Two-Wheeler Industry: Growth Drivers Intact

ICRA Rating Services

This is the third and concluding part of the ICRA Report. The second part focused on Influence of supply side factors on the growth of 2W industry. This part dwells on the changing preferences and re-segmentation in the domestic market, export potential and growth scenario in the medium term. Financial outlook for 2-wheeler industry is also brought forth in this part of Report.

Domestic 2W Market

Entry segment of motorcycles shrinking in size as OEMs pursue profitable growth through other 2W segments

Motorcycle models with a sticker price of up to Rs. 40,000 constitute the Entry segment. This segment largely consists of 100cc bikes and is currently composed of the CD Dawn and CD Deluxe models of HHML (now, Hero MotoCorp), Platina of BAL, Star Sport of TVS and Crux and Alba of Yamaha. The Entry segment has faced continual volume pressures in the domestic market over the last several years and was also the worst hit during the credit squeeze in H2, 2007-08 and the economic slowdown of 2008-09. Although sales volumes in this segment have remained flat over 2009-10 and 2010-11, the segment's share in the domestic 2W market has steadily declined from 43% in 2005-06 to 16% in 2010-11 (Refer Chart 6). Several factors have contributed to the waning importance of the entry segment in the Indian 2W market. These include the gradual shift in preference of consumers in favour of the more feature-rich Executive segment, reluctance of organized financiers to increase credit exposure on this segment and the OEMs' own strategy of reducing focus on this relatively less profitable segment.

 
The shrinking volumes in this segment have led to discontinuation of several leading brands of the past. For instance, Bajaj Auto's CT100 was clocking monthly volumes of 80-85,000 in 2005-06, but was eventually discontinued and replaced with the Platina whose current production volumes hover around 30-35,000 per month. Being a segment which offers limited scope for margin expansion and remains a highly interest-rate sensitive segment, almost none of the 2W OEMs have any plans for new model introductions into this segment. Nevertheless, the Entry segment bikes have a strong exports potential especially, to other developing markets. Even now, a large majority of motorcycle exports from India are in the entry segment. For instance, Bajaj Auto mainly sells its entry segment bike Boxer in Africa, a continent that accounts for around 50% of the company's exports. Yamaha, too, is considering export of its mass market bike Crux to Africa and South America. Unless any disruptive innovations materialise (like the Tata Nano in the passenger vehicle segment) resulting in significantly lower price points, ICRA expects the Entry segment volumes to grow at a much slower pace than the overall 2W industry and the volume growth to be driven mainly by exports.

Executive segment remains the largest volume generator for the 2W industry

Motorcycle models with a price between Rs. 40,000-50,000 comprise the Executive segment, which is largely concentrated around the 100-125 cc models. The segment has benefited the most due to up trading from the Entry segment consequent to the growing sophistication of customers, besides the steady and secure replacement demand. Accordingly, the segment's share in the domestic motorcycles segment has risen from 48% in 2005-06 to 65% in 2010-11 (Refer Chart 7). Being the largest volume generator, the Executive segment has also seen the largest number of new model launches and portfolio refurbishments by all players and involves the highest product and brand clutter.

 
Although the executive segment has high competitive intensity reflected in the presence of a large number of brands, Hero Honda remains the clear market leader on the strength of its Splendor and Passion series of bikes that have maintained a dominant position over the years. In fact, in 2008-09, Hero Honda's market share in this segment had touched the highs of 80%, due to subdued competition in that period following lowering of Bajaj Auto's focus on the 100cc segment and the absence of contemporary products in TVS' portfolio. Since then, both Bajaj Auto and TVS have introduced new products - Bajaj Auto launched the Discover 100 in July 2009; and TVS launched the Jive (110cc bike) in December 2009.'Bajaj Auto's Discover 100 has been a runaway success since its launch and has captured a market share of around 22% in less than two years of its launch (currently clocking monthly volumes of 1 lakh units), causing Hero Honda's market share in this segment to revert to historical levels of around -65%. TVS Jive's monthly run-rate, on the other hand, has remained low so far at - 4,000 units, even as it is uniquely positioned as the only auto-clutch bike in the country. While there are brands from several other players too that have a presence in this segment, none have been able to pose any serious competition to Hero Honda so far. Yet, the strong growth opportunity provided by this segment due to its large size has drawn regular new product introductions from all players including Honda Motorcycles & Scooters (third largest player in the Executive segment after Hero Honda and Bajaj Auto), Yamaha, Suzuki and Mahindra, significantly expanding the segment's pie.

Going forward, ICRA expects competition in the Executive segment to intensify further as Honda Motorcycles & Scooters and Suzuki have announced plans to introduce new products in this segment. Concurrently, the refurbishment rate of existing brands is also likely to gain further pace. However, considering the healthy growth prospects of the segment, it is less likely for competition to be based on price and below-the-line promotions. But the segment is expected to derive a greater share of marketing spends as investment in building brands could have positive long-term benefits for gaining/protecting market share in this large volume segment.

Premium segment expected to continue being the fastest growing in the motorcycles market

Motorcycle models with a price of over Rs. 50,000 comprise the Premium segment, which consists largely of greater than 150 cc engine capacity bikes. This category is the most segmented and includes:

(a)	performance bikes, ranging from 150cc to 220cc and consisting of Hero Honda's Glamour, Achiever, CBZ Extreme, Hunk and Karizma; Bajaj Auto's Pulsar family, Honda Motorcycles & Scooters' Unicorn Dazzler, and TVS' Apache RTR, besides models from the stables of Suzuki and Yamaha;
(b)	cruiser bikes such as Royal Enfield's Bullet and Bajaj Auto's Avenger;
(c)	ultra hiking range consisting of Bajaj Auto's Kawasaki Ninja, Honda Motorcycles & Scooters' CB 10000R, Suzuki's Hayabusa and Yamaha's YZF-R1.

 
 
The Premium segment has been the fastest growing one over the last five years having recorded a volume CAGR of 27%, a period in which its segment share increased to 17% in 2010-11 from 9% in 2005-06. Bajaj Auto's Pulsar family comprising of 135cc, 150cc, 180cc and 220cc bikes occupy the frontal position in this segment with a market share of -50% (monthly volumes of 70,000-75,000 units), followed by Hero Honda with a market share of -20%. The balance 30% is almost evenly distributed between Honda Motorcycles & Scooters, Suzuki and Yamaha.

Unlike Executive segment motorcycles, which are positioned as commuter products and family bikes providing basic transportation, the positioning of the Premium segment bikes is anchored on performance attributes. While Executive segment bikes typify higher fuel economy and lower operating costs, the features of Premium segment bikes are characterized by visual appeal, higher speeds, heady acceleration and superior ride, handling and braking. At the edge, however, such clear distinction in terms of target customers has now blurred. This is evident from Bajaj Auto's introduction of the Pulsar 135cc, targeted at the conventional commuter segment aspiring to experience sports hiking. Likewise, the Discover 150cc is positioned as a family bike for the commuter segment wishing to ride a higher displacement bike.

In ICRA's view, the market for this segment offers further scope for segmentation in terms of price points and performance characteristics. Also, the segment is expected to get crowded as new players like Harley Davidson, Ducati and Hyosung gear up to expand their presence in the super-premium segment. At the same time, Bajaj Auto, Suzuki, Honda Motorcycles & Scooters and Mahindra also have multiple products in the pipeline slated for launch in the near term. Some of the new products planned to be launched are either likely to be imported as completely built units (CBUs) or would carry a high imported content resulting in higher prices which could restrict volumes. Although these products are not meant for the mass market, considering the increase in customer awareness levels, the OEMs cannot afford to ignore the price-value equation. Overall, this segment is expected to remain the fastest growing over the medium term, given the disproportionate growth in purchasing power in the hands of middle-class urbanites, especially in the age group of 20-30 years. This should also translate into superior profit margins for players that are stronger in the Premium segment.

Segment repositioning driving growth in the Scooters segment

As a product category, scooters have undergone an image makeover over the last decade. From being a laggard in technology and characterised by two-stroke engines, high emissions and old styling, scooters have metamorphosed into vehicles with more refined engines and contemporary styling. Product positioning has also undergone a change with all OEMs relinquishing geared scooter designs and introducing gearless scooters with low kerb weight and self-start features that are suited to certain consumer categories like women.

Revitalised by these changes, the Scooters segment has grown at a fairly rapid pace over the last five years, albeit on a small base, having recorded a volume CAGR of 18% to reach 2.1 million units in 2010-11. During this period, its share in the total domestic 2W market has also increased from 13% in 2005-06 to 18% in 2010-11. The Scooters segment has also experienced a trend in growing segmentation with the category now having three differentiated sub-segments consisting of sub-100cc models, 100cc models and 125cc models, each having its own value proposition and target segment. While the sub-10Occ segment scooters are lightweight having fibre-bodies, the 125cc scooters are positioned as power scooters with metal bodies. Amongst these three sub-segments, the 100cc scooters sub-segment remains the largest, accounting for 67% of the total domestic scooters market in 2010-11, and is currently dominated by Honda Motorcycles and Scooters.

 
 
 
Overall, Honda Motorcycles & Scooters continues to maintain its leadership position in the Scooters segment, through its flagship brand Activa (besides Aviator and Dio) enjoying a market share of 43% in 2010-11, followed by TVS at 22%. In the past, several players such as Scooters India, Kinetic Motor and LML exited from the segment, unable to run the business profitably in an industry-wide declining volume scenario. In May 2010, Bajaj Auto too completely exited the Scooters segment where it once enjoyed a strong market position. That said, the segment has seen several relatively new entrants in the form of Hero Honda which launched the Pleasure in January 2006; Suzuki which launched the Access 725 in September 2007; and Mahindra which has been the latest entrant in the fast growing Scooters segment through its acquisition of the business assets of Kinetic Motor in July 2008. Yamaha too recently announced its plans to introduce an India-specific Scooter model in the domestic market in 2012, looking to repeat its success in this product segment in Indonesia.

ICRA expects the Scooters segment to maintain its growth momentum over the medium term and gradually increase its share in the domestic 2W market from 18% in 2010-11 to 24% by 2014-15. With this, the Scooters market is estimated to get double in size by 2014-15. Thus, even as a multitude of brands already dot the segment's landscape and more are expected to follow, the likely expansion in the pie should offer sufficient volumes for the industry to grow profitably. For the new entrants, a steady gain in market share could hasten the process of profitability improvement.

Exports

Overseas markets capturing the interest of most 2W OEMs in India

Exports offer strong growth opportunity to Indian companies, given India's low-cost manufacturing capabilities and reliable quality. 2W exports from India reported a CAGR of 25% over the period 2005-06 to 2010-11 to reach 1.5 million units in 2010-11. BAL is the largest 2W exporter from India, followed by TVS, with both companies exporting to a large number of countries. Together, BAL and TVS accounted for 79% of all 2W exports from India in 2010-11 and the managements of both companies consider exports a key component of their overall growth plans.

 
However, export volumes of the largest 2W manufacturer in the world Hero Honda, have remained rather flat, being around 0.1 million units and accounting for just 2% of its total 2W sales volumes in 2010-11. Nevertheless, following the cessation of its JV agreement with Honda Motor Company (Japan) recently, Hero Honda is expected to get aggressive on the exports front, something it could not do earlier due to the JV's constraints which restricted the markets to which it could export. Currently, HHML's export markets are limited to Bangladesh, Sri Lanka, Nepal and Columbia but the company is likely to expand its geographical footprint over the medium term. Yamaha too has announced plans to intensify its focus on exports and is even looking to set-up a third plant (in addition to the Surajpur and Faridabad plants) where it would manufacture mass-market bikes (like Crux and YBR) with Africa and South America as the key target markets.

Since the developed markets like the United States and Europe have altogether different product and technology requirements as compared to emerging markets, they get naturally excluded as target markets for the Indian players. Accordingly, a large majority of 2W exports from India are to developing markets like South Asia, Africa and Latin America. While the developing markets are quite large in terms of volume potential, their appeal from a profitability perspective is somewhat mixed. Bajaj Auto's margins in certain markets like Africa are either similar or lower than that in the domestic market; although in various other overseas markets, it does earn 3-4% higher margins. At the same time, competition from global players in other developing markets is also quite formidable. For instance:

-	The African market is replete with Chinese bikes, which provide strong price-based competition to other players;
-	The South-East Asian market also has high competitive intensity where the Japanese majors like Honda, Yamaha, Suzuki and Kawasaki command the bulk of the volume share; and
-	The Chinese market, the largest 2W market, has its own set of challenges including lack of respect for intellectual property and low price points.

 
Over the years, Bajaj Auto and TVS have expanded their overseas presence in a large number of countries and have even established assembly units in China (Bajaj Auto) and Indonesia (Bajaj Auto and TVS) to have direct local presence. However, for sustaining exports growth going forward, the domestic players will need to continuously identify new potential markets, develop products suited to local needs, invest in building brands for increasing market share and appropriately cope up with the challenge of establishing a distribution network.

Financial Outlook

Rising raw material costs remains the biggest challenge for sustaining profit margins

Raw materials remain the biggest component in the cost structure of OEMs accounting for around 85% of total costs. Thus, the Operating Profit Margins (OPM) of OEMs are quite sensitive to movement in prices of major raw materials like steel, aluminium and rubber. After a period of benign raw material prices in 2009-10, prices of most commodities showed an upward trend in 2010-11. Despite the strong demand, OEMs were able to pass on the increase in input costs to customers only partially; but could mitigate the adverse impact to some extent through internal cost reduction and focus on changing product mix towards superior margin products.

 
 
In case commodity-based headwinds continue, OEMs may be left with no choice but to further increase 2W prices whose impact on demand is expected to be different across segments - demand elasticity is higher in the Entry and Executive segment of motorcycles as compared to the Premium segment. However, the largest two OEMs have other levers available in the form of scale of operations, superior bargaining power with their vendors and dealers and scope to enhance capacity at their plants located in Uttarakhand where they benefit from fiscal incentives; which should enable them to partly offset the margin pressures imminent. Additionally, the strategy of select players to diversify into other related product categories like diversification into three-wheelers (3W) by Bajaj Auto and TVS; and proposed diversification into the Scooters segment by Yamaha is also expected to provide them scale benefits and support EBITDA growth.

Both Bajaj Auto and Hero Honda (now, Hero MotoCorp) currently have manufacturing plants in Uttarakhand, which provides them various fiscal incentives such as 100% excise exemption for the first 10 years, 100% income tax exemption for the first five years and 30% income tax exemption for the subsequent five years. Bajaj Auto had commenced commercial production at its Pantnagar plant in April 2007; and Hero Honda had commenced commercial production at its Haridwar plant in April 2008. Currently, both OEMs produce over a third of their total 2Wproduction from these plants which offers them excise duty exemption on effective value add and provides benefits in the form of lower effective income tax rates. Overall, operations from these plants are estimated to result in savings of around Rs. 500 per vehicle for these OEMs. As these fiscal incentives lapse, the comparative advantage enjoyed by these players on this aspect would accordingly reduce to that extent over a period of time.

 
In view of the strong demand, most OEMs have lined up capacity expansion plans over the short term. This is likely to increase the proportion of fixed costs in their cost structure in the initial phases till such time as production ramps up. In this period, the RoCE of such OEMs is likely to dip to a certain extent; however, the expected strong volume growth over the medium term should allow them to overcome such profitability challenges eventually.