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Hero Honda Motors
Short-term margin pressure
3Q PAT was hit by a prior-period provision for disputed central taxes. With an
EBITDA margin near the historical low, price hikes could be a short-term trigger.
With the amicable JV split, we believe the sharp stock price correction offers a
good entry point at which to ride rural volume growth and cost rationalisation.
December quarter results: margins slip sharply
Hero Honda’s 3Q results involved a large (Rs1.08bn) previous-period provision for tax claims
pertaining to its new Haridwar plant. Adjusting for the provision, normalised PAT recorded
6.2% qoq growth to Rs5.37bn on 13% net sales growth. The EBITDA margin slipped 164bp
qoq to 11.7%, 13% below our forecast. Higher raw material costs (up 119bp qoq) and
manufacturing expenses affected margins, which was marginally offset by a lower tax
provision of 12.8%. EPS was Rs26.9 for 3QFY11 and Rs72.8m for 9M.
Our EPS forecasts revised for weak 3Q and extraordinary items impact
The sharp erosion in 3Q EBITDA margin to near the historical low of 10.2% in 4QFY07,
despite historical peak volume and market share gains in the quarter, surprised us.
Management views steel and rubber costs as a key concern, and we feel a product price
hike is essential to reverse the margin trend. Building in the impact of the results and a delay
in the product price hike, we trim our FY11-12F EPS 6-7%. We feel the potential benefits of
cost rationalisation in the medium term as a result of the recent JV split are immense and
could help retrace historical average margins of 14-15%.
Outlook for cost savings benefit and rural play
The numbers prompted a sharp correction in the stock price (back to pre-JV split levels),
which we feel is a good entry point for medium-term investors as Hero announces expansion
plans at existing plants to extend volume growth in the short term until its new fourth plant
comes on stream in FY13 to provide medium-term growth. A sharp correction in the EBITDA
margin from 17.4% at FY10 to 11.7% within three quarters seems overdone to us,
considering peers’ flat trends and Hero Honda’s strong franchise profitability (dealers and
components vendors). From PAT contraction in FY11F, we feel cost restructuring offers
scope for a 22.6% EPS CAGR for FY11-13F, for which valuations are attractive at a 12.2x
FY12F PE. Buy, with a revised three-stage DCF-based TP of Rs2,107.
Historical peak volume, but lowest margins
Adjusting for previous-period items that affect margins and profits, PAT was 8% below our
and 5.5% below Bloomberg forecasts. In the absence of a much needed vehicle price hike
to overcome margin pressure, we trim our FY12F EPS 7% and revise our TP to Rs2107.
Volumes scale historical peak in festival quarter
By overcoming its capacity constraints, Hero Honda clocked a historical high in sales volumes of
1.43m, representing growth of 28.5% yoy and 11% qoq. This also helped it to partially reverse the
market share loss that has occurred over the past seven quarters and gain an impressive 221bp
qoq in the December quarter.
Dec quarter results disappoint sharply as margins slip to near historical low
Hero Honda’s 3Q results were affected by the provision made for the NCCD (national calamity
contingent duty) for production at its new Haridwar plant since the April-2008 fiscal year. It
provided for Rs798m for previous year provisions, and Hero Honda also paid Rs280m for 1HFY11
under protest to the government of India. As a result, the 3Q results reflected 17.5% of PBT as
prior-period expenses, distorting profitability. Treating them as one-time expenses, normalised
PBT was still 14.3% below our forecast, as the EBITDA margin disappointed at 11.7% vs our
forecast of13.7%. Higher qoq raw material expenses to net sales (up 119bp qoq to 73.9%) had an
impact on margins. However, due to a lower tax rate (12.8% vs 2QFY11 of 19.4%) led to just an
8% disappointment on PAT.
Despite leader gaining market share, margins collapse to historical low in quarter
Despite gaining market share in its leadership position in the domestic 2-wheeler industry in the
3Q, Hero Honda shocked us with an EBITDA margin collapse to a near historical low of 10.2%.
The sharp deterioration in profitability within three quarters is contrary to the performance of
industry peers, whose margins have been flat to marginally down. We feel this is due to the longpending price hike by Hero Honda, which has been involved in a JV split arrangement. Our
channel checks also suggest that Hero Honda’s franchise (vehicle dealers and component
vendors) profitability remains impressive and undisturbed for the same period. Hence, we feel
short-term margin relief could come about on a price hike, whereas a medium-term reversal to a
normal margin trend of 14-15% is easily possible through significant cost rationalisation following
the JV split as benefits in terms of lower royalty, overheads, etc, flow through.
Maintaining medium-term Buy, with revised target price
The short-term weakness in profitability has been worse than we expected. However, we feel the
downside risk from current levels is limited, as margins near historical levels and need to be
boosted by product price hikes. Considering Hero Honda’s strong demand pull and a longer
waiting period for its vehicles compared with peers, and near full capacity of operations, we feel
the benefit of a price hike will more than offset losses in market share or sales volumes. Hence in
the short term, pricing action should be a key driver of profitability. For the medium term, we
maintain a Buy rating, with a revised DCF-based target price of Rs2107, as the benefits from the
JV split (rural and export volume growth, cost benefits from lower royalty and overheads) offer
scope for a 22.6% EPS CAGR for FY11-13F, compared with an attractive PE valuation of 12.2x
for FY12F.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Hero Honda Motors
Short-term margin pressure
3Q PAT was hit by a prior-period provision for disputed central taxes. With an
EBITDA margin near the historical low, price hikes could be a short-term trigger.
With the amicable JV split, we believe the sharp stock price correction offers a
good entry point at which to ride rural volume growth and cost rationalisation.
December quarter results: margins slip sharply
Hero Honda’s 3Q results involved a large (Rs1.08bn) previous-period provision for tax claims
pertaining to its new Haridwar plant. Adjusting for the provision, normalised PAT recorded
6.2% qoq growth to Rs5.37bn on 13% net sales growth. The EBITDA margin slipped 164bp
qoq to 11.7%, 13% below our forecast. Higher raw material costs (up 119bp qoq) and
manufacturing expenses affected margins, which was marginally offset by a lower tax
provision of 12.8%. EPS was Rs26.9 for 3QFY11 and Rs72.8m for 9M.
Our EPS forecasts revised for weak 3Q and extraordinary items impact
The sharp erosion in 3Q EBITDA margin to near the historical low of 10.2% in 4QFY07,
despite historical peak volume and market share gains in the quarter, surprised us.
Management views steel and rubber costs as a key concern, and we feel a product price
hike is essential to reverse the margin trend. Building in the impact of the results and a delay
in the product price hike, we trim our FY11-12F EPS 6-7%. We feel the potential benefits of
cost rationalisation in the medium term as a result of the recent JV split are immense and
could help retrace historical average margins of 14-15%.
Outlook for cost savings benefit and rural play
The numbers prompted a sharp correction in the stock price (back to pre-JV split levels),
which we feel is a good entry point for medium-term investors as Hero announces expansion
plans at existing plants to extend volume growth in the short term until its new fourth plant
comes on stream in FY13 to provide medium-term growth. A sharp correction in the EBITDA
margin from 17.4% at FY10 to 11.7% within three quarters seems overdone to us,
considering peers’ flat trends and Hero Honda’s strong franchise profitability (dealers and
components vendors). From PAT contraction in FY11F, we feel cost restructuring offers
scope for a 22.6% EPS CAGR for FY11-13F, for which valuations are attractive at a 12.2x
FY12F PE. Buy, with a revised three-stage DCF-based TP of Rs2,107.
Historical peak volume, but lowest margins
Adjusting for previous-period items that affect margins and profits, PAT was 8% below our
and 5.5% below Bloomberg forecasts. In the absence of a much needed vehicle price hike
to overcome margin pressure, we trim our FY12F EPS 7% and revise our TP to Rs2107.
Volumes scale historical peak in festival quarter
By overcoming its capacity constraints, Hero Honda clocked a historical high in sales volumes of
1.43m, representing growth of 28.5% yoy and 11% qoq. This also helped it to partially reverse the
market share loss that has occurred over the past seven quarters and gain an impressive 221bp
qoq in the December quarter.
Dec quarter results disappoint sharply as margins slip to near historical low
Hero Honda’s 3Q results were affected by the provision made for the NCCD (national calamity
contingent duty) for production at its new Haridwar plant since the April-2008 fiscal year. It
provided for Rs798m for previous year provisions, and Hero Honda also paid Rs280m for 1HFY11
under protest to the government of India. As a result, the 3Q results reflected 17.5% of PBT as
prior-period expenses, distorting profitability. Treating them as one-time expenses, normalised
PBT was still 14.3% below our forecast, as the EBITDA margin disappointed at 11.7% vs our
forecast of13.7%. Higher qoq raw material expenses to net sales (up 119bp qoq to 73.9%) had an
impact on margins. However, due to a lower tax rate (12.8% vs 2QFY11 of 19.4%) led to just an
8% disappointment on PAT.
Despite leader gaining market share, margins collapse to historical low in quarter
Despite gaining market share in its leadership position in the domestic 2-wheeler industry in the
3Q, Hero Honda shocked us with an EBITDA margin collapse to a near historical low of 10.2%.
The sharp deterioration in profitability within three quarters is contrary to the performance of
industry peers, whose margins have been flat to marginally down. We feel this is due to the longpending price hike by Hero Honda, which has been involved in a JV split arrangement. Our
channel checks also suggest that Hero Honda’s franchise (vehicle dealers and component
vendors) profitability remains impressive and undisturbed for the same period. Hence, we feel
short-term margin relief could come about on a price hike, whereas a medium-term reversal to a
normal margin trend of 14-15% is easily possible through significant cost rationalisation following
the JV split as benefits in terms of lower royalty, overheads, etc, flow through.
Maintaining medium-term Buy, with revised target price
The short-term weakness in profitability has been worse than we expected. However, we feel the
downside risk from current levels is limited, as margins near historical levels and need to be
boosted by product price hikes. Considering Hero Honda’s strong demand pull and a longer
waiting period for its vehicles compared with peers, and near full capacity of operations, we feel
the benefit of a price hike will more than offset losses in market share or sales volumes. Hence in
the short term, pricing action should be a key driver of profitability. For the medium term, we
maintain a Buy rating, with a revised DCF-based target price of Rs2107, as the benefits from the
JV split (rural and export volume growth, cost benefits from lower royalty and overheads) offer
scope for a 22.6% EPS CAGR for FY11-13F, compared with an attractive PE valuation of 12.2x
for FY12F.
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