TVS reported decade-high margins in Q2, allaying concerns on post-BS-VI earnings impact. Diversified revenues and strong R&D capability provide long-term defensiveness — compelling in the current environment. Increased confidence on long-term margin trajectory prompts our upgrade to ‘buy’ (from ‘hold’); raise target price to Rs480 (from Rs370).
TVS reported its highest quarterly margins (ebitda margin of 9.3%) in over a decade, despite, nearly 20% lower volumes compared to the peak (in 2Q19); a headwind from the BS-VI-led cost increase, and higher commodity prices. The positive margin surprise was partly led by better mix, salary rationalisation and lower marketing expenditure.
However, on a more structural basis, the focus on fixed cost rationalisation, supply contracts renegotiation and value engineering is yielding results in earnest, in our view. There has been a steady rise in margins for the past five years, but the outperformance in recent quarters versus Street expectations is noteworthy given the tough demand environment, thus providing confidence on the medium-term margin trajectory.
We now factor in ebitda margins of 9.5%/9.6% for FY22e/23e, close to the current quarter margins, led by positive operating leverage, price hikes (average of 2.5% in the past three months) and cost-reduction initiatives.
Well positioned in the near term. TVS has seen an increasing revenue contribution from the export markets (now c30% of revenues) and 3Ws (9% of revenues in FY20) in the past three years. The near-term growth outlook for key export markets appears robust and should help offset any likely weakness in the domestic 2W market in the near term. Also among the listed 2W players in India, TVS is the only one with an equally strong presence in both domestic motorcycles (MCs) and scooters.
With the bulk of pent-up demand likely behind us after the festive season, recovery in urban demand and mobility are the key considerations going forward, in our view. From that perspective, TVS is well positioned with its presence in scooters as well as premium MCs.
Investment thesis. While we have been positive about TVS’s product development capabilities, our previous rating was driven by earnings vulnerability in a tough environment, as TVS’s margin profile and scale relative to domestic peers remain weak.
However, we think the risk-reward is now favourable, given the strong recovery in key export markets, the impact of the BS-VI transition now being behind (which, in our view, was a 70-100bp headwind) and better-than-expected cost management.
The defensive nature of the business is more compelling in the current uncertain demand environment, and we therefore believe the valuation premium to peers is justified. Margin expansion-led strong earnings growth (20% CAGR over FY20-23e) will likely continue in the medium term and drive stock returns. We upgrade the stock to ‘buy’ (from ‘hold’) with a DCF-based TP of Rs 480 (earlier Rs 370).
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