Hero Honda - "Nothing to cheer about" ::LKP

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Margins disappoint, lower tax rate and higher other income support earnings

Despite reporting 15.3 mn volumes in Q1, (up 24% yoy) and robust net sales (32% yoy), Hero Honda (HH) reported a disappointing margin performance, wherein EBITDA margins came in at 11.2% after adjusting for the Rs.1,785 mn royalty expenses. RM to sales percentage was the highest ever since last 11 years for HH at 74.7%, due to stiffened commodity costs. However, this was nullified by the higher other income at Rs.880mn and lower tax rate at 16.7%.

No significant improvement in profitability expected

HH has guided us for no significant product launches going forward, which weakens its product portfolio vis-à-vis competition. The company has taken a price hike of just Rs.500-750 in June which will slightly impact Q2 positively. However, rebranding expenses, Rs.1,785 mn royalty outgo for next 12 quarters, competition from Honda going solo, significant expenses in distribution set up and re building of image post Honda split will hurt margins. Management expects slight commodity softening to support margins to some extent. We have factored in 11.9%, which is flattish margin performance in FY 12E and a slight growth of 50 bps in FY 13E on RM cost softening. Management plans to increase its total capacity to 6.4-6.5mn from current 6.15mn through debottlenecking.

Tax rate at 16.7%, to remain stable at 17%

The company produced approximately 1.5mn units from its Haridwar plant in Q1, which has a capacity of 2.25mn thus taking the tax rate at 16.7%. With future ramp up happening at Haridwar, the tax rate for the full year is expected to be close to 17%, lower than 19.2% in FY11. This is expected to support the bottom-line performance of the company, however underperformance at the operating level will negate the tax benefit.

Concall highlights –

Ä     Volumes of 6mn expected in FY12, with July-August remaining seasonally weak, festive season is expected to provide a fillip

Ä     Inventories of 2,50-3,50,000 units at dealers’ end (2-3 weeks)

Ä     New plant with a capacity of 7, 50,000 units p.a. will be likely set up in FY13.

Ä     Urban to rural sales mix in the quarter was at 55%-45%

Ä     Cash balance of Rs.40 bn at the end of Q1 FY12.

Ä     Capex of Rs.8-9 bn planned, which will include the new plant

Ä     Recent new launches included remodeling of Glamour and refreshes of Karizma and ZMR

Outlook and valuation

Though we have factored in lower tax rate and slightly lower RM costs, the bottom-line is negated by higher other expenses which include higher marketing and R&D expenses for brand building and to tackle competition. We are maintaining our FY12 and FY 13 estimates and our Underperformer rating on the stock with target price of Rs.1,560.