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Hero Honda: How dark are the clouds?

Aug 25, 2004

If the recent trend is any indication, Hero Honda, the largest two-wheeler maker in the country, seems to be under some pressure. From highs witnessed during early July, the stock has lost around 18% to date, a significant fall for a leading two-wheeler company. Let us try to see whether the fall is really justified or is just a temporary aberration. As far as the financial performance is concerned, the company has had a decent first quarter where the bottomline grew by a good 20% albeit on a higher topline growth of 30%. Higher depreciation and tax outgo led to a lower bottomline growth. The company also managed to sell 33% more bikes than what it did during the same period last year. However, that is past and the stock price is a reflection of the future growth prospects of a company. How is the company expected to fare on this front?

As seen from the chart above, in recent years the company has had to fight hard to keep competitors at bay. From a high of around 50% in FY01, the market share of the company has dropped by around 3%. Indeed competitors like Bajaj Auto and TVS have become more aggressive and have taken away some market share from the leader. With more competition in the form of proposed entry of Honda into motorcycles and other foreign majors, the going is only going to get tough from here.

However, the company can take solace from the fact that it still has a lion's share of the executive segment that accounts for more than 50% of all the motorcycles sold in the country. Also, the penetration of motorcycles being still low as compared to other developing nations, the double-digit growth in this segment is likely to continue in the medium to long term as well.

Thus while the company might not be able to replicate the growth story of the late 90's and early 2000, it still is in a strong position to capitalize on the long term growth story and give attractive returns to its shareholders. This belief stems from two facts: first, the company generates significant cash from operations that is sufficient to meet any big capex plans (Rs 12 bn cash from operations in FY04) and has virtually no debt on its books. Secondly, it recently extended its technical collaboration with Honda until 2014, thus preserving its ability to come out with state of the art and fuel-efficient models, as the latter is a world leader in bikes. There seems to be an understanding between Hero Honda and Honda that the latter will make an entry only in the upmarket (premium segment) and not enter into segments where Hero Honda is dominant. Honda has already announced plans to launch 'Unicorn' a premium bike.

For the current year, the company has earmarked Rs 2 bn as capex and is expected to launch two new models in the motorcycle segment, besides of course, its maiden entry into the scooter segment (in all probability the ungeared segment). This segment has grown in the region of 15% CAGR in the last five years, thus making it the most attractive after motorcycles.

The stock is currently trading at Rs 450, implying a P/E of 12x its annualised 1QFY05 earnings. As mentioned earlier, while the company may not be able to replicate the growth story of the last five years, it still is in a strong position to capitalize on the motorcycles growth story. Besides, the track record of paying consistently high dividends is also one of the comforting factors. Hence, the story looks good enough from a long-term perspective.


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