Stock Review: HERO HONDA

 

HERO Honda's results for the December 2010 quarter underlines the inability of auto companies to fully pass on higher input costs. The company's operating profit margin declined 600 basis points year-on-year to 11.2% in the third quarter, despite a 34.4% rise in its net sales to 5,161.7 crore.

   Although its realisations per two-wheeler rose 4.6% in the third quarter, that was not sufficient to offset the surge in costs of inputs like metals. Its adjusted raw material costs as a percentage of net sales jumped 580 basis points yearon-year to 73.9% in the quarter under review. Hero Honda's net profit also fell 19.8% to 429 crore in the quarter.

   The results were broadly below analysts' expectations and the stock hit a 52-week low of 1,500.1 during intra-day trade on Wednesday. It ended the day's trade lower by 5.3% to 1,523.

   Earlier, its nearest rival, Bajaj Auto had reported a 170 basis points year-on-year fall in operating profit margins to 20.4% in the third quarter. In late December, the Japan-based Honda group announced its decision to exit from Hero Honda by selling its 26% stake. A new licensing agreement with Honda was also signed recently, although details are sketchy regarding royalty payments, amongst other factors.

Media reports indicate that the new licence agreement will enable Hero Honda to get access to new models and platforms from its overseas partner over the next few years, but there will be a need for Hero Honda to develop its own models. This, in turn, could push up Hero Honda's development and allied R&D costs, say analysts.

Going forward, the challenge for Hero Honda remains in its ability to manage the rising cost structure. This could continue to hurt the company's operating margins in the short term. Besides, auto finance rates have shown an upward trend and this could be an obstacle to sales growth for the broader two-wheeler sector, going forward.

Hero Honda trades at a P/E of 15 times on a trailing four-quarter basis. Its rival, Bajaj Auto, trades at a P/E of 24.5 times on a trailing basis, but it does enjoy superior margins.