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Hero Honda: A retake

Aug 27, 2003

Among auto stocks, Hero Honda (HROH) and Telco seem to be in the midst of action in the recent past. While the latter is expected to benefit from the upsurge in CV demand, challenges galore for Hero Honda continue going forward, if the company were to maintain its past growth rate. Just to put things in perspective, while industry volumes of motorcycles has grown at a CAGR of 33% over the last six years, Hero Honda has managed to grow its volumes at a similar rate. However, if one were to break-up this period into two phases i.e. prior to FY02 and post FY02, Hero Honda outperformed industry in the first phase and managed to increase its market share to 50% in the motorcycle market. But in FY03, against the industry growth of 41%, the company posted only an 18% rise in unit sales (44% in FY03 as compared to 50% in FY02). This is on account of stiff competition from TVS, Bajaj and LML.

But what are the prospects of the motorcycle segment in general? The segment has benefited from a steady shift in consumer preference from geared scooters, mopeds and step-thrus over the years. New model introductions at the entry-level segment, growing rural demand, affordable finance schemes and general improvement in income levels are the key growth drivers. Demand is expected to grow at a CAGR of 12% over the next five years.

Hero Honda has had a head start in the past when compared to its competitors as a result of which it has remained a market leader by a fair margin over the years. Honda’s expertise in fuel-efficient technology has given a big competitive advantage. The company has a strong presence in the executive segment (58% of motorcycle industry sales) with a market share of an estimated 65%. With concerns of continued access to Honda technology no longer hold true, the company is slated to launch eight new models till 2008. This is likely to fuel volume growth.

However, all is not rosy for the company.

  • Competition has increased manifold in the sector with players like TVS and Bajaj getting their act together. This has resulted in HROH losing its premium pricing power.

  • With more new models slated for launch, the company's market share may come under pressure. HROH may also be forced to offer higher credit period to customers to sustain market share. Debtor days have gone up by two times in the last four years already.

  • While the company hopes to improve efficiency by increasing localization of components from the current level of 80% for select models, pricing pressure and new model introduction costs will more than offset the benefit from the cost saving exercise. It also has to be borne in mind that industry volumes are gradually shifting towards the entry-level segment where margins are lower. As a result, operating margins could come under pressure.

  • More importantly, the company was operating at 93% capacity utilisation levels in FY03 despite capacity increasing by 0.2 m units. To grow volumes further, it will have to spend on capacity expansion, which Hero Honda is already contemplating. If capacity expansion were to be accompanied by slowdown in demand, margins could be squeezed further.

The stock currently trades at Rs 291 implying a P/E multiple of 9.1x FY04E earnings. Though valuations are on the lower side compared to Bajaj Auto and TVS, concerns outnumber positives at this point in time. This increases the risk profile of the stock.

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