• OCTOBER 14, 2003

Hero Honda: Weakness persists

Hero Honda has posted a lacklustre growth for the second quarter ended September 2003. While the topline has increased at a slower rate of 2% compared to the historical YoY growth in revenues, operating profit is more or less stagnant. Despite new model launches, the company continues to face pressure on market share.

(Rs m)2QFY032QFY04Change
No. of motorcycles sold (Nos)**829,297905,2439.2%
Sales 12,359 12,610 2.0%
Other Income 223 402 80.8%
Expenditure 10,311 10,530 2.1%
Operating Profit (EBDIT) 2,048 2,080 1.6%
Operating Profit Margin (%)16.6%16.5% 
Interest 6 (10) -
Depreciation 138 171 23.9%
Profit before Tax 2,127 2,322 9.2%
Tax 741 757 2.1%
Profit after Tax/(Loss) 1,386 1,566 13.0%
Net profit margin (%)11.2%12.4% 
No. of Shares (m) 199.7 199.7  
Earnings per share (Rs)*  31.4  
P/E (x)  10.7  
(*annualised, **Unit sales pertains to the first half of FY04)

Total volumes for 1HFY04 has increased by 9%. This is comparatively lower despite two launches by the company in 1HFY04, namely 'CD-Dawn' and 'Karizma'. While the former is an entry-level model (35% of industry volumes in FY03), the latter addresses the premium end of the motorcycle market (8% of the industry). In fact in May 2003, the company saw a 12% rise in volumes sold, with a decade old flagship model 'Splendor' accounting for 60% of unit sales. This is a cause for concern because players like Bajaj Auto, which had a weaker presence in this segment in FY03 (8% market share) have launched new models in this executive segment. Just to put things in perspective, the executive segment accounted for 57% of motorcycle industry volumes in FY03. Given Hero Honda's high dependence on its aged models, market share could come under pressure.

As is evident from the graph above that shows the YoY growth in revenues over the last eight quarters, Hero Honda has seen significant competitive pressure. In fact, in FY03, the company's market share stood at 44% as compared to 50% in FY02. We expect the pressure on market share to continue for the rest of FY04 as well as FY05, as competition is expected to increase with Honda expected to launch models next year (as an independent company from Hero Honda).

Higher input costs arising out of a rise in steel prices and pricing pressure have resulted in operating margins falling by 10 basis points in 2QFY04. Though net profit seems to have grown at 13% in 2QFY04 on the first look, if one were to ignore the rise in other income, net profit is the same as in 2QFY03. Depreciation charges are on the higher side on account of new investments in models (the company is estimated to have spent close to Rs 300 m on 'Karizma').

The stock currently trades at Rs 334 implying a P/E multiple of 10.7x annualised 2QFY04 earnings (10.4x FY04E earnings). Considering the intensity of competition in the motorcycle segment and the need for investments in new models to maintain market share, valuations seem to be on the higher side. The big factor that has been supporting the stock is the healthy dividend yield. However, it remains to be seen whether the company is able to maintain such a high payout when investment and working capital requirements are increasing.

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