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For 2QFY2011, Hero Honda (HH) reported decent performance on the top-line
front, while operating performance and bottom-line came in below our
expectations. OPM was largely impacted by higher input cost, which in turn
resulted in poor bottom-line performance. We downgrade our earnings estimates
due to lower than expected performance at operating level and maintain Neutral
rating on the stock.
Top line in line, net profit dips on input cost pressure: For 2QFY2011, HH posted
12.1% yoy growth in net sales to `4,552cr (`4,059cr), marginally above our
expectation. Growth was mainly aided by the 8.7% yoy jump in volumes and
~2.7% yoy increase in net realisation. HH reported an 18.3% yoy dip in
operating profits, where EBITDA margin fell substantiadlly by 498bp yoy on input
cost pressure. EBITDA came in below our expectation, with raw-material cost
increasing by 464bp yoy. Net profit came in at `506cr, down 15.3% yoy, against
our estimate of `510cr, largely aided by subdued operating performance.
However, higher other income, which increased to `78.4cr (`68.7cr in
2QFY2010), arrested further fall in net profit to a certain extent.
Outlook and valuation: We maintain our volume growth estimate and model the
company to record ~13% CAGR in revenue over FY2010–12E, aided by ~10%
CAGR in volumes during the period. We revise our OPM estimates downwards to
account for margin pressure due to increasing raw-material prices. We expect net
profit to register moderate CAGR of ~7% over FY2010–12E on account of tax
benefits availed by HH at its Uttaranchal plant. However, we believe this will not
be able to compensate for the drop in market share and leaves limited room for
earnings upgrade. We remain Neutral on the stock.
Investment arguments
Demand momentum continues; base effect arrests higher growth: In view of
normal monsoons and increased penetration in rural markets, we believe
demand momentum to remain strong over FY2011. Management has also
guided for volumes to exceed 5mn units in the current fiscal, implying
8–9% yoy growth.
Haridwar plant to ramp up production: HH commenced expansion plans at its
Haridwar plant in Uttarakhand, with the first plant commissioned in April
2008 with an initial capacity of 500,000 units. The company aims to increase
its total installed capacity to 5.7mn units from 5.4mn units in 2010. This will
be done through incremental investment of `130cr at its third and newest
plant at Haridwar. This plant also avails of tax benefits, including a 100%
excise exemption for 10 years and a 100% income tax exemption for the first
five years and 30% for the next five years.
Besides the Haridwar plant, HH has two plants in Gurgaon, which enjoy tax
benefits. Due to the increasing production levels at the Haridwar plant, the
company's overall tax rate for FY2010 has come down to 21.2% from 28% in
the previous fiscal and would further come down by ~2% over FY2011–12.
Outlook and valuation
Over FY2007–10, HH gained market share, benefiting from Bajaj Auto (BAL) and
TVS’s product failures and strong rural demand. However, competition is now
rising as evident from continued strong retail demand for new launches from BAL
and HMSI. HH’s domestic market share in the motorcycle segment dropped to
54% in FY2010 from 63% in FY2009. Further, the economic improvement in
FY2011 is likely to be led by urban demand, where BAL has a better presence. We
see HH’s motorcycle market share declining to ~50% (~53%) in FY2011. With the
industry estimated to post a ~13% volume CAGR over FY2010–12E, we believe
HH’s volume growth will lag behind the industry’s growth rate.
We maintain our volume growth estimate and model the company to record
around ~13% CAGR in revenue over FY2010–12E, aided by around ~10% CAGR
in volumes during the period. We revise our OPM estimates downward to account
for margin pressure due to increasing raw-material prices (aluminum and steel).
We expect net profit to register moderate CAGR of ~7% over FY2010–12E on
account of tax benefits availed by HH at its new plant in Uttaranchal. (HH has
increased capacity at its Haridwar plant to 1.8mn units and targets to produce
1.7mn units there in FY2011, up from 1.3mn units in FY2010. This will mitigate the
impact of cost pressure on earnings to a certain extent.) However, we believe this
will not compensate for the drop in market share and, thus, leaves limited room
for earnings upgrade. We maintain a Neutral stand on the company.
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