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Hero Honda (HROH.BO, Sell): Downgrade to Sell; high valuation
and renewed strategic challenges
Source of opportunity
1) Hero Honda operating margins declined the most relative to our
Indian auto coverage during the 2010 demand bull run in our view. We
believe margins could be more vulnerable in a normalizing growth
environment amid inflation and a potentially adverse pricing
environment.
2) We believe Hero Honda’s per unit raw material costs are already low
relative to Bajaj Auto and TVS Motors (Exhibit 25), and margin upside
from further rationalizing of the vendor base could be limited in our
view.
3) We also believe that decades old market leadership and brand equity
could face structural challenges with the exit of Honda, with incremental
headwind to margins from consequent spending on R&D and branding.
4) The stock is trading above historical averages on earnings based (P/E
and EV/EBITDA), balance sheet based (P/B, EV/GCI), and at a premium to
peers on relative returns based (Director’s Cut, P/B Vs RoE) parameters.
Our historical analysis suggests high correlation of Hero Honda’s
valuation to demand and EPS growth, we believe that the stock price is
likely to correct and underperform the sector over 12 months and
therefore downgrade our rating from Neutral to Sell.
Catalyst
1) High inflation, rising commodity costs, and moderating industry
demand growth in FY2012-13.
2) Lack of visibility on R&D strategy and commercial relationships with
vendors after Honda’s exit from the JV.
Valuation
Our view on valuation remains unchanged, and we continue to apply
below normalized P/E multiple (11x), adding back cash to arrive at our
12-month FY12E P/E based target price of Rs1,509. Our valuation is
backed by relative returns based (Director’s Cut) analysis.
Key risks
1) Higher than expected consumer confidence and demand growth. 2)
Lower than expected commodity costs. 3) Lower than expected
expenses on R&D and higher cost efficiencies resulting from vendor
rationalization.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Hero Honda (HROH.BO, Sell): Downgrade to Sell; high valuation
and renewed strategic challenges
Source of opportunity
1) Hero Honda operating margins declined the most relative to our
Indian auto coverage during the 2010 demand bull run in our view. We
believe margins could be more vulnerable in a normalizing growth
environment amid inflation and a potentially adverse pricing
environment.
2) We believe Hero Honda’s per unit raw material costs are already low
relative to Bajaj Auto and TVS Motors (Exhibit 25), and margin upside
from further rationalizing of the vendor base could be limited in our
view.
3) We also believe that decades old market leadership and brand equity
could face structural challenges with the exit of Honda, with incremental
headwind to margins from consequent spending on R&D and branding.
4) The stock is trading above historical averages on earnings based (P/E
and EV/EBITDA), balance sheet based (P/B, EV/GCI), and at a premium to
peers on relative returns based (Director’s Cut, P/B Vs RoE) parameters.
Our historical analysis suggests high correlation of Hero Honda’s
valuation to demand and EPS growth, we believe that the stock price is
likely to correct and underperform the sector over 12 months and
therefore downgrade our rating from Neutral to Sell.
Catalyst
1) High inflation, rising commodity costs, and moderating industry
demand growth in FY2012-13.
2) Lack of visibility on R&D strategy and commercial relationships with
vendors after Honda’s exit from the JV.
Valuation
Our view on valuation remains unchanged, and we continue to apply
below normalized P/E multiple (11x), adding back cash to arrive at our
12-month FY12E P/E based target price of Rs1,509. Our valuation is
backed by relative returns based (Director’s Cut) analysis.
Key risks
1) Higher than expected consumer confidence and demand growth. 2)
Lower than expected commodity costs. 3) Lower than expected
expenses on R&D and higher cost efficiencies resulting from vendor
rationalization.
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