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Hero Honda: Margins remain the villain - Views on News from Equitymaster
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Hero Honda: Margins remain the villain
Jul 24, 2007

Performance summary
  • Topline registers a near 4% YoY growth, despite 4% decline in volumes.

  • Operating margins tumble 270 basis points, resulting into a 17% YoY drop in operating profits.

  • Bottomline shrinks by 20% YoY, led by poor operating performance and reduced other income.

(Rs m) 1QFY07 1QFY08 Change
No of units sold 832,692 802,853 -3.6%
Net sales 23,644 24,480 3.5%
Expenditure 20,454 21,845 6.8%
Operating profit (EBDITA) 3,190 2,635 -17.4%
EBDITA margin (%) 13.5% 10.8%  
Other income 523 389 -25.6%
Interest (net) 33 90 170.4%
Depreciation 323 376 16.4%
Profit before tax 3,423 2,737 -20.0%
Extraordinary income/(expense) - -  
Tax 1,045 839 -19.7%
Profit after tax/(loss) 2,377 1,898 -20.1%
Net profit margin (%) 10.1% 7.8%  
No. of shares (m) 199.7 199.7  
Diluted earnings per share (Rs)* 47.6 38.0  
Price to earnings ratio (x)**   17.1  
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
Hero Honda Motors, the largest manufacturer of motorcycles in the world, is a joint venture promoted by Hero Cycles (P) Limited and Honda Motor Company of Japan. Each partner holds 26% stake in the company. The company is solely engaged in manufacturing and sale of motorcycles. Hero Honda's initial technology agreement with Honda expired in 2004. But the company has extended its technology agreement with Honda for a further period of ten years and has plans to introduce six new models/improved versions of existing ones. It has a commanding 47% market share in the motorcycle segment.

What has driven performance in 1QFY08?
Volumes – Not as bad as industry: The company sold 2% less motorcycles as compared to same period last year. While this is a big negative, if one pits this number against the near 15% decline in volumes registered by the industry during the same period, then indeed some amount of comfort can be drawn from the company’s performance. Drop in industry sales could be attributed to the strict stance being adopted by financial institutions towards funding two-wheeler loans. Availability of funds is becoming increasingly important as a considerable portion of the demand now comes from the Tier-II and Tier-III cities and the rural areas, where close to 70%-80% of the vehicles are financed.

Hero Honda was able to buck the trend to some extent as it resorted to aggressive new launches, with the entry level offering ‘CD-Deluxe’ deemed worthy of a special mention. With there being a fair amount of confusion regarding rival ‘Bajaj’s’ presence in this segment, Hero Honda’s ‘Deluxe’ was able to capitalise on such a trend and in the process, also gained some valuable market share. Besides, its other offerings, mainly ‘CBZ-Xtreme’ also performed well. Among its other segments, scooters recorded a fall of 15% in volumes, but the impact on overall volumes was rather limited as it currently accounts for a small percentage of sales. The company’s exports also fell by 28%, thus turning the 3% drop in domestic volumes to a 3.6% drop in total volumes on a YoY basis.

sales break up
Domestic 1QFY07 1QFY08 % change
Motorcycles 781,477 763,135 -2.3%
Scooter/scooterette 21,516 18,269 -15.1%
Total 802,993 781,404 -2.7%
Motorcycles 29,115 21,169 -27.3%
Scooter/scooterette 584 280 -52.1%
Total 29,699 21,449 -27.8%
Grand total 832,692 802,853 -3.6%
Source: SIAM

High costs continue to haunt: Despite a positive topline growth as opposed to the negative growth in volumes, Hero Honda’s operating margins shrunk by 270 basis points during the quarter. This is because the company was not able to pass on fully, the rise in input costs. Indeed, with battle for volumes becoming more intense than ever, raising prices would always remain a sticky issue. Instead, the company has chosen to fully absorb the same and take a hit on margins. Further, with the company having considerably stepped up its new launches, higher costs by way of ad spend and royalty also seem to be taking a toll on margins. We believe that though margins will improve in the medium term, the levels attained in the past might not be regained as the industry, especially motorcycles, has entered into a structurally higher costs orbit.

cost break up
(Rs m) 1QFY07 1QFY08 Change
Raw materials 17,029 17,847 4.8%
% sales 72.0% 72.9%  
Staff cost 868 966 11.3%
% sales 3.7% 3.9%  
Other expenses 2,557 3,032 18.6%
% sales 10.8% 12.4%  

The decline in bottomline for the quarter has come in at 20% YoY, slightly more than the 17% fall in operating profits, mainly due to the 26% fall in other income. As the company has invested towards building a new plant, it had comparatively lesser funds to deploy in liquid investments and this explains the fall in other income.

Over the last few quarters
As seen from the table below, the performance in the current quarter has been the worst in recent times. With pressure from all sides, it is highly unlikely that the company would be able to address this problem in the near term.

over the last few quarters
  1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Net sales (YoY growth %) 19.6% 2.9% 15.2% 17.0% 3.5%
OPM 13.5% 12.7% 11.3% 10.2% 10.8%
NPM 10.1% 9.7% 7.8% 7.4% 7.8%

What to expect?
At the current price of Rs 694, the stock is trading at a multiple of 10 times our estimated FY10 cash flow. While we were expecting the margins to be under pressure, decline in volumes has dealt another blow to the company’s medium term prospects. Over the long-term though, we remain positive and the company remains our best bet in the two-wheeler space, given its strong return ratios, leadership position and a focused approach.

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Feb 16, 2018 (Close)


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