UBS: Downgrade Hero Honda

Honda exit imminent, downgrade to
Neutral
􀂄 Downgrade from Buy to Neutral due to concerns over JV with Honda
We downgrade our rating for Hero Honda (HH) to Neutral due to concerns over
the possible culmination of its JV with Honda. We believe these concerns are well
founded given: 1) HH is currently completely dependent on Honda for R&D and
product development; 2) HH’s ageing product portfolio and the limited success of
its new products; and 3) competition from HMSI will increase following the breakup.
􀂄 Lack of R&D capability likely to lead to de-rating
We believe lack of demonstrated capability in terms of product development will
remain an overhang on the share price. During 2002-03, the stock was significantly
de-rated on concerns of a non-renewal of the Honda JV. While HH is financially
strong now, we believe successful new product development is likely to involve a
learning curve and could limit HH’s growth over the medium term. Therefore, we
lower our intermediate growth assumption from 8% to 5%.
􀂄 However, limited near-term earnings impact
Under the existing agreement, Honda will provide five years of technical support
beyond 2014 to HH even if the JV is not renewed in 2014. The company’s growth
continues to be driven by the popularity of its Splendor and Passion brands.
Therefore, we think the near-term earnings impact of Honda’s exit would likely be
limited.
􀂄 Valuation: lower price target from Rs 2,150.00 to Rs.1,950.00
We derive our price target through a DCF methodology, assuming a WACC of
11.6%, intermediate growth of 5% and a long-term operating margin of 13%.