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Hero Honda: Tried and tested

Jul 9, 2002

Despite concerns of increasing competition and higher discount sales, Hero Honda, has posted yet another impressive performance. The two-wheeler major has reported a 34% rise in sales for the first quarter ended June 30, 2002. Margins, in contrast to expectations, have also shown marked improvement.

(Rs m)1QFY021QFY03Change
No. of motorcycles sold (Nos) 306,930 421,679 37.4%
Net sales 9,520 12,744 33.9%
Other Income 30 160 434.3%
Expenditure 8,187 10,630 29.8%
Operating Profit (EBDIT) 1,333 2,114 58.6%
Operating Profit Margin (%)14.0%16.6%
Interest 4 7 62.5%
Depreciation 141 135 -4.3%
Profit before Tax 1,218 2,133 75.1%
Tax 430 754 75.3%
Profit after Tax/(Loss) 788 1,379 74.9%
Net profit margin (%)8.3%10.8%
No. of Shares (m) 199.7 199.7
Diluted Earnings per share* 15.8 27.6
P/E Ratio (x) 12.3
(* annualised)

Motorcycle demand continues to remain robust and Hero Honda, thanks to its impressive product portfolio, has taken full advantage of the upturn in industry volumes. The company's motorcycle sales volume has increased at a brisk rate of 37% in 1QFY03 to 421,679 units. Though volumes have risen by 37%, turnover has increased by only 34%. This is on account of two factors. One is the discount offer of Rs 1,001 per motorcycle offered by the company as part of its No.1 motorcycle manufacturer in the world campaign. Secondly, Hero Honda launched a new low-end motorcycle 'Dawn' priced at around Rs 30,000 per unit in 1QFY03 in response to Bajaj's 'Boxer' and TVS's 'Max 100'. Hero Honda, historically, has been able to price its models at a premium due to their fuel efficiency and acceptance amongst consumers. But the launch of the low-end model underlines the intense competition in the sector with Bajaj and TVS emerging strong over the last two years.

Despite the fall in realisations, the company has managed to improve on its operating margins. It had targeted at reducing raw material requirement per vehicle by around Rs 150-Rs 200 per vehicle apart from value-engineering initiatives. The benefits of these exercises are reflected in Hero Honda's margins, which have risen by 260 basis points in 1QFY03. A 75% rise in net profits was also facilitated by a sharp spurt in other income in 1QFY03. This negated the effect of higher interest outflow (short-term working capital requirements) and higher tax provisioning in the same period.

The stock currently trades at Rs 339 implying a P/E multiple of 12.3x 1QFY03 annualised earnings. As far as future growth prospects of the motorcycle segment are concerned, volumes are expected to grow at a slower rate of 20% in FY03 as compared to more than 35% in FY02. While we expect the operating margins of the company to improve in FY03, the improvement shown in 1QFY03 may not be sustainable in the coming quarters on account of competition. Hero Honda's heavy reliance on Honda has been the key cause of concern. The expiry of agreement with Honda Motorcycles in 2005 and uncertainty on further course of development on this front has been affecting valuations of the company.

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