• JULY 14, 2004

Hero Honda: The question is momentum

Hero Honda announced its 1QFY05 performance today. Backed by strong volume growth in light of new product launches, the company has posted impressive results. This topline performance is combined with margin improvement as well. Though the 1QFY05 performance is higher than our full year projections, we would maintain our numbers, as competitive pressures could keep margins under check.

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 in the last decade, in the last three years, market share has come under pressure owing to fragmentation in the industry. However, it has a consistent track record of maintaining profitability and rewarding shareholders (average dividend payout of 43% over the last six years).

(Rs m)1QFY041QFY05Change
No. of units sold 458,779 609,123 32.8%
Net sales 13,237 17,223 30.1%
Other income 361 229 -36.5%
Expenditure 11,103 14,369 29.4%
Operating profit (EBDITA) 2,134 2,854 33.7%
Operating profit margin (%)16.1%16.6% 
Interest (1) 2 -
Depreciation 152 205 34.8%
Profit before tax 2,344 2,877 22.7%
Extraordinary items - - -
Tax 766 980 27.9%
Profit after tax/(loss) 1,578 1,898 20.2%
Net profit margin (%)11.9%11.0% 
No. of shares (m) 199.7 199.7  
Diluted earnings per share (Rs)* 31.6 38.0  
P/E ratio (x)  12.3  
(* annualised)   

What has driven performance in 1QFY05?

Sales:  Motorcycles sold during the quarter was higher by 33% primarily led by a faster rise in exports (58%) and a domestic growth of 32%. The upgrade of its flagship model ‘Splendor’ has been the key reason behind this faster rise in the last two quarters. In fact, after a gap of two years, Hero Honda has managed to outpace industry growth rates in the last two quarters.

Operating margin:  Despite competitive pressure and firm steel prices, margins have improved. While we have estimated a lower margin for the company for FY05, we would maintain our stand when one considers the fact that the competition is intensifying. With Honda Motorcycles likely to launch motorcycles on a standalone basis, threat of cannibalization exists.

Net profit:  The net profit growth of 20% is in line with our estimates, despite lower other income. Since the company has significant investments in mutual funds, with the debt market return not favorable in the recent past, the other income benefit stands reduced. With the recent budget proposal of 20% retention by mutual funds on debt funds, it remains to be seen how it impacts the company’s other income in the future.

Over the last few quarters:  As can be seen from the graph below, there is a visible recovery in sales growth in the last six months owing to the launch of upgraded models. We have projected lower margins for FY05, as the scope of squeezing component suppliers from the current level is limited.

What to expect?

The stock currently trades at Rs 467 implying a P/E multiple of 12.8x our FY05E earnings. While the 30% CAGR growth in motorcycle sales in the past is unlikely in the next three years, the market size in expanding for sure and Hero Honda, being the market leader, is well placed to capitalize on the same. But the momentum could be different. However, our key concerns stem from price-based competition, fragmentation in the industry structure and the proposed entry of Honda into the motorcycles segment. The company’s reported venture into ungeared scooter segment also has to be viewed with caution.

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