Hero Honda

A market leader in two-wheelers, Hero Honda has outpaced rivals with a 12 per cent sales growth in 2008-09, as against a flat growth of 3 per cent for the industry this year. Good growth in sub-125 cc segment and a strong foothold in the semi-urban and rural markets has helped Hero Honda weather uncertainties such as lower credit availability and a slowdown in urban purchases relatively well.

However, with a 42 per cent gain over the past year (the Sensex declined 32 per cent in the same period), the stock has completely sidestepped the market meltdown and now trades at a sizeable valuation premium over the market.

At the current market price of Rs.1147, stock price discounts the company’s trailing four quarters earnings by 17 times. Though Hero Honda may continue to deliver reasonable profit growth in the coming quarters, this premium valuation limits the scope for substantial upside in the stock. Investors can thus take advantage of this opportunity choose to book profits on the Hero Honda stock.

Zip-zap-zoom

Of the three key sub segments in the motorcycles category — sub-125 cc, 125-250 cc and above-250 cc — Hero Honda has a presence in the first two.

The sub-125 cc segment accounts for over 70 per cent of Hero Honda’s motorcycle sales, with the base variants Splendor and Passion helping Hero Honda command a strong market position. The low cost of ownership and lower reliance on credit purchases have contributed to good growth in Hero Honda’s sub-125 cc bikes over the past year. The Sixth Pay Commission arrears have also helped sales of two-wheelers in this period. Bajaj Auto’s shift in focus to premium bikes in recent years has also helped Hero Honda gain the extra mileage to increase its market share from 70 per cent to 79 per cent between March 2008 and March 2009.

This strategy has proved to be a success, but the situation may change if more players stage an entry into the sub-125 cc segment, to take advantage of the stronger growth in this space. Honda Motors’ (which provides technical support to Hero Honda and holds 26 per cent stake in the latter) planned foray into the 100 cc market, after success with premium launches, may pose a threat to the company’s market share.

Moreover, a shift in consumer preference to higher variants from the sub-125 cc segment is evident. The proportion of above-125 cc bikes in the total motorcycle sales has increased from 26.6 per cent in 2007-08 to 29.1 per cent this fiscal. This category targets the youth in metro and rural areas, who give priority to style, efficiency and value for money.

In 2008-09, Pulsar, the flagship model of Bajaj Auto in this space, ceded market share to new entrants such as Honda Motors and Yamaha. A flurry of product launches from competitors limited Hero Honda’s growth and it was unable to cash in on this segment as it did with sub-125 cc bikes. It has just been able to maintain its 11.6 per cent market share.

While the motorcycles segment accounts for over 85 per cent of the total revenues, the rest is contributed by scooters. Targeted at urban women, Pleasure is the only scooter from Hero Honda, whose share in sales has risen from 9.8 to 12.8 per cent this year. The growth is reported to be driven by an increase in the proportion of cash purchases.
Pan-India presence

Launched in December 2007, Har Gaon – Har Aangan, the company’s rural initiatives target 23,360 villages. The programme established a strong rural distribution network — the important reason for Hero Honda’s success in the sub-125 cc segment. Factors such as farm loan waiver, better agricultural output and farm product prices and better access to credit in rural areas are said to be the key drivers of rural demand. For the year 2008-09, sales generated from semi-urban and rural areas constituted 45-50 per cent of the company’s total revenues.
Strong financial position

For the five years to 2007-08, Hero Honda posted compounded annual (gross) sales growth of 15 per cent. This moderated to 12 per cent for 2008-09; but remained well ahead of rivals. While operating profits expanded by 6.5 per cent for the year, benefits from the commissioning of the Haridwar plant (which enjoys excise, sales tax and income tax exemptions) aided net profit growth at 10 per cent for 2008-09. Fuller utilisation of the Haridwar plant in the coming year may further augment profits growth.

Steel and aluminium procured at spot prices account for 70 per cent of the total materials cost for the company. With these prices declining by 60 per cent from their July 2008 peak, margin pressures for Hero Honda have eased off significantly. There is further scope for savings as the company’s long term contracts for other materials such as alloy wheels and rubber, are likely to conclude by first quarter of 2010.
Launches

The company had seven launches in 2008-09, which kept sales buoyant. However, most of these are extensions of existing models (for example CBZ to CBZ Xtreme). Keeping up the momentum of product launches may be crucial to sustaining sales growth. The company has lined up nine launches in 2009, but it remains to be seen if they replicate the success of the original brands.

While Hero Honda has managed a difficult year, risks persist over the next couple of years. The company’s product portfolio is highly skewed towards sub-125cc segment and any slowdown in this category would certainly impact volumes. A major portion of Hero Honda’s sales in 2008-09 has been cash funded. It is quite possible that once credit availability increases, consumers may shift preference to higher end bikes. The farm loan waiver and Pay Commission revision may have delivered a one-off fillip to two-wheeler sales; it remains to be seen if sales growth is sustained in the coming months once the impact of these initiatives wears off.