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Hero Honda: Pressure season

Sep 18, 2002

Hero Honda (HROH), acclaimed the largest motorcycle manufacturer in the world, has been defying odds by posting impressive growth in both sales and profitability over the years. But it may not be a joy ride in the future given the scale of competitiveness in the industry. Against the industry growth of 29% CAGR over the last five years, HROH’s volumes have risen at a CAGR of 39% in the same period. As a result, there has been a marked improvement in the company’s market share in the motorcycle as well as the two-wheeler segment. For FY03, the management is confident of meeting the targeted volume growth of 26% as well.

But as the industry matures, there will more players eyeing incremental volumes. While capacity utilisation of major players has improved significantly, smaller players have gone on an expansion spree in the last three years. At some point in time in the future, these factors will have an impact on the sector in the form of falling price realisations and lower margins per vehicle sold. The current state of the tractor and cement sectors is a classic example of oversupply affecting growth.

Going by the recent trend, the Indian motorcycle segment is in similar growth curve i.e. close to maturity. Already players like Bajaj Auto have started to play the volume game by announcing special discounts on lower-end models like ‘Caliber’ and ‘Boxer’. This was followed by discount of Rs 1,000 per motorcycle announced by Hero Honda in 1QFY03. Every three months, the market is witnessing one new model launch. This is not a positive for Hero Honda, which itself has launched ‘Ambition’ recently. Given this backdrop, we do not foresee any sharp improvement in price realisation for Hero Honda. Operating margins at 15% in FY02 are expected to remain stable, if not fall in the future.

The company hopes to maintain margins through aggressive cost reduction. Hero Honda has addressed the issue of high import content in its models over the years by increasing indigenous components. Import cost per motorcycle has declined from Rs 4,039 in FY99 to Rs 2,176 in FY02, a compounded fall of 18% in the last four years. With lower import component, it is able to price its new models attractively and increase volumes without compromising on margins.

Another concern is that Honda has set up a 100% subsidiary in India for the manufacture of scooters in India. This company commenced operations in mid 2001 and has already garnered more than 10% market share. As per the agreement with Hero Honda, Honda can manufacture and sell motorcycles in India post FY05. This issue is of high significance given Hero Honda’s heavy reliance on the Japanese major. One is not sure about the fallout of the same and hence there is concern regarding the flow of technology from Honda Motor Company to Hero Honda in future.

While the past track record is one way of looking at a stock when making investment decisions, it is impractical to extrapolate similar growth in the future. The same applies to HROH as well. The stock currently trades at Rs 272 implying a P/E multiple of 12x FY02 earnings.

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