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Hero Honda: The key is profitability - Views on News from Equitymaster
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  • Oct 14, 2004

    Hero Honda: The key is profitability

    Performance summary
    Hero Honda, India’s largest two-wheeler manufacturer, has reported robust 2QFY05 results. While the topline has grown at a rate of 39% YoY, the growth in bottomline has been somewhat lower at 24%. Pressure at the operating level and higher tax incidence has led to a lower rate of growth in bottomline. For the first half ended September 2004, the topline and the bottomline growth stood at 35% and 22% respectively.

    (Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
    Net sales 12,610 17,572 39.3% 25,847 34,794 34.6%
    Expenditure 10,530 14,822 40.8% 21,605 29,191 35.1%
    Operating profit (EBDITA) 2,080 2,749 32.2% 4,242 5,604 32.1%
    EBDITA margin (%) 16.5% 15.6%   16.4% 16.1%  
    Other income 402 411 2.1% 763 640 -16.2%
    Interest (net) (10) (3) -73.7% (11) (4) -61.3%
    Depreciation 171 208 22.0% 350 413 18.0%
    Profit before tax 2,322 2,955 27.2% 4,666 5,835 25.0%
    Tax 757 1,011 33.6% 1,523 1,991 30.7%
    Profit after tax/(loss) 1,566 1,944 24.2% 3,144 3,844 22.3%
    Net profit margin (%) 12.4% 11.1%   12.2% 11.0%  
    No. of shares (m) 199.7 199.7   199.7 199.7  
    Diluted earnings per share (Rs)* 31.4 38.9   31.5 38.5  
    Price to earnings ratio (x)   10.9     11.1  
    (* annualised)            

    What is the company’s business?
    Hero Honda is the market leader in the motorcycle segment with an estimated market share of 47% in FY04. While the company has benefited from the shift in preference from geared scooters to motorcycles over the last decade, in the last three years, its market share has come under pressure owing to industry fragmentation. However, it has a consistent track record of maintaining profitability and rewarding shareholders (average dividend payout of 43% over the last six years).

    What has driven performance in 2QFY05?
    Motorcycles continue to shine:  During the quarter, the company managed to sell 35% more motorcycles over last year. Its growth in sales was significantly higher than closest rivals Bajaj Auto and TVS Motors, whose motorcycles sales grew by 25% and a negative 18% respectively during the same period. Despite new launches by rivals, the company’s brand equity and strong rural presence ensured that it stood ahead in the number game. In value terms, the growth was a little higher at 39%, a result of improved product mix. We expect the motorcycles industry to close the year with a 14%-16% growth in volumes and also expect the company to grow in line with the industry.

    Operating profits:  Higher raw material costs as well as rise in other expenses has resulted into a 90 basis points dip in operating profit margins. Prices of key components such as steel and rubber have continued to remain at high levels and this has impacted the operating performance. Moreover, in view of the increasing competition, the company seems to have incurred higher marketing and sales expenses, thus resulting into higher other expenses during the quarter. Going forward, with the competitive landscape expected to get further crowded, margins are likely to remain under pressure.

    Cost break-up...
    (Rs m) 2QFY04 2QFY05 %Change 1HFY04 1HFY05 %Change
    Raw materials 8,499 12,072 42.0% 17,522 24148 37.8%
    % sales 67.4% 68.7%   67.8% 69.4%  
    Staff cost 547 632 15.5% 1,077 1271 18.0%
    % sales 4.3% 3.6%   4.2% 3.7%  
    Other expenses 1,484 2,118 42.8% 3,006 3771 25.5%
    % sales 11.8% 12.1%   11.6% 10.8%  

    Net profits:  Apart from higher expenses, what has also affected the profitability at the net profit level is the significant 34% growth in tax outgo. As a consequence, the growth in bottomline has been restricted to 24% YoY.

    What to expect?
    At Rs 426, the stock is trading at a P/E multiple of 11 times its annualised 1HFY05 earnings. While the growth in volumes may not be a problem for the company, it is the increasing competition and the consequent drop in profitability that raises concern. Although it is likely to outperform its peers, it may not be able to replicate the growth story of the last five years and to that extent, caution in the near to medium term is advisable.



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