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Hero Honda Motors – Favourable split; fundamentals improve
With favourable JV split terms benefiting the medium-term outlook, we believe the valuation
will return to a premium to the sector average as Hero Honda has begun to gain market
share from the low of September and guides for long-term export opportunities. Buy, with a
revised DCF-based TP and EPS forecasts.
Favourable and early split terms offer new medium-term growth opportunities
The 16 December announcement of Hero Honda’s (HH) JV split was a surprise, in terms of it
being favourable to HH shareholders and an early separation. According to the signed
memorandum of understanding (MoU), the Indian promoters will buy out Honda Motor’s (NR)
26% stake in HH in 2011 at an agreed price yet to be announced. Honda Motor will continue
to provide technical support without a change in the royalty payment structure until 2014. We
believe this provides sufficient time for HH to bolster its in-house research and development
(R&D) capability and to take advantage of significant export opportunities in the medium term.
After 2014, royalty payments (2.7% of net sales) will cease and R&D costs should be in line
with industry standards of about 1% of net sales.
Uptick in market share and vehicle prices favours Hero Honda in the short term
With the split agreement favouring Hero Honda shareholders, we believe the focus will shift
to business fundamentals. Hero Honda has overcome component vendor supply constraints,
fulfilling demand for its vehicles, which in turn lifted its domestic two-wheeler market share
sharply in the December quarter from its low in September. Given a 1% vehicle price hike
recently and historically high volumes, we expect a 15% qoq increase in PAT in the 3QFY11.
We are raising our EPS forecasts and target price; reiterate Buy
Building in the short-term benefits of market share gain and pricing action, and the medium-term
benefits of the JV settlement (such as new plants, export opportunities and reduced
royalty/research expenses), we raise our EPS forecasts by 3.5% for FY11 and 7.4% for FY12.
Building in the medium-term cost benefits from the JV split, which we see as greater than the
threat of competition, we upgrade our three-stage DCF-based target price to Rs2,382, implying a
PE of 17.7x FY12F and 14.9x FY13F. We believe demand for Hero Honda products would be
little affected by rising fuel prices and rising vehicle financing costs, justifying a PE premium to the
auto sector.
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