HERO HONDA - Margins skid on higher RM costs:: Edelweiss

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HERO HONDA MOTORS LTD
Margins skid on higher RM costs



􀂃 Net profit, at INR 5 bn, below our estimate
Hero Honda Motors’ (HH) Q2FY11 net profit, at INR 5.0 bn (down 15% Y-o-Y and
up 3% Q-o-Q), was 11% below our and market expectations. The variance was
on account of higher-than-expected increase in raw material costs.
􀂃 EBITDA margins continues to disappoint, down 60bps Q-o-Q
While net sales, at INR 45.5 bn (up 12% Y-o-Y and 6% Q-o-Q), led by volume
growth (up 9% Y-o-Y, 4% Q-o-Q), were in line with estimates, EBITDA margins
disappointed at 13.4% (down 500bps Y-o-Y and 60bps Q-o-Q).
The key deviation was in the raw material costs which were up 150bps Q-o-Q,
after having risen 400bps in Q1FY11. This increase is particularly surprising
given the higher realizations per vehicle (up 1.5% Q-o-Q) inspite of a stable
product mix. We note that all other automobile OEMs have reported a sequential
decline in raw material costs to sales.
􀂃 Hero and Honda to split?
Unconfirmed media reports consistently seem to indicate that the Hero Group is
likely to acquire Honda’s 26% stake in the joint venture. We would view this
development as a negative as the company could be severely hampered by the
lack of new technology in introducing new products (please refer to our note,
Honda to offload stake?, dated July 26, 2010).
􀂃 Outlook and valuations: Uncertainty prevails; maintain ‘BUY’
On the back of subdued Q2FY11 performance, we revise our earnings down
2.5% each for FY11E and FY12E. Our new estimates take into account a 100bps
reduction in EBITDA margins to 14.5% and 14.7%, respectively for FY11E and
FY12E.
On our revised estimates, the stock is trading at ~14.5x FY12E EPS. While we
continue to maintain our ‘BUY/ Sector Outperformer’ recommendation/rating
with a target price of INR 2,000 (16x FY12E EPS) on the stock in view of its core
strengths, we remain cautious on account of the potential corporate action. In
the automobile OEM space we prefer a shift to Mahindra & Mahindra (M&M) on
account of its strong domestic business with limited competition, and reasonable
valuations.