Stock Review: Hero Honda

The entire process of Honda exiting from the Indian listed joint venture Hero Honda appears to be opaque, with sketchy details emerging on this transaction. In the latest development, the Munjal family controlled Hero Investments will buy out the 26% stake held by the Japanese company in Hero Honda at . 740 per share, or nearly half of the stock's current price.

From the perspective of the minority shareholder in Hero Honda, it once again raises several unanswered questions, as to the rationale for the Japanese player to exit at such a steep discount and its potential impact on the listed entity's stock price, in the near term. Earlier, in mid-December 10, when Honda announced its formal decision to exit this joint venture, there remained several unanswered questions too, especially relating to the royalty structure, going forward. Hero Honda's royalty and technical fees to its Japanese parents amounted to 2.6% of its net sales of . 15,758 crore for the year ended March 10. Media reports indicate that the royalty payments for the Indian entity should not rise substantially, going forward, but that may not be sufficient to assuage investor concerns for this stock in the near term. And that's because the operating profit margins of Hero Honda in the first nine months of current financial year declined 530 basis points year-on-year to 12.2%. In addition, Hero Honda's operating margins were substantially lower than the nearest rival during this period.

Apart from that, the exit of Honda would require the Indian listed entity to substantially boost its R&D costs, in a bid to remain competitive, and that could hurt Hero Honda's operating margins in the short term. The Hero Honda stock had hit a 52-week low of . 1,377 in late February, and has recovered some ground since then. Although, the time period is not strictly comparable nor the operating environment, but a leading two-wheeler manufacturer in the South had also separated from its Japanese partner in late 2001.
Clearly, from the perspective of the minority shareholder of Hero Honda, they would be hoping that their company would also grow aggressively in the medium term. Besides, there is considerable interest on the Street regarding the price at which private equity players would acquire a stake in the unlisted entity, controlled by the Munjal family, in a bid to help finance the exit of Honda.