Stock Review: HERO HONDA

Hero Honda's March 2011 quarter results failed to meet analyst expectations, as the largest player in the domestic two-wheeler market bore the brunt of rising key commodity input costs like steel and rubber.

The company's operating profit margin declined 190 basis points year-on-year to 15.4% in the fourth quarter, despite a 30.8% rise in net sales to . 5,390.9 crore in the period under review. No doubt, the company's average realisation per unit rose 6.7% y-o-y in the quarter under review, but that was not sufficient to meet cost pressures. Its adjusted raw material costs, as a percentage of net sales, rose 560 basis points y-o-y to 72.8% in the fourth quarter. The higher cost structure hit its March 2011 quarter net profit, which fell 16.1% y-o-y to . 501.6 crore. Hero Honda had also grappled with a fall in quarterly net profit in the second and third quarters of FY11 on a y-o-y basis. The stock fell 3.6% to . 1,600 on Wednesday.

Hero Honda is confident that its new licence agreement with Japan-based Honda Motor will enable it to maintain licence payments at broadly 2.8% of net sales over the duration of this agreement till June 2014, in line with earlier years.

However, the current rate environment for auto finance along the slow growth rate forecast for auto sales during the year ending March 2012 , could upset the assumptions related to licence calculations in the short term, say analysts.

Assuming a 15% growth in net sales for Hero Honda for the year ending March 2012 (lower than what was recorded in FY11), licence payments, as a proportion of net sales, could reach nearly 3.2%. However, given the duration of the licence agreement with Honda Motor, analysts highlight that licence payments could average broadly 2.8% of net sales, depending upon the operating environment, going forward.

Hero Honda's two-wheeler sales improved by 22.6% in the fourth quarter, which was faster than the growth reported in the first nine months of FY11. The stock trades at a P/E of nearly 16.6 times on a trailing fourquarter basis and broadly factors in the growth opportunities in the short term.