Goldman Sachs: Hero Honda Motors - Below expectations – input costs and other expenses surprise; Sell

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EARNINGS REVIEW
Hero Honda Motors (HROH.BO) 
Sell  Equity Research
Below expectations – input costs and other expenses surprise;  Sell
What surprised us
Hero Honda reported adjusted net income (excluding impact of
exceptional item) of Rs5bn, down 5% yoy and 22% below our and
consensus estimates. During the quarter Hero Honda’s volumes grew 28%
yoy and 11% qoq, but EBITA margins declined by 606bps yoy and 221bps
qoq. Raw material costs as percentage of net revenue rose from 68.6% in
3QFY10 and 73.4% in 2QFY11 to 74.5% in 3QFY11. Other expenses rose
48% yoy to Rs6bn (12% of net sales vs 10.7% in 2QFY11 and 10.9% in
3QFY10). We would seek further information from the company on
composition of other expense items that drove this surprise. According to
the company press release, margins could remain under pressure in the
short term on account of supply constraints and rising input costs.

What to do with the stock
We retain our Sell rating on Hero Honda with 12-month FY12E P/E based
TP of Rs1,509. We believe that margins for this company could come
under further pressure due to increased spending on R&D and branding
post Honda’s exit from the JV. Further, Hero Honda’s exposure to the
economy segment of the market potentially makes it more vulnerable to
rising inflation in our view. Hero Honda is currently trading at 13.7X FY12E
P/E, vs. its 13.0X historical average, Indian auto coverage group trading at
12.0X, and global coverage at 10.4X. Key risks: lower-than-expected
capacity constraints or expenses on R&D, higher-than-expected
efficiencies on vendor rationalization.