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Motorcycle Market Leader Hero Honda reported 2.9% YoY top line growth to Rs. 27430.7 mn for the quarter ended December 2007. The growth witnessed in top line was despite marginal decline of 0.3% in overall volumes during the third quarter. The motorcycle division from where the company generates nearly 95% of its volumes has almost remained stagnant during the third quarter. Infact, the company’s performance in the domestic market has been way better than industry’s, where motorcycles sales have fallen by a huge 12.2% YoY during the period. While the numbers look unimpressive, it should be borne in mind that the industry is going through tough times as high interest rates are making people postpone purchases.

The company’s volume was impacted mainly due to weakening of demand in entry level motorcycle segment. This adversely affected performance as majority of sales of the company come from less than 125 cc segment. We believe rising interest rates and higher down payment demands from the financing institutions have impacted the sentiments of two wheeler customers. It is important to note that availability of funds from financial institutions is becoming increasingly important as considerable portion of the demand now comes from the tier II and tier III cities and rural areas. Estimates suggest that approximately 80% of the vehicles in two-wheeler market are being financed by Financial Institutions.

Like the previous fiscal, new model launches have once again come to the rescue of the company and have helped it beat the competition. Hero Honda launched Hunk(150 cc) and refreshed Splendor + during the third quarter. We believe the company will be able to strengthen its product portfolio in premium segment with recently
launched 150 cc bike ‘Hunk’. This offering, along with CBZ – Xtreme, Karizma and Achiever, is its fourth product in the segment. Among its other segments, major contribution has come from the scooter division. Thanks to the launch of a new refurbished ‘Pleasure’, domestic volumes grew by 6.3% YoY. The company has announced the launch of 12 new models and variants of existing products over next 18 months. Apart from new launches, improved product mix has also helped the company during the quarter, as is evident from the 3.2% YoY rise in sales realization to Rs 30,697 per vehicle.

EBDITA margins improved by 260 basis points

Hero Honda’s EBITDA for Q3FY08 increased by 26.7% YoY to Rs 3826.0 mn and its
EBITDA margins improved by 260 bps YoY to 13.9%. Raw material costs as a percentage of sales came off substantially to 70.9% and this helped company post a big 260 basis point expansion in operating margins. Also, the fact that costs of quite a few commodities have come down worked in its favour. Further, with the company taking the all-important decision of postponing production in its new plant, staff costs and other expenses were also kept under control, giving the margins an additional boost. For 9MFY08, Hero Honda’s EBITDA increased by 3.7% YoY to Rs 9375.3 mn ad EBITDA margins stood flat at 12.4% as compared to 12.5%.

Hero Honda’s net profit improved by 31.5% YoY in Q3FY08 to Rs 2750.1 mn. The growth was mainly on account of 55% YoY rise in Other income to Rs 521 mn and modest increase of 8.6% YoY in depreciation charges to Rs 408 mn.

Business Outlook:
Hero Honda is the leader in the two-wheelers in India. The company was able to improve its EBDITA margins sequentially from 12.4% to 13.9% by focusing on cost reduction across all divisions. We believe the rising interest rates and increase in down payments by financing institutions would impact the two wheeler sales in the short-medium term. We expect the slowdown in two-wheeler segment to remain for another three to four months especially for entry level segment. We also estimate the pressure on margins to continue and it would impact the profitability of Hero Honda in FY08E. In order to face cut throat competition, the company has announced to launch 12 new models over the next 18 months. The new models will be launched across the three segments viz. entry, executive and premium. The new launches will make the existing product portfolio of the company even stronger and thereby help in enhancing its market share. Despite the stiff competition from Bajaj Auto, Hero Honda has maintained its leading position in two-wheeler market. Infact, It improved its market share to 53.1% for the 9MFY08 from 46.9% in 9MFY07.

Report card

PE ratio           17.09        26/02/08
EPS (Rs)          42.96       Mar, 07
Sales (Rs crore)      2,743.07     Dec, 07
Face Value (Rs)            2   
Net profit margin (%)   8.58      Mar, 07
Last bonus               1:1           04/08/98
Last dividend (%)   850       11/05/07
Return on average equity 34.73     Mar, 07