Monday, March 30, 2009

>Hero Honda Motors (KARVY)

Way ahead of the competition....

ero Honda Motors Limited (HHML) is the undisputed market leader in the domestic two wheeler industry with 48.6% share (59.4% market share in domestic motorcycle segment). We believe HHML would benefit from Bajaj Auto Ltd’s (BAL) change in strategy to focus on 125cc+ segment as the sub 125cc segment still accounts for majority of domestic sales volume. HHML has a strong presence in the rural and semi urban market which is expected to perform in the current economic slowdown. On back of margin improvement and tax benefits from the new plant the company is expected to continue its strong earnings growth for the next two years. We are optimistic about HHML's future prospect and therefore we initiate coverage on the stock
with an Outperformer rating.

HHML to continue its dominance in the domestic motorcycle segment: HHML has a strong presence in the sub 125cc segment and is expected to further strengthen its position in this segment on back of BAL's shift in focus from the 100cc segment to the 125cc+ segment. HHML would take advantage of the benefits ushered to the rural economy through its strong rural distribution network and thereby survive the current difficult economic scenario. Furthermore, the company's higher dependence on cash sales (relative to its peers) would facilitate strong performance vis-à-vis its peers in the current high credit risk situation. Improvement in EBITDA margins: HHML's margin is expected to improve on account of cooling off of raw material prices and excise duty benefit. Major raw material like steel and aluminium which accounts for ~75% of the total raw material cost have been on a declining trend since the past few months. Due to lowering of excise duty by the government and excise duty exemption at Haridwar plant the effective excise duty is expected to come down significantly. We expect the company to report EBITDA margin of 13.8% and 14.0% for FY10E and FY11E respectively.

Haridwar plant to help boost bottom line: During FY09, HHML started production at its 0.5mn unit capacity plant at Haridwar (Uttaranchal). Haridwar plant offers various fiscal benefits which include 100% excise duty exemption for 10 years and 100% income tax exemption for the first 5 years and 30% for the next 5 years. Due to lower effective excise duty and lower effective tax rate, net profit is expected to grow at CAGR of 19% over FY08- FY11E as against 10.4% expected CAGR growth in revenues during the same period.

Valuations: HHML is the market leader in the Indian two wheeler space having presence in all the significant sub segments and categories. Better EBITDA margin and lower tax rate would help the net profit to grow strongly at a CAGR of 19% over FY08-FY11E. HHML is a debt free company having cash reserves of Rs27bn and the same is expected to double by FY11E. HHML enjoys strong return ratios with FY08 RoCE and RoE of 49.2% and 35.5% respectively. HHML is trading at 15.6x and 13.3x its FY10E and FY11E estimated earnings respectively. We initiate coverage on the stock with an Outperformer rating and value the stock at Rs1,250 (15.3x its FY11E EPS of Rs81.7). In our view, HHML’s high return ratios, strong balance sheet, double digit earnings growth, negative working capital cycle, positive net cash flow and huge cash reserves justifies the premium valuations assigned to the stock.

To see full report: HERO HONDA