Hero Honda:Disappoints again; switch to Bajaj Auto and TVS: JM Financial

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Disappoints again; switch to Bajaj Auto and TVS
􀂄 Margins disappoint despite record revenues: Hero Honda’s 2QFY11
earnings were 8.5% below our and street expectations as operating margins
at 13.4% (JMFe 14.8%) disappointed due to adverse mix and higher RM costs.


􀂄 Gross margins at thirteen-quarter low: Net sales grew 12% YoY and 6% QoQ
to `45.5bn (JMFe `45.1bn). Raw material/vehicle grew 10.2% YoY and 3.9%
QoQ due to higher commodity prices and change in emission norms (Exhibit
3). However, per vehicle realisation grew just 3.2% YoY and 1.7% QoQ due to
adverse mix and limited pricing action. Mix continued to slip as volume
contribution from higher-margin Splendor-Passion declined 330bps YoY and
40bps QoQ to 67.6%. (Exhibit 5). Operating profit at `6.1bn (JMFe `6.7bn) degrew
18% YoY and remained flat QoQ. Net profit grew 3% QoQ (down 15%
YoY) to `5.1bn (JMFe `5.5bn) on a 47% QoQ jump in other income.

􀂄 FY11/FY12E EPS revised downward by 5.5%/7%: The company has missed
our and street estimates for two consecutive quarters, warranting another
earnings downgrade. Post 1QFY11 results, we had revised downward our
FY11/FY12E earnings by 9.7%/8.4%. Our revised FY11/FY12E EPS stands at
`105/`113. We introduce FY13E with volume growth, operating margins and
EPS at 8%, 13.1% and `122 respectively. Our volume assumptions remain
unaffected by the probable Honda exit from the company. In event of Honda’s
exit we see considerable downside to our estimates.

􀂄 At 15.8x Sept’12E EPS risk:reward unfavourable; switch to Bajaj Auto and
TVS: Considering the sustained underperformance for the last two quarters
and risk to the business arising from probable Honda exit the stock looks
expensive. Our revised TP of `1,530 is based on 13x Sept’12 EPS. Our earlier
TP of `1,588 was based on 14x FY12E EPS with EPS CAGR of 5%. We maintain
SELL on the stock and recommend switch to Bajaj Auto and TVS Motor which
are trading at 13x and 8.3x Sept’12E EPS, offering far superior earnings
growth (FY11-FY13E CAGR of 26% and 53% against 3% for Hero Honda), and
stand to gain from the probable exit of Honda from Hero Honda.