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Hero Honda: Hits a roadblock

Jul 14, 2003

The first quarter ended June 2003 results of Hero Honda, the market leader in the motorcycle segment, clearly indicate that it is not going to be a joy ride for the company any more. While volume growth is good, there has been significant pricing pressure and consequently a squeeze on margins in 1QFY04. As a result, operating profit has grown only by 1% in the same period.

(Rs m)1QFY031QFY04Change
No. of motorcycles sold (Nos) 421,679 458,779 8.8%
Net sales 12,744 13,237 3.9%
Other Income 160 361 125.2%
Expenditure 10,630 11,103 4.4%
Operating Profit (EBDIT) 2,114 2,134 1.0%
Operating Profit Margin (%)16.6%16.1% 
Interest (net) (7) (0)-98.5%
Depreciation 135 152 12.6%
Profit before Tax 2,146 2,344 9.2%
Tax 754 766 1.6%
Profit after Tax/(Loss) 1,392 1,578 13.4%
Net profit margin (%)10.9%11.9% 
No. of Shares (m) 199.7 199.7  
Diluted Earnings per share* 27.9 31.6  
P/E Ratio (x)  8.3  
(* annualised)   

Total volumes in 1QFY04 is higher by 8.8% at 458,779 units. Volume growth has shown a decelerating trend over the last three quarters, which could be attributed not only to competitive pressures but also to slowdown in demand. Since Hero Honda is highly reliant on 'Passion' and 'Splendor' for volume growth, the launch of 'CD-100 Dawn' and 'Karizma' augurs well for the rest of the fiscal. In fact, in May 2003, Hero Honda has posted a 14% rise in motorcycle volumes primarily led by new products. We expect the company to post a 10% rise in volumes for FY04 and a further decline in market share.

Operating margins are lower by 50 basis points due to two broader factors. Firstly, the launch of new products could have resulted in higher marketing and adspend (other expenses as a percentage of sales has increased from 11.1% in 1QFY03 to 11.7% in 1QFY04). Secondly, there has been significant pricing pressure in 1QFY04 as reflected in a 4% rise in net sales as against a 9% growth in volumes. We have factored in a 40 basis points fall in operating margins for FY04 in our estimates.

Net profit has risen by 13.4% primarily on account of higher other income. The stock currently trades at Rs 261 implying a P/E multiple of 8.3x 1QFY04 annualised earnings. Though valuations seem to be attractive, we expect margin pressure to increase in the remaining quarters. Also, in order to sustain market share and keep volume momentum going, Hero Honda may have to resort to higher credit sales in the future. But with the Indian economy expected to grow at 6.5% in FY04 (Source: CMIE), there could be a revival in volumes. This could bring in some respite to the motorcycle major.

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