Company plans to shut its Akurdi plant and shift production to Waluj to take advantage of tax concessions and reduce costs

If it sells the 200 acre Akurdi land, we estimate it could add INR100/share, a potential upside risk

We maintain our earnings forecast and Neutral rating with an unchanged target price at Rs 2,420

Akurdi land could add to value

Bajaj Auto plans to shut down its Akurdi plant from September 2007 and shift its production to its Waluj plant (both in Maharashtra). The company was manufacturing its Kristal scooter at the Akurdi plant, which was operating at 4% capacity utilisation. The company expects to save Rs 1,000 per bike due to sales tax benefit and other tax concessions, by shifting production to Waluj.

We have done a scenario analysis to estimate the net gain that may accrue to Bajaj Auto if it chooses to sell its 200 acre Akurdi land after reaching an agreement with workers. HSBC estimates the land rate at Akurdi to be about Rs 1,000-1500 per square foot, based on discussions with real estate agent. The average of this translates into Rs 107 per share of Bajaj Auto. The Akurdi plant currently employs 2,730 workers. Since this is the oldest plant of Bajaj Auto, we expect the average age of the worker to be 45 years. If we assume that the company and the employees agree to a voluntary retirement scheme of 5 years’ pay at the current rate, it could cost the company Rs 8/Bajaj Auto share. We believe the whole transaction could add Rs 100/share to Bajaj Auto’s valuation. Our sum-of-the-parts value of Rs 2,420 per share does not include the Akurdi land value, as the sale is not certain; this is a potential upside risk to our estimates.

Maintain Neutral with unchanged target price of Rs 2,420

We value Bajaj Auto using a sum-of-the-parts valuation methodology. Our DCF-based fair value estimate of the automobile business is Rs 1,200. In our DCF, we have assumed a cost of equity of 13.5%. We have used a three-stage DCF with the semi-explicit forecast period of 10 years starting FY11 in which we assumed NOPLAT CAGR of c11%. Our target price of Rs 2,420 comprises Rs 1,200 for the automobiles business, Rs 501 for the insurance business and Rs 717 for value of investments (rounded up) net of debt.

Risks

Valuation of life insurance business is dependent on the new business growth and margin assumption. Lower than expected growth and margin represents potential downside valuation risk.

We have assumed that Allianz would be able to raise its stake to 74% from existing 26% in life insurance business. Allianz’s inability to exercise a call option represents an upside risk.

Better than expected performance of its new bike is also a key potential upside valuation risk.

The possibility of the sale of land at the Akurdi plant represents and upside risk.