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Hero Honda: A valiant effort - Views on News from Equitymaster
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Hero Honda: A valiant effort
Oct 18, 2007

Performance summary
  • Battling harsh industry environment, the company has reported a decent 6% YoY growth in topline during the second quarter.

  • Operating margins shrink by 0.3% as inflationary pressures continue to mount.

  • Led by higher interest as well as depreciation charges, bottomline has contracted by 5% YoY during 2QFY08.

  • An improved performance during the second quarter restricts the half yearly bottomline fall to 13% YoY, on the back of a 5% YoY growth in topline.

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Units sold 751,967 756,633 0.6% 1,584,659 1,559,486 -1.6%
Net sales 22,300 23,521 5.5% 45,943 48,001 4.5%
Expenditure 19,465 20,606 5.9% 39,919 42,452 6.3%
Operating profit (EBDITA) 2,835 2,915 2.8% 6,025 5,549 -7.9%
EBDITA margin (%) 12.7% 12.4%   13.1% 11.6%  
Other income 595 393 -34.0% 1,118 782 -30.0%
Interest (net) 65 101 55.1% 98 190 94.0%
Depreciation 344 384 11.7% 667 760 14.0%
Profit before tax 3,151 3,024 -4.0% 6,573 5,761 -12.4%
Extraordinary income/(expense) - -   - -  
Tax 991 980 -1.1% 2,036 1,819 -10.6%
Profit after tax/(loss) 2,160 2,043 -5.4% 4,537 3,942 -13.1%
Net profit margin (%) 9.7% 8.7%   9.9% 8.2%  
No. of shares (m) 199.7 199.6   199.7 199.7  
Diluted earnings per share (Rs)* 43.3 40.9   45.4 39.5  
Price to earnings ratio (x)**         18.6  

What is the company’s business?
Hero Honda Motors, the largest manufacturer of motorcycles in the world, is a joint venture promoted by Hero Cycles (P) Limited and Honda Motor Company of Japan. Each partner holds 26% stake in the company. The company is solely engaged in manufacturing and sale of motorcycles. Hero Honda's initial technology agreement with Honda expired in 2004. But the company has extended its technology agreement with Honda for a further period of ten years and has plans to introduce six new models/improved versions of existing ones. It has a commanding 47% market share in the motorcycle segment.

What has driven performance in 2QFY08?
New launches push sales: Hero Honda’s overall volumes have improved marginally over the corresponding previous quarter. Major contribution has come from the scooter division, where thanks to the launch of a new refurbished ‘Pleasure’, domestic volumes grew by an impressive 41% YoY. Exports too have grown at a robust pace, registering a 57% YoY growth.

The motorcycle division, from where the company generates nearly 95% of its volumes, has however grown by a mere 0.5% YoY (domestic volumes) during the quarter. While the number looks unimpressive, it should be borne in mind that the industry is going through tough times as higher interest rates are making people postpone purchases. Infact, the company’s performance in the domestic market has been way better than industry’s, where motorcycles sales have fallen by a huge 16% YoY during the second quarter. Like the previous fiscal, new model launches have once again come to the rescue of the company and have helped it beat the competition. The company made four new launches during the first half and more are in the pipeline. Apart from new launches, improved product mix has also helped the company, as is evident from the 6% rise in sales as against a mere 0.6% rise in volumes on a YoY basis during the quarter.

Sales break-up (2QFY08)
Domestic 2QFY07 2QFY08 % change 1HFY07 1HFY08 % change
Motorcycles 702,365 706,181 0.5% 1,483,842 1,469,316 -1.0%
Scooter/scooterette 21,311 29,935 40.5% 42,827 48,204 12.6%
Total 723,676 736,116 1.7% 1,526,669 1,517,520 -0.6%
Exports
Motorcycles 27,899 19,901 -28.7% 57,014 41,070 -28.0%
Scooter/scooterette 392 616 57.1% 976 896 -8.2%
Total 28,291 20,517 -27.5% 57,990 41,966 -27.6%
Grand total 751,967 756,633 0.6% 1,584,659 1,559,486 -1.6%
Source: SIAM

Cost pressure persists: Company’s margins during the quarter have shrunk by 30 basis points and quite expectedly; the main culprit has been the input costs, which formed an even larger part of the total costs. However, thanks to softening of prices of certain metals like aluminium, the impact was not as big as the previous quarters. Further, a cost reduction effort being initiated by the company across all divisions also helped contain costs to an extent.

Cost break-up…
(Rs m) 2QFY07 2QFY08 Change
Raw materials 15,838 17,013 7.4%
% sales 71.0% 72.3%  
Staff cost 848 870 2.6%
% sales 3.8% 3.7%  
Other expenditure 2,778 2,724 -2.0%
% sales 12.5% 11.6%  

Stiff competition has led to an escalation in the company’s capital expenditure program and this seems to have dented the other income as surplus funds have been diverted to meet the company’s capex needs. Besides, higher interest as well as depreciation charges have also not helped matters, resulting into a decline in bottomline to the tune of 5%.

Over the last few quarters As seen from the table below, while the margins seem to be back on track, the low growth on the topline front remains a cause of concern. However, once the industry scenario improves, we believe the company is likely to be the foremost beneficiary of the same.

Over the last few quarters…
  2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales (YoY growth %) 2.9% 15.2% 17.0% 3.5% 5.5%
OPM 12.7% 11.3% 10.2% 10.8% 12.4%
NPM 9.7% 7.8% 7.4% 7.8% 8.7%

What to expect?
At the current price of Rs 730, the stock is trading at a multiple of 11 times our estimated FY10 cash flow. Though the first half performance has come in slightly below our expectations, we believe the company should catch up in the second half as historically, the second half performance of auto companies tend to be better. Thus, while there may be medium term concerns vis-à-vis margins and volumes, we remain upbeat on the long-term performance of the company.

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