Is The Indian Two Wheeler Industry Back to Recovery? – Part 1

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I. DEFINITION, SIZE, AND SCOPE OF THE INDIAN TWO WHEELER INDUSTRY

Definition of the Industry:

The two-wheeler industry can be defined on the basis of its functions:

  1. Designing and manufacturing of engines
  2. Assembling various components purchased from Auto ancillaries
  3. Branding the product. 

Language of the Industry:

Before attempting to understand and analyze the two-wheeler industry, it is important to be familiar with some key jargon often used in the industry. Below is its link.

https://drive.google.com/file/d/1EghgeCSSwjFLgxJ2aYshkm93Iwz3vMGi/view?usp=sharing

Size and growth of the Industry:

More than 1.74 crore two-wheelers were sold in India in FY20 (-18% YoY). This was the first year of de-growth experienced by the industry in the last decade, mainly due to weak consumer sentiment, subdued rural demand, and an increase in the cost of ownership.

Geographically speaking, export sales have been growing faster (~12%) than domestic sales (~6%) leading to a higher share in the overall two-wheeler sales.

Within domestic sales, the ‘Scooters & Mopeds’ segment has been growing 3x faster than the ‘Motorcycles’ segment resulting in the latter losing share in the domestic market from 78% to 65% in the last 10 years

Excel file containing the Industry sales data –

https://drive.google.com/file/d/1PpBxB-sfhrwabRFgXuf93fiKoxgE0NDB/view?usp=sharing

Geographic scope:

Export sales have been growing at a compounded annual growth rate of 12% over the last 10 years. In FY15, Asia and Africa combined accounted for ~64% of the total export sales. As we can see below, even today, Asia and Africa remain the key export destinations for Indian two-wheeler manufacturers followed by Latin America.

II. SEGMENTATION AND SUB-SEGMENTATION OF THE INDUSTRY AND VALUE CHAIN ANALYSIS

‘Segmentation’ refers to the bifurcation within an industry. Say for instance – Under the ‘Banking, financial services and insurance’ (BFSI) sector; Banking, Insurance, etc. are industries.

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Now within the Banking industry, there are segments like Private banks, Public banks, etc. Segmentation can be done on the basis of pricing, products, market types, business models, etc. The purpose of this exercise is to provide a holistic view of the entire sector broken down to its last segment.

Below is an illustrative representation of ‘Segmentation’ done within the BFSI sector.

The value chain, on the other hand, shows a horizontal flow of how the initial raw material gets converted to the final finished product which is eventually sold to the customer. It shows us the value addition happening at each stage. The purpose of making a value chain is to understand where exactly our industry/company lies in the entire sector landscape.

In the automobile sector, segmentation can be done on the basis of value addition happening at each stage, and hence ‘Segmentation’ and ‘Value chain’ will be one and the same here.

Below is the Segmentation/Value chain of the entire automobile sector

The process flow of the automobile sector goes like this –

  1. Raw materials like Steel, Aluminium, Rubber, etc. are purchased by auto ancillaries and are converted by them into automobile parts like Axles, bearings, chain, tires, etc.
  2. These parts are then sold to vehicle manufacturers where they assemble them to make their desired vehicle.
  3. The vehicle is then sent to auto dealers from where the customers buy them through cash or credit (vehicle financing)

III. INDUSTRY MAP

Industry Map (or ‘Lay of land’ as Michael Mauboussin calls it), is a diagrammatic representation of all the factors, internal as well as external, that might have an impact on the industry’s profitability. It helps us understand the potential opportunities and threats that might arise due to a change in these factors.

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  1. Crude oil prices – Rising fuel prices have a negative impact on consumers buying decisions when it comes to automobiles because that would mean higher transportation costs once the vehicle is bought.
  2. Adoption of EV –The fate of the entire automobile sector would be dependent on how fast and innovatively they shift to EVs. It is currently the single biggest threat to the entire sector.
  3. Insurance costs – Effective 1st September 2018, it has become mandatory to take a 5-year third party insurance cover for new two-wheelers purchased and the entire premium for those 5 years has to be paid upfront. This has led to an increase in the premium amounts. Until FY18, insurance costs accounted for ~4-6% of the vehicle cost but post the increase in the insurance cost in Q3FY19, insurance now accounts for roughly 11-13% of the vehicle cost.
  4. Bharat Stage Emission Standards (BSES) – Implementation of BSVI had an impact on the price of two-wheelers.

5. Interest rates – An increase in the cost of financing will increase the overall cost of ownership for two-wheelers leading to a fall in demand.

6. INR/USD exchange rate – Exchange rates play an important role in the two-wheeler industry’s profitability. A strong dollar implies more Indian rupees coming in from export sales.

7. Raw Material prices – Raw material costs form around 70% of the overall revenue of the industry. Thus, it remains a major factor impacting the industry’s profitability.

8. GST – Two-wheelers currently attract the highest GST rate of 28%. Any reduction in the following tax will further increase the industry’s profitability or lead to a reduction in the cost of vehicles, depending on whether or not the tax benefit is passed on to the customers.

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IV. PROFIT POOL ANALYSIS

The word ‘Profit’ here refers to ‘Economic/Real profit’ i.e. Return earned over and above the cost of capital. Profit pool analysis helps us understand as to how the industry’s economic profit is distributed amongst its players with respect to the capital employed by them. It shows us where the profits of the industry are concentrated.

This is how the profit pool has moved from FY14 to FY19. As we can see, Bajaj Auto accounted for 68% of the total economic profit of the industry* in spite of contributing to only 38% of the total capital employed.

Another observation here is how drastically opposite Hero Motocorp and TVS Motors have performed since FY14. Hero Motocorp which accounted for around 18% of the total profit in FY14, now accounts for only 6%.

On the other hand, TVS Motor which didn’t contribute to profits in FY14 now contributes to about 16% of the total industry profits. An interesting thing to note here is how in both the years, only 2 players accounted for more than 80% of industry profits. This is where the profits are concentrated.

Profit Pool analysis calculations

https://drive.google.com/file/d/1iiBGnqt5c9IzhKDWZbdvjwQA7srQax2e/view?usp=sharing

*in FY19 these 5 players accounted for around 93% of the total two-wheelers sold and hence they have been used as a proxy for the entire industry.


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Amey Chheda
Amey is a Chartered Accountant, an Equity Investor, and a Blogger.
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