UBS:: Hero Honda - Beneficiary of rural-led growth

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UBS Investment Research
Hero Honda Ltd.
Beneficiary of rural-led growth
􀂄 Raising price target on lower royalty costs, stronger margin outlook
We raise our price target to Rs2,250 as we increase our earnings estimates to
incorporate lower-than-expected royalty payments to Honda for FY12 and FY13.
We remain positive on Hero Honda on account of: 1) its strong exposure to the
rural market; 2) the positive pricing environment offsetting the input costs
pressure; 3) a strong long-term margin outlook as royalty payments will reduce as
licensing agreements for the existing models expire in FY14.

􀂄 64% of volumes from rural areas
We believe rural India will drive 2W growth in FY12 as it benefits from: 1) high
rural income growth; 2) strong growth in the rural economy due to government
programmes. In addition, 2W penetration in rural India is relatively low at 27% vs.
55% in urban areas. Hero Honda has a strong rural presence, deriving ~64% of its
volumes from rural areas and towns primarily dependant on agri-related income.
􀂄 Increase our EBITDA margin estimate by 161/64bps in FY12/13
We increase our EBITDA margin assumptions by 161/64 bps to 14.7% for
FY12E/13E mainly due to our lower royalty costs. This translates into a YoY
increase of 16%/9% in our PAT assumptions. We are 6%/3% ahead of consensus
in EPS estimates for FY12/13E.
􀂄 Valuation: maintain Buy, raise price target to Rs2,250
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation driver using UBS’s VCAM tool, assuming a WACC of 11.3%


Maintain Buy, raise PT
We maintain our Buy rating on Hero Honda due to the following investment
positives:
1) We believe Hero Honda to be the major beneficiary of rising rural
demand. We expect rural demand to drive 2W growth in FY12.
2) We expect margins to strengthen in the long term as royalty payments
disappear post FY14
3) We expect the pricing environment to remain positive in the near term
and will help offset rising input cost pressure
4) We believe Hero Honda will benefit from the opportunity to grow
internationally.
We raise our price target to Rs2,250 from Rs1,950 as we lower our royalty
assumptions till FY14 and remove royalty payments post FY14.


Change in estimates
We expect margins to strengthen in the long term as royalty payments disappear
post FY14. We increase our EBITDA margin estimate by 161bps mainly as we
lower our royalty costs assumptions from 3.7% of sales to 2.4% in FY12. We
expect the royalty payments to remain in the range of 2.4-2.3% of sales until
FY14.
We increase our margin assumptions by 161/64 bps to 14.7% for FY12E/13E
mainly due to our lower royalty costs assumptions till FY14. This translates into
16%/9% for FY12/13 in our PAT estimate. We are 9%/7% ahead of consensus
in EBITDA estimates for FY12/13E.
We believe that the positive pricing environment will help Hero Honda offset
the raw material cost pressure.


Valuation
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool with a WACC of
11.3%.We maintain our price target of Rs2,250. Our 12-month target price
implies Hero Honda will trade at 15.3x FY13 EPS estimates.