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Hero Honda: Appraisal time

Mar 28, 2003

Of the top five losers over the last one year among the auto sector, Hero Honda is the noticeable one. The company's market capitalisation has declined by 38% during the course of FY03. We take a brief look at reasons for the decline in stock and its growth prospects.Over the last five years i.e. during the transition of preference to motorcycles from geared scooter, Hero Honda has been the biggest beneficiary. The motorcycle demand grew at 33% CAGR in the last five years. Consequently, the company has extended its market share to 50% in FY02 as compared to 45% in FY98. However, the concern now seems to stem from the fact that Hero Honda is more likely to lose market share going forward, given the intensity of competition in the motorcycle segment. Bajaj Auto, TVS, LML and MNCs have tasted success in the recent past.

More importantly, as far as Hero Honda is concerned, it is important to look segment-wise even in the motorcycle sector. Broadly speaking, the sector has three main categories i.e. entry-level, executive and power. These segment contributed to 37%, 56% and 7% of motorcycle sales in FY02. If one were to look at the category-wise market share of Hero Honda in FY02, it stood at 18%, 74% and 18% respectively. The reason for the lacklustre performance of the company in FY03 is primarily due to the lack of competent models in all categories. In the power segment itself, Bajaj Auto is expected to sell more than 140,000 units (Pulsar) in the current year apart from the impressive volume performance of TVS 'Victor'. Hero Honda 'CBZ' has lost its sheen with monthly volumes not more than 4,500 units as against 12,000 for 'Pulsar'.

Besides, Hero Honda has been a negligible player in the entry-level category historically. Attempts to address this concern with the launch of 'Dawn' and 'Joy' in 2001-02 failed to deliver results. As a result, the company has lost market share in the current fiscal. The company has set a target of selling 1.8 m motorcycles in FY03, which it scaled down in 4QFY03. We expect the company to record total volumes of about 1.7 m in FY03.

The stock currently trades at Rs 198 implying a P/E multiple of 7.1x our FY03E earnings (dividend yield is at an impressive level of 10%). Apart from concerns about competition, the expiration of agreement with Honda was also affecting the stock. However, with Honda now having extended its technology agreement till 2008, concerns in this context have abated to an extent. That said, the company will face competition from Honda Scooters in the future and it remains to be seen how model launches pare out (cannibalisation is also a key issue). Given this backdrop, despite strong brand equity, extensive dealership and attractive valuations, it is a status quo kind of a situation at the current juncture.

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