Hero Honda: In sight of a landmark

One month and approximately 0.2 m vehicles short! If Hero Honda, the market leader in the motorcycles industry, were able to achieve the above-mentioned sales target for the month of March, then it would be the first auto company to break past the 2 m barrier in a single financial year. The performance can definitely be termed as credible as the company had a rather poor FY03 (company's unit sales grew at a rate of 18% as compared to industry growth rate of 41%) and also a sluggish start during FY04.

As is clear from the above chart, the company had a rather sedate start to the year, registering sales of modest 0.13 m units for the month of April 2003. However, with the launch of the company's new models, 'Splendor Plus' and 'Passion Plus' in the month of September and also the onset of festive season, sales picked up and the company had three strong months (Oct, Nov and Feb) where two-wheelers sales touched the 0.2 m mark. Thus, with strong sales expected in the month of March, the company is hopeful that it will break past the 2 m barrier.

*Sales until Feb'04

If one assumes unit sales for FY04 to be 2 m units, then the vehicles sold by the company over the last five years have grown at a CAGR of an impressive 27%. The motorcycle industry during the same period (assuming a 15% industry growth rate for FY04) has grown by almost similar rate of 28%, thus signifying the fact that despite intense competition, the company has been able to more or less maintain its market share in the industry over the long term.

However, the next three years are going to be crucial from the motorcycles industry's point of view. While the industry is expected to grow in the region of 15%, new product launches and aggressive pricing will be the order of the day and the company will have to try hard to preserve its market share.

Similar to its competitors, Hero Honda will also have to make significant investments in new product development and this is where the company's strong cash and liquid investments in the vicinity of Rs 12 bn will act as a strong cushion. Unlike its rivals, Hero Honda is predominantly a producer of motorcycles and hence has slightly better operating margins on account of higher realisations for the same. Though the company's products command a premium in the market, which we expect to narrow in the future.

The stock is currently trading at Rs 450, implying a P/E of 13x its annualised FY04 earnings. While the prospects of the industry look good, much will depend on the company's ability to preserve its market share in the face of intense competition. Given the company's track record and its strong cash flow position, we believe the company will reward its shareholders adequately from a medium to long-term perspective.