Hero Honda - Operating performance disappoints, volume guidance encouraging ::Standard Chartered Research,

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 Revenue below our estimate given lower-than-expected
average realisation.
 RM/sales at record high of 74.7%; as a result, margin
declined 80bps qoq (-270bpsyoy) to 11.3%.
 Higher other income and lower tax rate supported
earnings – up 14% yoy.
 Volume outlook strong, but cost pressure (re-branding,
R&D investments, ad-spend) to limit margin expansion
 Fully valued at 12.6x FY13E earnings and at 8x
EV/EBITDA. Maintain IN-LINE.
Net sales up 32% yoy. Net sales were up 32% yoy to
Rs56.8bn (we expected Rs57.5bn) led by 24% yoy growth
in volume and 7% yoy growth in average realisation.
Revenue was lower than our estimate as average
realisation remained flat qoq despite price hike in Mar ’11.
Input cost pressure sustains. RM/sales rose 190bps qoq
to 74.7% (highest ever increase) due to rising commodity
costs. Other expenses were also high at 11.5% of net sales
on account of IPL spend expensed in the quarter. As a
result, EBITDA margin declined 80bps qoq (-270bps yoy) to
11.3%.
Earnings up 14% yoy at Rs5.6bn. Other income was
above our estimate given investments in higher yielding
securities. The average tax rate declined to 16.7% given the
Haridwar plant ramp-up. Net profit grew 14% yoy to
Rs5.6bn.  
Outlook. We expect 2W demand momentum to continue
with HH targeting to cross the 6m mark this year. However,
while commodity cost pressure is declining, increase in
other operating expenses (re-branding, R&D, adspend) is
likely to limit margin expansion going forward. The Hero
group will continue to be in investment phase over the next
couple of years to develop products on its own, establish its
brand without Honda, spend on capacity addition and for
establishing its presence in export markets, which are likely
to hurt return ratios.
Valuation. Even after factoring in 100bps margin expansion
from current levels for FY12, the stock is trading at 12.6x
FY13E earnings and at 8x EV/EBITDA and appears fully
valued. Maintain IN-LINE with a revised price target of
Rs1,780 (rolling forward to 14x June 12E earnings, earlier
Rs1,764).


Conference call highlights
 The company has already launched four new variants in 1Q: remodelled Glamor, Glamor FI,
Karizma and ZMR.
 Retail demand continues to be extremely strong with the finished goods inventory hovering at
less than two weeks. The company expects the strong demand momentum to continue for the
remaining fiscal and is targeting to cross the 6m mark in sales in FY12.
 HH has raised prices by Rs500-750 per unit from June 24th.
 While commodity cost pressure is softening, HH could have additional one-time costs in
1) rebranding costs of removing the Honda brand (~Rs1bn to be incurred over 2Q and 3Q)
2) R&D costs at ~1-1.2% of sales. This would also incur recruiting additional employees as
well as a possible technical tie-up with some other partner. Part of this expense if likely to be
capitalized for the fiscal.
3) The royalty amortization of ~Rs1.8bn as agreed on separation of the JV.
 The company can achieve peak production of ~6.5m units in FY12 (installed capacity of
6.15m). HH is expected to produce ~2m units from Pantnagar in this fiscal.