355.3 136.6 31.7
ROCE (%) 11.6 25.3 29.0
ROE (%) 6.0 13.1 14.6
PE (x) 29.8 12.6 9.6
Price/Book value (x) 1.8 1.5 1.3
JM Financial Research is also available on:
EV/EBITDA (x) 17.6 6.8 4.8
Source: Company data, JM Financial. Note: Valuations as of 20/08/2010
Please see important disclosure at the end of the report


Eicher Motors 30 August 2010

About EIM

EIM is promoted by the Delhi-based Vikram Lal group. Automobile segment
remains the core focus of the group, with business interest in other areas like
management consultancy, engineering solutions and exports of food
products. Mr S Sandilya (Chairman), Mr Siddhartha Lal (MD & CEO), Mr Vinod
Aggarwal (CEO of VECV) and Mr R L Ravichandran (CEO of Royal Enfield) hold
the key positions of the company. The core management team has vast
experience in various functional areas within and outside the Eicher Group.
Currently, the Indian promoter holds 55.9% and Volvo owns 8.5% stake.

EIM structure
Exhibit 14. EIM Structure

Eicher Motors Ltd

Motorc y c le (Roy al Enfield) VE Commerc ial Vehic les LTD
100% standalone business (VECV) 54.4% subsidiary

Eic her Engineering Solutions
(EES) (USA, 100% subsidiary )

Hoff Automotiv e Design
(China, 100% subsidiary of EES)

Hoff Tec hnology Serv ic e
(China, 100% subsidiary of EES)


Manufacturing facility
Exhibit 15. EIM product profile
Product profile Location Annual Capacity (units)

Motorcycles (Royal Enfield) Thiruvottiyur, Chennai (TN) 60,000 (being expanded)
CV (Trucks, Buses and
Chassis) , Automotive Pithampur (MP) 48,000
gears (for Exports)
Automotive gears (for
Domestic tractors and CV Thane, Mumbai -
sector)
Automotive gears
(transmission gears and Dewas (MP) -
safts)
Source: Company



About AB Volvo’s India operations
Sweden-based AB Volvo is the world’s second largest producer of heavy
trucks. Volvo entered India in 1997 to meet the rising demand for luxury
buses. As the company sells only fully built buses it entered into a JV with
local coach builder, JAICO Automobiles, for manufacturing buses. The
manufacturing facility is located at Hoskote, near Bangalore with monthly
production capacity of 200 plus vehicles. After establishing itself as a
synonym for luxury buses the company started selling high tonnage trucks
for mining application. Volvo is offering FM and FH range of heavy duty trucks
(49tn-150tn) in the Indian market, catering to construction, mining,
petroleum and other similar heavy load areas.

Rationale behind the JV
Despite being present in the country for ten years Volvo was not able to make
much impact in the truck segment due to lack of India specific products
which are low on power, tonnage and price. Incidentally, the company faced
the same problem in other emerging markets where the requirement is for
cheaper trucks. With growth stagnating in developed markets and lack of
emerging market specific products the company decided to partner EIM. The
bus business of Volvo was kept out of VECV as it already had a JV with JAICO.
However, the after sales business for buses was merged into VECV.

Volvo – Eicher Alliance

In Jul’08, EIM formed a joint venture company, VECV, with Volvo. VECV
comprises EIM’s CV, component and engineering solution businesses and the
Volvo Group’s Indian truck sales and services (buses and trucks) operations.

Key highlights of the joint venture

• EIM and Volvo hold 54.4% and 45.6% respectively in the JV company (VECV).
VECV is jointly managed by EIM and Volvo with shared management and
equal representation rights on the board. VECV is a subsidiary of EIM.
• The CV business of EIM along with related components and design services
business was transferred to VECV at an enterprise value of US$506mn.
• Volvo invested a total of US$350mn in VECV (with US$275mn cash and its
Indian truck dealer and service network worth US$75mn).
• Volvo acquired 8.1% stake in EIM from EML promoters.
• Post acquisition of stake in EIM, Volvo’s economic ownership in VECV is 50%.



Exhibit 16. Valuation of the deal
US$ mn
Enterprise value of CV business along with components and engineering
and design business of Eicher motors 506
Amount paid by Volvo for 45.6% stake 350
Divided as
Cash 275
Value for dealership and after sales network of Volvo India (20 in numbers) 75

Value of JV taking value of Volvo's stake 768
Value of Eicher Motors stake of 54.4% (A) 418
Value of Eicher motors business for JV (B) 506
Cash received by Eicher Motors from JV (B-A) 89
Source: Company

JV with AB Volvo a game changer: The JV with AB Volvo (VECV, which
accounts for 85% of consolidated earnings) will increase their presence
(currently 3%) in the `250bn domestic HCV market and also grow as a major
sourcing hub for AB Volvo. EIM on its own had limited technology and
financial resource to take on the quasi duopoly of Tata Motors and Ashok
Leyland in the HCV market. AB Volvo also wanted to participate more
meaningfully in the fast growing Indian market. JV with EIM gave AB Volvo a
complementary product portfolio, a strong manufacturing base and a
management which was ready to take them on-board as equal partners rather
than as a minority partner providing technology.

Huge upsides from engine deal: AB Volvo recently announced VECV as a
global manufacturing hub for 85,000 Euro 3,4,5 and 6 medium duty engines,
thanks to the compatibility of the partners and VECV’s efficient operations.
With this deal AB Volvo will be bringing in its latest technology to India. Of
these 85,000 engines, VECV will do the final assembly of 55,000 Euro 3 and 4
engines and export bulk of them to AB Volvo. Another 30,000 engines for
Euro 5 and 6 will be exported to AB Volvo in the base form. This deal not only
throws up an additional source of revenue (c. `12bn in CY13 and increasing
in subsequent years) but also gives VECV a huge lead over domestic
competition in terms of engine technology. With the Euro 6 engine, VECV will
be ready to meet the Indian emission norms beyond 2020.

Engine deal a precursor to more sourcing: Sourcing of the most critical part
from the JV is, according to us, a precursor to bigger sourcing opportunities
which will also result in deployment of huge surplus cash. We expect large
outsourcing announcements over the next two years.

Success of JV very crucial for AB Volvo: Since Jul’08, when the JV was
formalised, AB Volvo’s global business has taken a big hit due to the
meltdown in the developed world. Revenue fell from US$46.7bn in 2008 to
US$28.7bn in 2009 as demand collapsed in Europe and America. However,
India and other emerging markets have come out stronger from the
slowdown, growing beyond the pre-crisis highs. Increasing its presence in
these markets is very crucial for AB Volvo and a lot of it will depend on the
success of VECV. AB Volvo expects Asia to be its largest market by 2015 with
60% of the demand coming from India and China.



Exhibit 17. Geographical break-up of sales of AB Volvo

100%
8 9 9 5
14 18
80% 19 21

60%

40%

20%

0%
CY03 CY04 CY05 CY06 CY07 CY08 CY09 1HCY10
Europe North Americ a S outh Americ a Asia Other markets

Source: Company

Volvo’s technology and Eicher’s reach, a great combination: Amongst all
the recent JVs in the truck market VECV is best placed to quickly ramp up its
marketshare. While AB Volvo brings in its expertise in R&D, production, sales
and after sales, EIM brings a wide product portfolio, a strong reach and
understanding of the market. The JV has already launched the new line of
HCVs under the VE Series (Value Enhanced) which has resulted in monthly
HCV volumes improving from 100 units to 300 units.

Exhibit 18. Segment wise presence of all the players
Key players tonnage < 3.5 3.5-5 5-7.5 7.5-12 12-16.2 16.2-25 >25 TT 26.4-35 TT > 35
AMW - - - - - - Y - Y
Ashok Leyland - - Y Y Y Y Y Y Y
Force Motors Y Y Y - - - - - -
Hino Motors - - - - - Y - Y -
M&M / Navistar Y Y Y - - - Y - -
MAN Force - - - - Y Y - - Y
Mercedes-Benz - - - - - - Y - -
Piaggio Vehicles Y - - - - - - - -
Swaraj Mazda - Y Y - - - - -
Tata Motors Y Y Y Y Y Y Y Y Y
VECV - - Y Y Y Y Y - Y
Source: Company

Bridging the gap between Indian and European trucks: We expect VECV to
launch a new platform of trucks priced between the existing Indian HCVs and
the European trucks. The current 49tn Indian CV costs around `2mn while a
European truck costs around `6mn. Launching a truck in the mid-segment will
result in greater volumes, and according to us, VECV is best placed to
outperform its peers here. There is a bigger scope for such development in
the bus segment where AB Volvo is a synonym for luxury buses.
Government’s focus on improving the quality of public transportation and
network bodes very well for the luxury bus segment, especially, if prices
could be made more affordable.

AB Volvo bringing in the best talent and practises: AB Volvo has tapped its
global network to bring in the best of the talent into VECV. The plant head
deputed to VECV was handling the Nissan Diesel plant in Japan, one of the
best in the world. Similarly AB Volvo executives have been deputed in areas
like marketing, services, spares and quality.



Vision 2015: 15% of HCV market share against current 3%: The
management has set itself a target to achieve atleast 15% of the HCV market
share in India compared with under 3% currently. In the process, the company
wants to reach the 100,000 units sales milestone compared with 25,164 units
in CY09, implying a target CAGR of 26%.

Exhibit 19. Management vision for 2015
50 35
Thousands

45 43
30 30
40
35 25
30
30
20

%
25
20 15
20 15
10
15 10
10
10 6
4 5
5
- 0
Bus MCV HCV
2008 2015E 2015E minimum marketshare (RHS)

Source: Company

Negative working capital; sales to core capital employed and net fixed
assets over 7.5x: The total capital employed at the consolidated level stood
at `17.8bn for CY09, of which c. `14bn was surplus cash and cash equivalent,
implying capital employed (net of surplus cash) to be a mere `3.8bn.
Similarly, net fixed assets stood at `3.8bn, implying a sales/net fixed assets
turnover of 7.8x. VECV is not only much better placed than its peers, Tata
Motors and Ashok Leyland, but is also comparable to the two wheeler players.

Exhibit 20. Trend in consolidated working capital

2,400

1,526
1,600

826 906
800
Rs mn

89
0
Mar-09

Mar-10
Jun-09
Dec-08

Sep-09

Dec-09

-800
-924
-1,600 -1,347

Source: Company



Royal Enfield can be a big opportunity: We believe, Royal Enfield is
operating much below its potential and can surprise hugely on the upside
going forward. Cult brand equity, lack of competition and successful new
launches are resulting in an unprecedented demand for its bikes. Its latest
offering Classic 350 and 500 have a waiting period of over 5 months. The
company is in the process of ramping up production to meet demand and
aims to sell 100,000 units/year by 2013 with the existing portfolio, implying
a CAGR of 18% for CY09-CY13E. We expect the recent launches in the
superbike segment (Kawasaki Ninja, the cheapest bike costing around
`300,000) and the proposed launch of Harley Davidson (Harley) will lead to
significant growth in lifestyle biking. Harley will create huge aspirational
demand for lifestyle bikes but will be out of reach for many customers due to
the steep prices (ranges from `0.7mn to `3.5mn). This bodes well for Royal
Enfield due to its low pricing (Classic 500, the most expensive bike in the
portfolio, costs around `150,000) and near Harley experience.

Exhibit 21. Classic 500

Source: JM Financial

Expect volume CAGR of 30.5% for VECV and 17.6% for standalone: We
expect VECV and standalone volumes to grow by 30% and 18% between CY09-
CY11E.



Exhibit 22. EIM growth and volumes trend

90 70

72 60
75

50
60 57
Units '000s

52
40

%
45
40
33 30

30
21 20

15
10

- 0
CY09 CY10E CY11E

VECV Standalone VECV YoY Standalone YoY

Source: Company, JMFinancial

Revenue CAGR much higher at 35% and 31% driven by mix: We estimate
VECV’s realisations to see CAGR improvement of 3.4% over CY09-CY11E
driven by ramp-up in HCV business. The standalone motorcycle business is
expected to grow realisations by a whopping 11.1% during the same time
with the launch of Classic range.

Operating profits to post CAGR of 80.8% and 60.3%: Strong volume growth,
mix improvement and benefits of operating leverage will result in operating
margins at VECV to improve from 5.2% in CY09 to 9.3% in CY11, translating
into an operating profit growth of 80.8% to `4.3bn. On the standalone side,
launch of Classic is driving stupendous mix improvement, leading to
operating margins expanding from 10.3% in CY09 to 15.5% in CY11E. Here,
we expect operating profit to grow by 60.3% to `1bn in CY11.

Cash accretion to continue despite huge capex: We expect the current
cash/share to increase from `352 to `518 in CY11 driven by strong business
growth. Even in CY12, when bulk of the `2.8bn for the engine facility will be
invested in VECV, the cash levels are expected to improve due to strong
operational cash flow. VECV is expected to generate over `3bn of free cash
flow in CY11 itself, much more than the total investment in the engine
facility.


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