Hero MotoCorp – A Splendid Core Holding

  • Date: May 16, 2012. Price: Rs 1893, Large Cap – Market Cap 36,800 crores
  • Advice: Low Risk, Medium Gain. Buy now and systematically.
  • Current valuation is Rs. 2025. It is available at a 7% discount.
  • Target: Rs. 3320 by April 2014, a 75% appreciation.

Subscribers received this report on 17th May 2012. 

Hero MotoCorp is the #1 two-wheeler manufacturer in the world. For a large company, the growth figures are impressive: Sales is up 19%, EBITDA 24% and Net Profit 23% CAGR over the last 5 years. Ranked #28 by market cap, it is a truly Indian blue chip. Post the split with Honda, Hero MotoCorp focus is on exports, capacity growth and premium segment offerings. Domestic competition is set to intensify, but the international potential is tremendous. Market leadership, good financial management and a recent fall in price give us a good entry point. 

Hero MotoCorp – Description and Profile

  • Hero MotoCorp (HM), formerly Hero Honda Motors is the world’s #1 maker of two wheelers, from fuel-efficient scooters to powerful motorcycles.
  • The revenues for FY12 were 23,900 crores, with PAT at 2,380 crores. It sold 6.2 m two wheelers in FY12; against capacity of 6.6 m. Manufacturing is at Gurgaon & Dharuhera (Haryana) and Haridwar (Uttrakhand). It employs 5,257 personnel.
  • It is New Delhi based. Listed since 1984, HM today is #28 in Indian Market Cap rankings at 36,800 crores.
  • HM dominates In India with 45% market share. The brands include Splendor, Passion, CBZ, Hunk, Karizma, Glamour, Achiever, Impulse and CD-Dawn/Delux. Splendor sells more than 1m per year. HM has a customer loyalty program since 2000, called the HM Goodlife programme. Exports comprise 3.4% of revenues.
  • HM has 4,500+ consumer touch points, including 800 dealers, Parts distributors and Auth. Service Centers. HM has run the successful ‘Desh ki Dhadkan’ campaign. It sponsors many sporting events, including cricket.
  • Shareholding pattern is: Promoters – Individual/Corporate 52.2%, MFs/ DII 5.3%; FIIs 33.8%, Bodies Corporate plus others 1.7%, Individuals retail & HNI 7%. Thus Promoters hold majority stake – a good sign.
  • Executives: Chairman Brijmohan Lall Munjal, MD /CEO Pawan Munjal, Directors Pradeep Dinodia and VP Malik

Strategies Executed and Updates

  • In June 2010, the Munjal family split the Hero group among themselves. Each family got ownership of the business they were already managing. Hero Honda continues with the Brijmohan Lall Munjal family.
  • In Dec 2010, the 25-year partnership between Hero Group and Honda Motors Japan was terminated. Hero Group bought Honda’s stake through an undisclosed payment and relaunched as HM in Aug’11. HM, the new entity can use the Honda brand name till 2014.  Royalty payments will also cease in ’14.
  • HM has tied up with an engine developer, AVL (Austria), to develop technology for 100 /110 cc models; for the high end products it has signing a technology-sharing deal with US m’cycle firm Erik Buell Racing (EBR). The R&D setup at Daruhera will also become a full-fledged design and engineering center with EBR.
  • Vision (5-7 Years): HM has targeted revenues of $10b and volumes of 10m by ‘16-17, with exports 10% of this.
  • HM will invest 4,500 cr. over 5 years in 2 factories (South & West India) and a global parts center (Rajasthan). Exports will expand from Bangladesh, Nepal and Sri Lanka, to Africa & Latin America, with 100-125cc bikes.
  • In Auto Expo 2012, HM showcased a hybrid scooter. The commercial launch is however some time away. In Nov’11 HM launched an Off Road Bike, Hero Impulse, creating a new category; it has been received well.

Product Classification

The two wheeler market is classified as:

  • Economy/Entry segment vehicles are priced < than 40,000, and engine 100-110cc. This segment makes up 16% of market. HM has a strong presence with 40% share. Products include CD Dawn and CD Delux.
  • Executive segment bikes are in 40-50,000 range, with engine 110-135cc. This segment has 60% of the market. HM is very strong with 71% share, with Glamour/Pro, Passion Pro, Splendor+/NXG/Pro/Super
  • Premium segment bikes have price > 50,000 and engine 150-225cc. This segment has 19% of the market. HM is weak in this segment with 13% share, with Achiever, Hunk, CBZ Xtreme, Impulse, Karizma/ ZMR.
  • Power (250cc plus) segment. This segment makes up 5% of the market. HM has no presence here.

Customer Experience: A visit to a Hero MotoCorp dealership is a revelation. The visibility and feel was good, but a lot of bikes were just lined up as if for storage, eating up the otherwise roomy showroom space. The dealership is geared to handle a lot of customers, and the noise and interactions gave a feeling of an enclosed bazaar, busy but comfortable. The salespersons were courteous and helpful. The process included a pamphlet with products, features, photos and prices, and a Test ride. The overall feel was functional, but not special.

Industry Analysis

The players in the two-wheeler space include HM, Honda, Bajaj, TVS, Suzuki, Mahindra and Yamaha.

Two Wheeler Industry Market Shares, Hero MotoCorp, JainMatrix Investments

Fig 1 – Two Wheeler Industry Market Shares (Click graphic to expand)

  • The biggest gainers in this five year  period have been HM and Honda
Two Wheeler – Domestic Sales, Hero MotoCorp, JainMatrix Investments

Fig 2 – Two Wheeler – Domestic Sales, JainMatrix Investments (Click)

  • The industry has grown at 11.7% CAGR over the last 7 years

Stock valuation, Performance and Returns

HM has been listed for a long time. For our analysis purpose, we will consider the period from 2003-12.

Hero MotoCorp, Share Price, JainMatrix Investments

Fig 3 – Hero MotoCorp Share Price

  • The Hero MotoCorp share is up 22% CAGR over the last 5 years. The all time peak was at 2279, achieved recently on May 2, 2012. It is today at 17% below this.
  • This sharp recent fall may be partially due to a lower Dividend announcement as we can see in Fig 5. The lower Dividend was to conserve cash for upcoming investments in new capacities, new products and exports.
Quarterly Sales and Profits, Hero MotoCorp, JainMatrix Investments

Fig 4 – Quarterly Sales and Profits, JainMatrix Investments

  • The growth numbers are excellent with Sales up 19%, EBITDA 24% and Net Profit 23% CAGR over 5 years.
  • Margins are not high, but have held up well in current inflationary conditions.
Five year Price and Dividend details, Hero MotoCorp, JainMatrix Investments

Fig 5 – Five year Price and Dividend details, JainMatrix Investments

  • Dividend is 2250%, which gives a yield of 2.4%.
Fig 6 – Cash Flow and EPS, Hero MotoCorp, JainMatrix Investments

Fig 6 – Cash Flow and EPS, JainMatrix Investments

  • Cash from operations has risen steadily at 38.3% CAGR
  • EPS is up 22.6% CAGR over the last 4 years.
  • ROCE was 52% in 2011, and between 42-75% in 5 years before that. One of the reasons for this is that the Equity Capital has been 40 crores for the last 10 years. This is excellent, a sign of good capital stability.
Price and PE Trend, Hero MotoCorp, JainMatrix Investments

Fig 7 – Price and PE Trend, JainMatrix Investments

  • The Price and PE Chart of HM, Fig7, indicates that in the last 6 years, the average PE has been 17. Current PE of 15.9 indicates below average valuations and a possible entry point.
Price and EPS Trend, Hero MotoCorp, JainMatrix Investments

Fig 8 – Price and EPS Trend, JainMatrix Investments

  • The view of the EPS charts in Fig 8 shows that EPS grew very rapidly in end ‘07- early ‘10 period, then fell in the 2010. The recovery has come in 2011, so that EPS is today at all time highs currently.
  • The EPS of HM is expected to stay in the channel as per Fig 8.
  • The Beta is 0.56. This indicates lower volatility than the Sensex.
  • PEG is at 0.7 – indicates undervalued status

Peer Benchmarking and Financial Projections

In a Benchmarking exercise, we have compared HM to other two-wheeler companies.

Peer Benchmarking, Hero MotoCorp, JainMatrix Investments

Exhibit 9 – Peer Benchmarking, JainMatrix Investments

Bajaj Auto rates highly on several parameters. This is because they have an established exports business. HM has been priced lower due to recent dramatic changes like split with Honda. However, HM should be able to execute on plans and command premium valuations soon.

The financials and PE of HM have been projected for the next 3 years. See Exhibit 10.

Financial Projections, Hero MotoCorp, JainMatrix Investments

Exhibit 10 – Financial Projections, JainMatrix Investments

Risks

  • Competition in India is intensifying: Honda is launching new products, and planning Chinese model imports and new manufacturing capacity. Bajaj, Yamaha and even Ducati, and Harley Davidson are launching high-end bikes in India.
    • New partnerships with AVL and EBR (detailed above) will strengthen products. New capacity is planned.
  • HM is strong on the lower end products, Economy and Executive. However these are lower margin products. While HM has some products in the Premium (and none in Power), it is a weakness.
    • As a volume leader, HM is best placed to get profits from Economy and Executive segments.
    • HM certainly needs to strengthen offerings in the profitable upper end segments and launch an attractive Power segment product. One way to do this is to open higher end focused dealer outlets.
  • HM is close to 100% capacity utilization at its plants. This makes the firm sensitive to any production disruption. Also the firm may not be able to respond to any surge in demand, if it happens.
    • HM is an experienced market player, and will be able to respond to market demands profitably.
    • By 2012, HM plans a capacity of 10m units, an almost 40% growth.
  • Macro economic risks like hike in interest rates, high inflation, petrol prices and Retail and GDP slowdown.
    • To some extend these above are already playing out in India. However two wheelers are the main means of personal transportation for the vast majority of middle and lower middle class Indians, and demand may remain robust. Also above economic headwinds should clear in 6-9 months
  • The acquisition of Honda stake in 2011 by promoters was for an undisclosed sum, which was never revealed to public. Estimates vary from 5,000 to 9,500 crores. It is a liability taken by promoters, so there is no compulsion to go public with this, but it would have been a good example of corporate governance and transparency if this were done.
  • Labour: HM is a large employer at its factories. It is critical to have good staff relations, not just in HM itself, but also in the ancillary complex of suppliers to HM. There have been strikes at suppliers like Exide (Mar 2010) and Rico Auto (Oct 2009).
    • So far Labour relations has been a positive for HM. The last public report of a strike at HM is in April 2006 (5 days at Gurgaon).

Opinion, Outlook and Recommendations

  • Two wheeler sales in India reflect of the state of the economy, perhaps better than four wheelers. The Indian economy today is at a demand inflection point, due to a combination of ‘demographic dividend’, increased per capita wealth and lifestyle aspirations. HM is well placed to take advantage of these economic conditions.
  • In the next 5 years, India will establish itself as an accepted manufacturing and export base for Automobiles, particularly smaller cars and two wheelers. HM will be able to exploit this trend.
  • HM has for long dominated the Indian two-wheeler market. This will continue. Additionally, free of restrictions from the Honda JV, HM should enter a new phase of technology independence and export led growth.
  • Consumers have accepted the Honda JV split and HM has outperformed in 2012. This is a fine stability signal.
  • The 5-year financial review has revealed good growth, high profitability, excellent ROCE and low debt.
  • A recent dip in the shares of 17% makes for a good entry point for investors.
  • HM is a Blue Chip, Low Risk, Medium Gain stock with a good dividend. It can be a Core holding for Long Term & Retirement investments. At these levels and in this trajectory, it is a BUY.
    • Our valuation prices the share at Rs. 2025. Thus today it is available at a 7% discount.
    • By Mar ’14, our projected price is Rs. 3320, a 75% appreciation
    • By Mar ’15, our projected price is Rs. 4171, a 120% appreciation
  • Invest regularly in a SIP fashion to reduce the risk of market volatility.

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 Disclosure: It is safe to assume that if the JainMatrix website recommends a stock, the researcher has already invested in it.

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