Despite a challenging environment, Hero Honda has posted yet another impressive topline growth for the second quarter ended September 2002. While margins have also increased significantly during the quarter, there are some grey areas that need to be taken into consideration.
No. of motorcycles sold (Nos)
Operating Profit (EBDIT)
Operating Profit Margin (%)
Profit before Tax
Profit after Tax/(Loss)
Net profit margin (%)
No. of Shares (m)
Earnings per share (Rs)*
Motorcycle sales in 2QFY03 and 1HFY03 have increased by 24% and 30% respectively. The company had targeted a 26% growth in motorcycle volumes for FY03 to 1.7 m units. Till 1HFY03, the company has achieved 46% of the target. While volume growth at 24% is commendable, the impact on competition is apparent from the table below. Compared to an average YoY growth in volumes of 36% in each of the last six quarters, volume growth in 2QFY03 in on the lower side. But it also has to be viewed in the context of slower economic growth, higher base and increased competition.
(% YoY growth)
Gauging from growth in turnover, which is in line with expectations, increased competition has affected average realisations as well. Against an increase in volumes of 23% in 2QFY03, turnover has gone up by only 19%. This means around 3%-4% fall in prices. The scenario is same for 1HFY03 as well. The price war was triggered by Hero Honda itself when it announced a Rs 1,000 discount on all models in 1QFY03. Following this, Bajaj Auto and TVS also reduced prices on key volume models like 'Boxer', 'Caliber' and 'Max 100-R' in the beginning of 2QFY03. Hero Honda's 'Splendor' and 'Passion', which accounted for as high as 80% of total motorcycle sales in FY02, seem to have been affected by competition in the executive segment in 1HFY03, consequently impacting sales growth.
To sustain profitability, the company has been focusing on reducing raw material cost to maintain operating margins at 15% levels. Absolute raw material cost per motorcycle reduced by 1% in FY02 as a result of value engineering efforts (total imports as a proportion of operating expenses reduced from 13% in FY01 to 8% in FY02). The rise in operating margins in 2QFY03 is due to the combination of increase in indigenous components and better working capital management. The rise in other income is due to sale of investments in 2QFY03. Since the company generates around Rs 5 bn as net cash flows from operation, we expect other income to rise sharply in FY03. Despite a sharp spurt in interest, depreciation and tax outgo, net profit in 2QFY03 and 1HFY03 has gone up by 40% and 35% respectively.
The stock is currently trading at Rs 252 implying a P/E multiple of 9.2x FY03 expected earnings. Till 1HFY03, the company has managed to achieve 46% of FY03 volume target of 1.7 m units. While demand in the festive season tends to be on the higher end, keeping the intensity of competition in the two-wheeler sector and macro-economy in mind, achieving the target seems to be a tough task. Even if Hero Honda manages to attain the target, the key cause of concern is price realisation and the consequent effect on operating margins. Since new products are eating into overall profitability, we expect the company's operating margins to remain under pressure in the next two years. However, based on peer group comparison and keeping in mind superior return ratios of the company, valuations are on the attractive side. That said, the stock has been volatile off late and one will not be surprised if the trend continues in the near-term.
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