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Hero Honda: 2 wheels of growth at its 'splendor' - Outside View by Luke Verghese
 
 
Hero Honda: 2 wheels of growth at its 'splendor'

Prophetic coinage in haste

Page 2 of the annual report begins with the prophetic words and I quote "In the year gone by, Hero Honda sold more than a record million units of two wheelers in each quarter and notched its highest ever annual revenues, operating income and earnings per share. All...achieved a pole position in the industry and continues to maintain its lead. Still we at Hero Honda consider these achievements as one amongst many milestones in our long journey ahead, full of promises and further prosperity...Today we pause to ponder what sets up apart from the rest. Where can a company that has already been there and done that go from here"?

The script writer was unfortunately not blessed with clairvoyant powers for sure, and must now be ruing his writing skills. The father son duo of Brijmohan Lall and Pawan must now be pondering hard at the road ahead, the continued prosperity, and, where the company and their fortunes will go from here. And also ponder on whether the ‘two wheels of growth' story will continue to hold good. News reports already aver that the new avatar will enter the three wheeler segment soon enough. Haha! From one point of view, one may wonder why the co-promoter, Honda Motors, chose to cash out when the company, 26 years after incorporation, and currently the world's No. 1 two wheeler company (in volume terms), was firing on all cylinders. But apparently from Honda's viewpoint, the time to cash out is precisely when the road ahead is paved with gold. Not that Honda is getting the full bang for the buck for parting with their holding. Their Indian partners are completely out of pocket trying to pony up the dosh for the enterprise value of Honda's 26% stake in the joint venture. The Munjals hold 26.21% of the voting capital of Rs 400 m.

The quid pro quo, and which was roundly criticized by the minority shareholders, was to pay a higher royalty on sales for a specific period to make good the loss that Honda would be making in the immediate aftermath of their stake sale. The Indian management will have to now grapple with the debt burden that they will take on, in addition to the many problems that they will encounter in steering the company now divested of the Honda tag.

How the saga began

Investors of longer vintage may like to remember that Hero Honda is the only real winner among the slew of two wheeler companies that launched operations in India starting in the early 1980s. The garbage dump so to speak, is littered with iconic brands which did not quite make the cut that they intended to - there was the Yamaha collaboration with Escorts, the TVS collaboration with Suzuki, The Kinetic Honda collaboration with the Firodias, Chamundi Mopeds, a French collaboration JV with Deepak Insulated Cables, Piaggio which got rechristened to LML et al. Kawasaki however lent only its name plate to Bajaj Auto, with the latter escaping unhurt in the bargain.

So, what was the magic mantra which enabled this company to click just right with the Indian mindset? In all probability it is the very fortuitous circumstances which led Honda to be amongst the first off the starting block in the new gen era, and that too with a four stroke engine (which gave so many more kilometers per liter than the competition) and with the Honda brand emblazoned upfront. The launch of these new gen vehicles coinciding with a period in time, when the potential customers' primary concern was for a personal mode of transportation which would not strain their limited resources. And the Honda motorcycle responded in ‘ishtlye' by giving the necessary bang for the buck. Hamara Bajaj was a scooter producer in those days of yore.

There are other plausible reasons too. With the 100 cc motorcycle delivering value to the customer on the price and quality front (and which in turn enables the company to sells cash down), the proprietors moved in, in tandem to create a complete complimentary management environment. By creating the right shop floor practices, it in turn led to much higher labor productivity. It also instituted professional financial management practices for another. It replicated the inventory control systems of the parent, and put into effect related working capital management skills. The instituting of just in time inventory management in an environment which presented logistical nightmares was another notable feature. This led to paring working capital expenses to the bone. The results are there for all to see.

Debt free and much more

The company adds very proudly in its latest annual report that it has been debt free for the last nine years. One may add here that this ground reality would not have been possible but for Honda having an equal says in the management of the company's resources. Left to ourselves, Indian managements have a penchant for squandering any publicly listed company's resources in a intricate web of floozy investment outlets what can more correctly be termed as ‘mirthful deceit'. Internally generated resources invariably find a hundred different devious routes, and the Munjals have more than their share of privately held group companies. (It is also a moot point whether the Munjals have been able to inculcate these acquired skills in other group companies.)

Take a look at Hero Honda's liquid investment portfolio. At year end, a shade more than Rs 39 bn has been socked away in a variety of investments, almost all of it in debt schemes of mutual funds. The only investment that one can directly link to a group company is its paltry investment of Rs 35 m, in Hero Honda Finlease Ltd. The parent also made an intercorporate deposit of Rs 1 bn with this sibling. There is however a direct link between the two. During the year the company also furiously bought and sold these debt instruments. It bought securities worth Rs 231 bn and sold securities worth Rs 228 bn and it realized a profit of Rs 2 bn from this exercise. There was a net accretion to the investment portfolio during the year. It also realized dividends and interest receipts of Rs 400 m.

The promoters are big beneficiaries

For sure, the parent also found ‘good reason' to buy raw materials and components from group companies. Both the promoters have benefitted significantly in many ways here. As a matter of fact purchases of raw materials and components from enterprises over which key management personnel and their relatives exercise significant influence amounted to Rs 35 bn or 33% of all such consumption during the year, against 28% in the preceding year. In this grouping, ‘related party transactions' toted up to Rs 26 bn, against Rs 20 bn in the preceding year. The latter purchases were effected from 5 Munjal group companies. Presumably these purchases were made in the best interest of the company.

The Honda group was the recipient of quite some goodies - in cash. Together with royalties, dividend, commissions, and a small income accruing from the sale of raw materials and components, it anted up to Rs 10 bn against Rs 4.8 bn in the preceding year.

Simmering tensions

The simmering tensions between the two co-promoters have also led to a few comic and unbecoming asides. Between the two Munjals, and the two Japanese executive directors, the foursome took home a humungous gross salary of Rs 1.2 bn - with each of the four pocketing Rs 300 m. Add to this the sitting fees of all the directors which adds up to another Rs 10 m. Together that totes up to Rs 1.2 bn. Emoluments to all employees during the year came to a mere Rs 5.6 bn. In other words a motely crew of the top management took away some 22% of the total employee bill. This must rank as some sort of a world record of sorts for a listed company, and should also be featured, as India's unique contribution, in the Guinness book of World Records. The Munjal duo must in a sense be more than happy that this sorry episode will now be put behind them. They will now have to find a good enough reason to hold on to their present outsized salaries!

The how and the what of it

The company produced 4.6 m, 2 wheelers, at its three manufacturing units at Gurgaon (1.6 m units), Dharuhera (1.6 m lakh units), and Haridwar (1.4 m units.) This production was 24% higher than that recorded in the preceding year. Installed capacity rose to 5.4 m units from 5.2 m units in the preceding year. It sold 4.6 m units (4.6 m motorcycles and 208,000 scooters), which is a wee bit more than what it produced. The latter diversion of making scooters is only to take on Honda Motorcycles and Scooters, and much less than a well thought out strategy. The Haridwar plant is the youngest of the three units and production from this unit is being rapidly ramped up. This plant has the lowest electricity consumption per unit of production among the three plants by far. While the Gurgaon plant consumed 37 KWH of electricity per vehicle produced, it was 32 KWH for the Dharuhera plant, and a mere 17.3 KWH for the Haridwar plant. The elementary logic is that the younger the plant, the lower the consumption cost.

Gross revenues rose to Rs 171 bn from Rs 138 bn, (exports of 100,000 two-wheelers to boot), while the pre-tax profit rocketed to Rs 28.3 bn from Rs 17.8 bn in the preceding year. The dividend payout of Rs 22 bn almost equaled its after tax profit of Rs 22.3 bn. This payout was to celebrate its silver jubilee (It was also a unique achievement in its silver jubilee year. Will there be a follow up in the current year too?). The payout translated into a percentage payment of 5500% which the company claims is the highest ever percentage payment in Indian corporate history. (Amazingly the company has a mere 56,829 shareholders sharing in the good tidings.) The company arrived at this unique situation due to the low equity base of Rs 400 m, relative to the turnover. The capital base is totally out of tune with its operational stats, with the gross sales being 420 times its paid up equity.

Munjal's take on the emerging scenario

The senior Munjal in his annual pontification to the shareholders says that a different facet of India will unfold in the current decade. I am convinced he says that the lower middle class will become the torchbearers of the consuming class. This decade will belong to the Great Lower Middle Class Indian is his esteemed viewpoint. The two wheeler industry will be able to sustain a growth of 10% and more over the next ten years he adds.

Will the management be able to keep up the tempo in the new environment and reap the whirlwind? The corporate governance report states that ‘Your' Company belongs to ‘You' - the shareholders. The chairman and the directors are ‘Your' fiduciaries and trustees. If it can continue to practice what it preaches, then the company may well be able to hold on to its 48% market share, and the shareholders may have much to look forward to in the years to come.

Disclosure: Please note that i am not a shareholder of this company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

Disclaimer:
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