Hero Honda -Shrinking margins provide dim outlook :: Macquarie Research

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Hero Honda
Shrinking margins provide dim outlook
Event
 Hero Honda reported disappointing 4Q results with net sales of Rs53.5bn (↑
31% YoY) and net profit of Rs5bn (↓16% YoY). Net profit was impacted by a
526bp decline in EBITDA margin. We believe margin pressure is unlikely to
ease in the near term given raw material inflation. Reiterate Underperform.

Impact
 4Q results significantly below expectation. Hero Honda reported net sales
of Rs53.5bn driven by 23% volume growth. Despite strong sales, EBITDA and
PAT de-grew 11% and 16% to Rs6.1bn and Rs5bn, respectively. PAT was
~10% below our estimates due to higher than expected margin contraction.
 EBITDA margin contracted by 522bp in 4Q. Hero Honda’s EBITDA margin
contracted to 11.4% due to severe raw material cost pressure. Raw material
costs as % of sales increased 574bp to 73.4%. We expect margins to remain
under pressure due to additional costs on account of R&D expenses and a
rebranding exercise post the JV break-up with Honda Motors. Raw material
costs are also unlikely to cool off in the near term.
 Rs8bn capex planned for FY12E. HH is planning to set up its fourth
manufacturing facility (location to be decided shortly) with a capex of ~5bn in
FY12E to add to its existing capacity (6.15mn) by 0.75mn in view of strong
volume growth. Management expects sales volume of ~6mn for FY12E and
sees the export market as a significant opportunity, going forward.
 Rs24.8bn license fee payment over 42 months. HH has stated that the total
license fee payout to Honda Motors by the end of June 2014 is ~24.8bn for
the existing products. This includes an export license fee of ~Rs5.5bn.
However, royalty on new products sourced from Honda will be ~3-5%.
 Competitive pressures set to rise. Now that Honda (HMSI) has exited from
the JV, we expect HMSI to compete aggressively in the high-volume
executive motorcycle segment through new launches. HMSI management has
already announced their intent of reaching a leadership position in the Indian
two-wheeler market. We believe this could impact HH most given its 67%
market share in the segment which contributes ~80% of its sales.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs1,550.00 based on a DCF methodology.
 Catalyst: Volume deceleration and margin compression
Action and recommendation
 Reiterate Underperform. Due to strong margin pressure along with an
emerging high-competition scenario, we expect HH’s profit growth to lag
significantly behind its sales growth. HH stock is trading at 14.8x FY12E PER,
which we believe doesn’t reflect its weak earnings growth prospects.