Assignment Part 1

Company Profile

The Bajaj group comprises of 27 different companies. Bajaj Auto Ltd. (BAL) is the flagship company of the group.

The Bajaj group of companies in the year 1926. Mr. Jamnalal Bajaj was the founder. In 1942, his son Kamamnayan took over the reins of the company. He consolidated the group and also diversified the business, thereby elevating the Bajaj group to its current position in the industry. Rahul Bajaj is the Chairman and Managing Director of the company today. Madhur Bajaj is the Vice Chairman and Rajiv Bajaj is the President. Sanjiv Bajaj is the Vice President (Finance).

BAL came into existence as M/s Bachraj Trading Corporation Pvt. Ltd. on November 19, 1945. In 1948, it started sales of two- and three-wheelers in India by importing them. It was much later in 1959 that the company obtained a license from the Govt. of India to manufacture two- and three-wheelers. The growth of BAL since then can be termed as spectacular. In 1969-70, Bajaj sold its 100, 000^th vehicle. In 1976-77, Bajaj sold 100, 000 vehicles in a financial year. In 1986-87, 500, 000 vehicles were produced and sold in a single year. In 1994-95, BAL sold a phenomenal 1 million vehicles in a single financial year. Today BAL is the second largest two- and three-wheeler manufacturing company in India, and one of the largest in the world.

Production figures for January 03 in comparison with last year are given below:

It has three manufacturing facilities, in Akurdi (Pune), Aurangabad and Chakan (Pune). In keeping with the consumer preference for motorcycles compared to scooters, BAL has re-oriented itself to produce more motorcycles than scooters.

Bajaj Auto Ltd. became a public limited company in the year 1960. Today its annual turnover is a healthy Rs. 44.03 billion and market capitalization stands at Rs. 51.9 billion. In addition to two- and three-wheeler manufacture, BAL has also forayed into insurance and investment business. However, as per fiscal 2002 revenues, automotives resulted in 95% of the revenues.

Significant Financial Data and Performance Indicators

Listed below in the following tables are the key figures from the P/L account and Balance sheet for BAL for the last few years. Also listed are the key financial ratios and valuation ratios that are the Performance indicators for BAL. This data is also used in subsequent sections for analysis purposes.

Shareholder value maximization framework

The four key elements that affect the shareholder value of a company are

• Profitability
• Growth
• Risk
• Capital Market Conditions

Applying the shareholder value maximization framework to Bajaj Auto Ltd. for year 2001 and 2002, we get the following table:

As can be seen from a comparison of the P/BV ratios, it has risen from 0.99 in 2001 to 1.8 in 2002. This indicates a definite increase in shareholder value from the previous year.

Let us apply the shareholder value maximization framework to Bajaj Auto Ltd. and to its close competitors, Hero Honda Motors Ltd. and TVS Motor Company Ltd. The information that we have is presented below:

Sales Comparisons (Fiscal Year ending 2002)

Profitability Comparisons (Fiscal Year ending 2002)

As can be seen, Hero Honda is doing really well, followed by Baja Auto Ltd. TVS is bringing up the rear.

Applying this information, we get the following table:

Checking out the P/BV and P/E Ratios for the three companies, we get

Assignment Part 2

Calculate intrinsic value

The dividend payout for Bajaj Auto Ltd. for the last 10 years is as seen below

So it looks like Bajaj Auto Ltd. has been paying out a dividend ranging from Rs. 8/- to Rs. 10/- per share for most years ranging from 1990 onwards.

If we look at the market prospects for Bajaj, it has taken an aggressive game plan to counter the fierce competition and changing consumer preferences in the market. It has decidedly shifted its focus from geared scooters to motorcycles. It has also planned an onslaught of new releases in the market, targeting all the different market segments in motorcycles. Its major brands Boxer and Pulsar are doing very well in the market. So it appears that BAL has been able to come out of the low level it had hit in 2001. In 2002, Bajaj reported a 15% growth in value due to increased sales. However, BAL is operating in a highly competitive market. It will be very difficult for BAL to maintain these high growth rates for a long time. So it would be advisable to assume a zero-growth model for BAL.

According to the zero-growth model, intrinsic value is given by the formula

IV = D/R

Given D = 10 (assuming BAL will maintain dividends at Rs. 10/-) and R = expected rate of return as 15%, the intrinsic value of BAL works out to

IV = 10/0.15 = Rs. 66.67

The current market price is Rs. 512.95, which is much higher in comparison to the intrinsic value.

(At the current price of 521.1, we can calculate R = 10/521.1 = 1.9%, which is very low)

Hence it is not advisable to buy BAL shares in the market today with the intention of keeping them. In the short run, of course, there could be capital gains as the share value rises on the basis of expected growth in the two-wheeler market segment.

Assignment Part 3

The Beta value for Bajaj Auto Ltd. is 0.73.

            To calculate the Cost of Capital, we will use the Weighted Average Cost of Capital (WACC) formula

            WACC = (E/V) X R_E + (D/V) X R_D X (1 - T_C)
where

            E = Market Value of the firm's equity

            D = Market Value of the firm's debt

            V = Combined Market value of debt and equity = (E + D)

            R_E = Cost of Equity Capital

            R_D = Cost of Debt Capital

            T_C = Corporate Tax Rate

            Calculating the cost of capital for BAL, we get:

The weighted average cost of capital works out to 12.54% a year. As can be seen for BAL, 98% of the capital is in the form of equity. Only about 2% of the capital is funded through debt. It can also be observed that the interest on loans works out to be approximately 9% (excluding the Sales Tax Deferral), whereas the cost of equity works out to be around 12.5%. Since the debt part of the capital is very low (D/E ratio = 0.22), we can see that the financial risk of the company is very low.

Hence it can be seen that in the current scenario of falling interest rates on loans, BAL has a higher cost of capital than is optimum. In addition, BAL has huge reserves of surplus cash that it is unable to invest at the rates matching the cost of capital. Bajaj Auto is estimated to hold about Rs.18, 000 million in the form of loans & advances, debt/equity investments and cash in hand.

BAL is aware of this problem, as is evident from the fact that BAL decided to buyback some of its outstanding equity shares in 2001. This reduction in the capital base has reduced the cost of equity for the company. It has also reduced the huge amount of surplus cash that the company has on its hand.

Assignment Part 4

To calculate the ratios, let us first write down the values as observed in the 57^th Annual Report of Bajaj Auto Limited.

Now calculating the ratios as per the formulae, we get the following values

A look at the short-term solvency ratios indicates that the liquidity position is comfortable, since the current ratio and quick ratios are both above 1, though only slightly. But there is a decrease in both the ratios in year 2002 compared to year 2001 that is of slight concern. This seems to be mainly due to increases in provisions for taxation and proposed dividends.

Looking at the long-term solvency ratios, both the Debt-Equity ratio and the Long-term Debt ratio are in the range of 0.2, which indicates that the company is funded mostly by equity.

Among the activity ratios, the Inventory Conversion Period has been reduced from 30 days to 18.16. This is a positive sign as it indicates an overall reduction in inventory levels held by the company. However, the Average Collection Period has increased from 14.5 to 20. One possible explanation for this could be a more lenient credit policy owing to heavy competition in the industry. The annual report mentions an increase in debtors because of four bank holidays in the last week of March 2002. This could also possibly have had some effect on collections.

The profitability ratios indicate that Gross Profit Margin and Profit Margin have increased significantly in 2002. If we look at the data available for the previous years (See "Significant Financial Data and Performance Indicators"), we perceive that the profitability had drastically fallen in 2001. In 2002, Bajaj seems to be recovery path. These figures, thus, infuse some credibility into the statements by BAL that 2001 was an anomaly year, as far as performance went.