RBS: Buy Hero Honda Target Rs 2116

Hero Honda Motors
Favourable technology options
We recently met management at Hero Honda. The company has favourable
technology  options  when/if  the  JV  ends,  either  from  Honda  itself  or  global
consultants. Capacity can be dealt with at existing plants and, so, we believe HH
is well placed to benefit from rising rural demand given the good monsoon. Buy.

Favourable technology options Rumours that the Hero Honda JV is to end continue, despite chairman Brij Mohan Munjal
stating at the AGM that there was no immediate threat. If the rumours prove true, the JV
agreement gives Hero the option of extending its technology sharing agreement with Honda
until 2017 (vs the current 2014 expiry) or to discontinue the agreement and stop royalty
payments immediately. Hero has limited in-house component design and testing capabilities
and we believe it would take three years for it to establish full model development capabilities
with the help of global design and technology consultants and at a cost of around 1.5% of net
sales (ie, in line with peers).
Alternative capacity plans on track
Given the delays to its new plant, management is looking to set up additional assembly lines
in existing plants to meet strong expected demand. This, plus capacity de-bottlenecking, may
address short-term capacity issues until next year’s festival season, beyond which we
believe the new plant will be necessary. But, with new plants reducing in-house component
manufacture drastically (to 18% the Haridwar plant vs 26% at the older Gurgaon plant),
management is believes it can get new plants off the ground faster.
Valuation looks attractive on JV split fears: Buy
Hero Honda shares have underperformed the Sensex by 20% over the last three months on
concerns about capacity constraint and that Honda will exit. We feel the JV agreement works
in Hero’s favour with regards to technology support and that the current valuation (12.7x
FY12F) is attractive bearing in mind: 1) 44% of Hero Honda’s sales come from the rural
sector, which is best positioned for high growth from a good monsoon; and 2) 75% of its
sales are from 100cc products, where incremental technology support is less critical and
where Hero Honda has ambitious distribution plans. We reiterate our Buy recommendation.
Our three-stage DCF-based target price of Rs2,116 is supported by cash in hand of Rs236
per share and a high ROE. At our target price, the stock would be trading at 14.8x FY12F.