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Hero Honda: A SWOT analysis

Apr 11, 2005

Today if one talks about Indian two-wheeler industry, reference to Hero Honda Motors Limited is by default. It is not only the market leader in the two wheeler segment in India but also is the number one two wheeler company in the world by volumes. The company's name is synonymous with fuel-efficient bikes and longevity. The company has a presence in all bike segments viz. economy (CD 100SS, CD Dawn) executive (Super Splendor, Splendor+) and premium (Karizma, CBZ). Splendor is the most successful product of the company and accounts for almost 50% of the company's turnover.

Background
Hero Honda is a two-decade-old story. It came into existence as a joint venture agreement between the Munjal family's Hero Group and Honda Motor Company (HMC) of Japan, each having 26% stake in the company. A ten year agreement was first entered in the year 1984, whereby HMC brought in technical expertise and Hero Honda brought in local talent to manage all other functions including marketing, finance, and human resources. The agreement was once again renewed in 2004 and has been extended till 2014.

Performance vis-a-vis Industry
The Indian two wheeler industry has seen a paradigm shift from being a regime of regulation and tight control in the 1980s to a more liberalised and a competitive present day era. After missing out on the initial boom in two wheeler segment during the period of 1993-1996, Hero Honda has emerged as a world leader. The gap between motorcycles sold by Hero Honda and its closest rival is approximately 1 m units (23% of industry size). One of the reasons for the tremendous performance of Hero Honda is the significant increase of share of motorcycles in the two-wheeler segment, from 42% in FY99 to 77% in FY04. No doubt, that the shift in preference of Indian populace from scooters and mopeds towards motorcycles has facilitated the growth of Hero Honda. However its performance vis-a-vis industry indicates that the performance of Hero Honda was better than the industry peers, barring two years. In the seven-year period ending FY04, it has achieved a CAGR of 30% in two-wheeler volumes against 11% of the industry.

Past 5 year performance...
As can be seen from the table below, the company the sales as well as the profits have increased enormously. The company net sales has shown a CAGR of 27% and net profits have shown a CAGR of 39% led by its motorcycle led dominance. The operating margin of the company has improved by 290 basis point to 16.8%.

(Rs m)FY00FY01FY02FY03FY04
Motor Cycles sold (m)0.76 1.03 1.43 1.68 2.07
Net sales22,46431,68744,65451,01758,324
Other income2042217679561,681
Total revenues22,66831,90745,42251,97360,005
Operating profit3,0704,2856,8078,6369,801
Depreciation347443510580733
PBIT 2,7243,8436,2978,0569,068
Interest4725151717
PBT2,8804,0387,0498,99510,732
Extraordinary Items-34-268-105(149) (7)
Tax9251,3012,3153,0383,441
Net Profit 1,9212,4694,6295,8087,283
Operating profit margin13.7%13.5%15.2%16.9%16.8%
Net profit margin8.6%7.8%10.4%11.4%12.5%
Number of shares (m)39.9199.7199.7199.7199.7
Face Value (Rs)10.02.02.02.02.0
DPS (Rs)10.03.017.018.020.0
EPS (Rs)48.112.423.229.136.5
Fully Diluted EPS (Rs)9.612.423.229.136.5

Strong Fundamentals
As evident from the table company has a strong balance sheet. Further the company has a consistent record of paying dividend.

RatiosFY00FY01FY02FY03FY04
RONW20.0%100.0%100.0%100.0%100.0%
ROCE37.8%36.5%58.5%59.0%55.5%
Debt Equity (x)0.10.10.20.20.2
Interest coverage (x)57.8151.9417.0465.7527.2
Dividend payout0.9%0.6%0.4%0.4%0.3%
BVPS111.130.533.842.557.0

The company has clarified about its intention of setting a third plant in addition to its existing two plants. The company has embarked upon a green field expansion plan and has earmarked Rs 2 bn for the same. It should be noted that the company has a strong cash flow position, it generated Rs 9 bn from operation in FY04 and is virtually a debt free company.

What to expect?
With liberalization take a strong hold in the country, the automobile sector has changed from a sellers' market to a buyers' market. The automobile sector is one of the most competitive sectors with competition on all fronts i.e. pricing, new launches, innovativeness, efficiency, network of dealers etc. Further, the market share of motorcycle in the two-wheeler industry at present 78%, presenting a limited further upside.

From Hero Honda's perspective, the effect of competition and the pricing pressure is evident from the fact that though the growth in sales volume in FY04 was 24% YoY, the same was only 14% in value terms. Further the operating profit is showing a decreasing trend, from 66% growth YoY in FY00 to 13.5% YoY in FY04, and is expected to continue. The rise in the cost of inputs like steel, rubber, plastics pose a significant problem due inability to aggressively price the product thereby adversely affecting the operating margins. Further publicity and advertisement expenses are expected to rise for aggressive marketing of new launches and existing products.

Among other concerns, the new agreement between Honda Japan and Hero Honda does not have 'no compete clause'. Secondly, The company is planning to foray into the scooter segment with a launch scheduled in mid-2006. The rational behind this seems to be obscure, as the share of the scooters in the two-wheeler industry has reduced to 16% from a high of more than 50%. Even the market leader, Bajaj Auto, is facing the industry pressure.

As per the NCAER report the demand for motorcycles in India is expected to be 10 times that of the scooters and moped by 2011-12. At the same time one has to bear in mind that Hero Motors (a Munjal group company) has entered into an agreement with 'Aprilla' to strengthen its presence in the ungeared scooter market. Thus in effect this would result in two companies of the same promoter group competing against each other. Further, Honda Motors, Japan through its 100% subsidiary has a significant presence in the scooter segment.

At Rs. 535, the company trades at a price to earnings multiple of 12 times and Price to free cash flow ratio of 27.5 times our FY07E estimates. Though Hero Honda has done well in the past, we are skeptical of its prospects in view of the competitive environment within the segment. We foresee margins coming under pressure. We prefer Bajaj Auto within this segment.

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