Hero Honda Motors -Consecutive quarter of disappointment:: Religare

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Hero Honda Motors Ltd
Consecutive quarter of disappointment; downgrade earnings

Hero Honda’s (HH) Q2FY11 earnings were 13% below our and 10% below
consensus estimates, disappointing for the second quarter in a row on account
of higher input costs which the company has not been able to recover despite
price hikes. Surprisingly, in a quarter of relatively softer commodity prices,
while the rest of the players in the automotive industry have been reporting a
QoQ decline in RM/Sales ratio, HH has reported a 150 bps QoQ increase.
EBITDA margins for HH between Q4FY10 and Q2FY10 have declined by 390
bps, with increase in raw material cost per vehicle of Rs 2,400 being only
partially offset by realization increase of Rs 650. We downgrade our FY11/FY12
earnings by ~5% to reflect higher costs, which we do not expect to be
completely recovered from customers even with the recent price increase.
Though we downgrade earnings, rolling forward of our target to Sep ’12
earnings partially arrests the decline in target price – maintain HOLD with a
target price of Rs 1,900 (vs. Rs1,925 earlier).
Q2 performance below expectations: During Q2FY11 HH’s net revenues grew
12% YoY to Rs 45.5 bn, driven by a 9% growth in volumes and a 3% growth in
realizations. EBITDA margin at 13.4% was lower by 60 bps QoQ, against our and
consensus estimates of a margins expansion. Margin hit was due to RM Costs-to-
Sales increase of 150bps QoQ witnessed by Hero Honda (even while other
players in the automotive industry witnessed a decline in raw material costs
during the quarter). Consequently, net profit at Rs 5bn was 13% below estimates.
Year-to-date performance worst amongst two-wheeler players: Despite being the
market leader, the operating performance of HH in the year has been poorer than
competitors. Since the beginning of the calendar year we note that while Bajaj
Auto and TVS Motor have improved EBITDA per unit sold by Rs 25 and Rs 105
respectively, Hero Honda has actually lost Rs 1,219/unit (See fig 4, 5)
Maintain HOLD, lower target price to Rs 1,900: We expect HH’s price
performance in the stock market to under performance other OEMs in the auto
space due to poor operating performance it has shown YTD. We have
downgraded our earnings estimate by ~5%, to reflect the disappointment in
margins. However, as we roll forward our target price to Sep ’11, the decline in
target price gets partially arrested – we maintain HOLD with a target price of
Rs 1,900. The stock is currently trading at 17.1x FY11E earnings and 15.4x FY12E
earnings. We prefer Bajaj Auto to play the two-wheeler story.