ICRA EQUITY RESEARCH SERVICE

HERO MOTOCORP LIMITED

Q4, 2012-13 Results Update Industry: AUTO April 29, 2013
ICRA Online Grading Matrix Valuation Assessment A 5 4 3 2 1
Fundamental

Results in line with expectations; two-wheeler industry volume growth outlook remains weak Volumes and Revenue Growth: In Q4 2012-13, the sales volumes of Hero MotoCorp Limited (HMCL) at 1.5 million units (domestic+exports), declined by 2.8% YoY, as customer demand for two-wheelers (2Ws) continued to remain soft reflected in flat industry sales volumes. Despite decline in HMCLs volumes, its revenues at Rs. 6,072.5 Crore in Q4 2012-13 grew by 1.8% YoY by virtue of 4.8% YoY improvement in average realizations. This was largely the outcome of a favourable product mix attributable to rise in volume proportion of 125cc bikes and scooters, at the expense of 100cc bikes; and partly due to a marginal increase in product prices (by Rs. 300 per vehicle) implemented with effect from October 2012. Overall, the companys revenues in 2012-13 were in line with our estimates. We expect HMCLs revenues to grow by ~4% in 2013-14. Profitability: HMCL recorded EBITDA margin of 12.8% in Q4 2012-13, which was in line with our estimates. While the companys margins in Q4 2012-13 were up 72 basis points (bps) on QoQ basis, the margins shrunk by 152 bps on YoY basis. This was consequent to rise in royalty costs pertaining to two new model launches (Ignitor and Passion XPro) and increase in power and transportation costs. The decline in HMCLs volumes combined with increase in costs resulted in 4.9% YoY decline in HMCLs PAT to Rs. 574.2 Crore in Q4 2012-13. The decline could have been sharper but for the reduced effective tax rate (16.3% in Q4 2012-13 Vs 19.2% effective tax rate in Q4 2011-12) in view of higher proportion of profits contribution from the companys Haridwar plant where the company enjoyed 100% income tax exemption till March 2013. We expect HMCLs EBITDA margins to improve to 14.2% in 2013-14 as the company looks to benefit from its ongoing cost rationalization programme, besides a benign raw material cost environment. The key downside risks to our margin estimates shall be the direction of currency movement, the companys ability to sustain the scale required to absorb the additional expenses being incurred for building R&D capability and spending related to exports scale-up. Equity Grading: We retain the fundamental grade of 5/5 assigned to HMCL, considering the 2W industrys steady growth prospects over the medium term, the strong brand equity enjoyed by HMCLs select models and the companys established supply chain, distribution channel and scale economies. We also retain the valuation grade of C for HMCL on a grading scale of A to E, which indicates that the company is fairly valued on a relative basis.
Key Financials
Operating Income (Rs. crore) EBITDA Margin (%) PAT Margin (%) EPS (Rs.) EPS Growth (%) P/E (x) P/BV (x) RoE RoCE EV/EBITDA FY12A 23,579.0 15.4% 10.1% 119.1 23% 13.8 7.7 65.6% 77.4% 7.8 FY13E 23,768.1 13.8% 8.8% 105.2 -12% 15.7 6.6 45.2% 53.5% 8.6 FY14P 24,819.2 14.2% 8.2% 102.0 -3% 16.2 5.8 38.1% 47.9% 8.0 FY15P 27,384.9 14.2% 10.0% 136.5 34% 12.1 5.0 44.4% 56.7% 7.3

Key Stock Statistics

Current Market Price* (Rs.) Shares Outstanding (crore) Market Cap (Rs. crore) 52-Week High (Rs.) 52-Week Low (Rs.) Free Float (%) Beta P/E on FY13 EPS (x) *As on April 29, 2013 1,648.8 19.97 32,924 2,279 1,434 51% 0.8 15.7

Current Valuations
18 16
14 12 10 8.6

Assessment

C 5/C

Fundamental Grading of 5 indicates Very Strong Fundamentals Valuation Grading of C indicates Fairly Valued on a relative basis

15.7

16.2

12.1
10.0 8.0 7.3

8
6 4 2 0 2012-13

6.5

2013-14P
Price/ Earnings

2014-15P
EV/ EBITDA

2015-16P

Source: ICRA Onlines Estimates

Shareholding Pattern (March 2013)

Others, 8.8%

Foreign Institutions, 30.6% Domestic Institutions, 8.5%

Indian Promoter Group, 52.2%

Relative Share Price Movement (18 months)

130 120 110

100
90 80 70 60

Dec-11

Apr-12

Oct-11

Mar-12

Dec-12

May-12

Source: Company, ICRA Onlines Estimates

Hero MotoCorp

Sensex

BSE Auto

Mar-13

Nov-12

Aug-12

Oct-12

Jun-12

Jan-12

Nov-11

Feb-12

Sep-12

Jan-13

Feb-13

Jul-12

ICRA Equity Research Service

Hero MotoCorp Limited

Q4 2012-13 Results
Revenues: HMCLs Q4 2012-13 Net Sales at Rs. 6,072.5 Crore grew by 1.8% YoY (1.3% QoQ decline) on the back of 4.8% YoY improvement in average realizations, even as volumes dipped by 2.8% YoY. EBITDA Margins: HMCLs EBITDA margins at 12.8% in Q4 2012-13 decreased by 152 bps YoY but improved by 72 bps QoQ as the companys other expenditure (which comprises of marketing costs, royalty charges and power and transportation costs) increased substantially during the last quarter. Net Profits: HMCLs Q4 2012-13 PAT at Rs. 574.2 Crore declined by 4.9% YoY but grew by 17.7% QoQ as the company experienced sequential improvement in EBITDA margins, relatively lower amortization charges (Yen benefit) and higher non-operating income. The effective tax rate was consistent at 16.3% during each of the four quarters of 2012-13. HMCL improves market share in both the motorcycles segment as well as in the scooters segment in Q4 2012-13 vis--vis Q3 2012-13 Despite rise in competitive intensity in the domestic motorcycle segment over the last one year following the launch of several new models by various OEMs and aggressive expansion efforts of smaller players, HMCL had been able to sustain its strong market position in this segment. In fact, HMCLs market share in this largest sub-segment of twowheelers (that accounted for 73% of the 2W industrys domestic sales volumes in 2012-13) had improved from 54.7% in 2010-11 to 55.9% in 2011-12. Even in Q1 2012-13, HMCLs market share in the domestic motorcycle segment stood at 56.5%, same as in Q1 2011-12 (56.1% in Q4 2011-12). However, in Q2 2012-13, following sharp production cut undertaken by the company for its Splendor and Passion brands, besides rise in competition, sales volumes of HMCLs 100cc bikes declined sharply by 16.8% YoY. This resulted in sharp erosion in HMCLs market share in the motorcycle segment to 50.0% in Q2 2012-13. In Q3 2012-13, however, HMCL maintained a steady monthly production volume run rate and capitalized on the sales opportunity offered by the festive period allowing it to regain some of its lost market share which stood at 51.9% in Q3 2012-13. In Q4 2012-13, HMCL further consolidated its position in both the 2W segments on the back of its strong market position in the relatively faster growing entry segment of bikes, besides steady scale-up in volumes of new models launched in 2012-13.
Chart 1: Annual Trend in HMCL's Domestic 2W Sales Volumes and Market Share
Chart 2: Quarterly Trend in HMCL's Domestic 2W Sales Volumes and Market Share

7.0 6.0
million units (Nos.)

50% 48%
million units (Nos.)

2.0 1.5

48% 46% 44%

5.0
4.0 3.0 2.0 1.0

46%
44% 42% 40%

1.0 0.5

42% 40% 38%

0.0 2008-09
Source: SIAM

38% 2009-10
Volumes

2010-11

2011-12
Market Share

2012-13

Q1 FY12 Q2 FY12 Q3 FY12 Q4 FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13

36% Volumes Market Share

Source: SIAM

Over the last two years, the growth in volumes of the scooters segment has generally outperformed that of the motorcycles segment (barring Q1, 2011-12), partly due to the formers smaller base. In Q4 2012-13 too, the sales volumes of the domestic scooters segment recorded a growth of 3.5% YoY, against 1.9% YoY decline in motorcycle sales volumes. Overall, the volume share of the scooters segment in the domestic two-wheeler industry increased to 21.2% in 2012-13 (19.1% in 2011-12). HMCL had introduced a new scooter brand Maestro (targeted at male population) in March 2012 to complement the already existing Pleasure model (targeted at female customers). On the back of discrete positioning of these two brands, HMCL has been able to improve its relative standing in the segment over the years, reflected in its ability to surpass TVS
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ICRA Equity Research Service

Hero MotoCorp Limited

Motors Company Limited (TVS) in Q4 2011-12 to emerge as the second largest player. While Honda Motorcycles and Scooters India Limited (HMSI) continues to remain the distant market leader in the scooters segment, commanding a market share of 47.9% in Q4 2012-13, HMCL is now the second largest player with 21.1% market share in Q4 2012-13 (20.6% in Q3 2012-13); trailed by TVS at 12.6%. As HMCL continues to focus on model-specific ad spends in the near term, it is likely to enable it to further consolidate its position in the fast growing scooters segment. With this, HMCL may be able to partially neutralize the relative moderation in sales volume growth in the motorcycles segment. We expect competitive pressures in the domestic 2W industry to remain high following increased pace of new product/ variant launches and strong focus on distribution network expansion by most players. While there are no near term concerns on HMCLs competitive position, the companys ability to maintain its market share over the long term would critically hinge on its success in developing in-house technical capability to maintain a contemporary product portfolio. Over the last one year, HMCL has firmed up partnerships with Erik Buell Racing (EBR, a US superbike company), AVL (the Austrian engine manufacturer) and Engines Engineering (a motorcycle design house based in Italy). At the same time, the company is in the process of setting-up an integrated R&D centre near Jaipur. Also, the company has been relatively more aggressive in introducing new products vis-a-vis competition having added the 150 cc on-road off-road bike Impulse; 125 cc bike Ignitor and 110cc scooter Maestro in its portfolio; besides introducing the Passion X-Pro 110cc bike in October 2012, initiatives which should augment overall sales volumes of HMCL. Volume growth outlook over the near term remains weak; although medium term growth drivers stay intact We expect the 2W industry (domestic + exports) to record a sales volume CAGR of 8-9% over the four year period till 201617 and HMCLs net sales to also grow at CAGR of 8-9% during the above period. The volume growth of the domestic 2W industry is expected to be driven by favourable underlying demand drivers like rising per capita GDP, moderate 2W penetration, favourable demographics, growing urbanization and swelling replacement demand. Over the years, HMCL has maintained its market leadership in the 2W industry particularly in the entry and executive segment of motorcycles. We expect HMCL to maintain its leadership status over the medium term by virtue of the companys strong brand equity, vast distribution network, established supply chain and healthy cost structure. HMCLs ongoing capacity expansion push in the form of setting up new plants at Neemrana (Rajasthan) and Gujarat is expected to allow it to capitalize on the growth opportunities continued to be offered by the 2W industry. HMCLs success in significantly growing its exports will be an upside to our estimates. HMCLs EBITDA margins declined in 2012-13 over the previous year but improvement over current levels expected in 2013-14 HMCLs EBITDA margins declined from 15.4% in 2011-12 to 13.8% in 2012-13 consequent to (a) pressure on sales 14% volume growth, (b) increase in raw material import costs 6000 12% due to depreciation of INR against JPY, and (c) increase in 5000 10% marketing spends as well as royalty charges related to 4000 launch of new models. However, we expect HMCLs 8% EBITDA margin to improve gradually over the ensuing 3000 6% quarters benefitting from (a) benign raw material cost 2000 4% environment, (b) price increase of Rs. 500 to Rs. 1,500 1000 2% undertaken across models in April 2013, and (c) cost 0 0% rationalization initiatives being taken across cost heads. Q3 FY12 Q4 FY12 Q1 FY13 Q2FY13 Q3FY13 Q4FY13 On the back of these factors, we expect HMCLs EBITDA Net Sales EBITDA Margins Net Margins margins to improve to 14.2% in 2013-14. The company Source: Company Results, ICRA Online's Estimates management has indicated that its recent industry-first initiative to offer five-year warranty on its products is estimated to have a cost impact of Rs. 60 per vehicle (~Rs. 35 Crore per annum) but given that this initiative would further increase customer confidence on its products, its long-run impact on HMCLs market position and earnings would be favourable. Over the medium term, HMCLs margins will remain sensitive to the direction of currency movement, its ability to scale-up operations to absorb the expected increase in R&D costs and product launch/ distribution costs in overseas
Chart 3: Quarterly Trend in HMCL's Revenues and Margins
7000 16%

Rs. Crore

ICRA Equity Research Service

Hero MotoCorp Limited

markets. Further, other factors including intensifying competition leading to diminished pricing power and higher amortization charges are likely to restrict expansion in net margins. Also, it would be critical for some of the key vendors of HMCL to continue to draw technical support from their existing Japanese collaborators, something which may not be as forthcoming as it was when the Hero Group and Honda (Japan) were partners. In such a scenario, some vendors of HMCL may have to upgrade their in-house design capabilities or forge alternate tie-ups to continue to have access to new technology, which may in turn result in increase in costs for HMCL.

Valuation Grade
Since our last update (on January 18, 2013), HMCLs stock price has declined by 6.7%, S&P CNX Nifty has declined by 2.6% and the BSE Auto Index has declined by 3.5%. We find HMCLs current valuation (16.2 times FY14E earnings) to be at a premium to its nearest listed competitor and also the broader indices. We believe HMCLs current valuations factor in the companys steady market position (barring recent blips) in the domestic 2W industry and steady earnings growth, notwithstanding increasing competitive pressures. Although HMCLs stock trades at a premium as compared to the broader indices, we believe the premium is justified in view of the relatively stable financial performance expectations from the company. Hence, we maintain the valuation grade of C for HMCL on a grading scale of A to E, which indicates that the company is fairly valued on a relative basis. HMCL^ FY13 Price/ Earnings EV/ EBITDA Price/ Sales Price/ Book Value Price/ Cash Flow 15.7 8.6 1.4 6.6 FY14E 16.2 8.0 1.3 5.8 Bajaj Auto Limited# FY13 17.8 13.8 2.7 7.3 FY14E 14.7 11.4 2.3 5.8 NSE S&P CNX Nifty Index# FY13 FY14E 11.6 7.7 1.1 1.8 8.7 11.8 7.5 1.3 1.9 8.9 BSE Auto Index# FY13 9.8 5.1 0.6 2.1 6.3 FY14E 9.5 5.2 0.6 2.1 6.3

10.2 10.0 16.7 13.5 ^ICRA Onlines Estimates based on share price as on April 29, 2013 #Bloomberg Consensus Estimates as on April 29, 2013

P&L Results
Rs. Crore Net Sales Other Related Income Operating Income EBITDA Depreciation Extra-ordinary gain/(loss) PBT PAT Number of Shares (crore) EPS CEPS Q4, 2012-13 6,072.5 6,072.5 776.5 265.5 685.7 574.2 20.0 28.8 42.1 Q3, 2012-13 6,151.3 6,151.3 742.3 283.2 582.6 487.9 20.0 24.4 38.6 12.1% 7.9% Q4, 2011-12 5,962.5 5,962.5 852.9 280.4 746.9 603.6 20.0 30.2 44.3 14.3% 10.1% QoQ% -1.3% -1.3% 4.6% -6.2% 17.7% 17.7% YoY% 1.8% 1.8% -9.0% -5.3% -8.2% -4.9%

EBITDA Margin 12.8% PAT Margin 9.5% Source: Company Results; ICRA Onlines Estimates

ICRA Equity Research Service

Hero MotoCorp Limited

Annexure I: P&L Estimates Rs. Crore Net Sales Other Related Income Operating Income (OI) OI Growth EBITDA Depreciation & Ammortization EBIT Interest Expenses Other Income/ (expense) PBT (before extraordinaries) Extraordinary gain/ (loss) PAT Minority Interest PAT (Concern Share) No of Shares (Cr) DPS EPS CEPS Annexure II: Balance Sheet Estimates Assets (Rs. Crore) Net Fixed Assets Capital Work-in-Progress Total Net Fixed Assets Total Long-Term Investments Cash and Bank Balances Receivables Inventories Loans & Advances Other Current Assets Total Assets Liabilities (Rs. Crore) Net Worth Minority Interest Total Debt Deferred Tax Liability Trade Creditors Other Current Liabilities and Prov. Total Liabilities

2011-12A 23,368.1 211.0 23,579.0 21.6% 3,635.2 1,097.3 2,537.9 21.3 348.1 2,864.7 0.0 2,378.1 0.0 2,378.1 1996,87,500 52.3 119.1 174.0

2012-13E 23,582.7 185.4 23,768.1 0.8% 3,284.5 1,141.8 2,142.7 11.9 381.9 2,512.7 0.0 2,101.7 0.0 2,101.7 1996,87,500 70.2 105.2 162.4

2013-14P 24,625.6 193.6 24,819.2 4.4% 3,520.4 1,261.0 2,259.4 12.7 365.8 2,612.5 0.0 2,037.7 0.0 2,037.7 1996,87,500 68.1 102.0 165.2

2014-15P 27,171.3 213.6 27,384.9 10.3% 3,884.3 717.2 3,167.1 13.6 385.6 3,539.1 0.0 2,725.1 0.0 2,725.1 1996,87,500 91.0 136.5 172.4

2015-16P 30,460.4 239.4 30,699.9 12.1% 4,354.5 499.0 3,855.6 14.6 479.9 4,320.8 0.0 3,283.8 0.0 3,283.8 1996,87,500 109.7 164.4 189.4

2011-12A 3,940.6 38.8 3,979.5 3,964.3 76.8 272.3 675.6 17.2 783.3 9,768.9 2011-12A 4,289.8 0.0 0.0 208.3 2,293.2 2,053.3 9,888.9

2012-13E 3,133.1 0.0 3,133.1 3,623.8 181.0 665.0 636.8 0.0 1,402.0 9,641.7 2012-13E 5,006.2 0.0 0.0 132.4 1,873.3 1,227.9 9,641.7

2013-14P 3,572.1 0.0 3,572.1 3,249.2 150.0 869.2 700.2 0.0 1,463.9 10,004.7 2013-14P 5,684.9 0.0 0.0 132.4 2,330.4 498.0 10,004.7

2014-15P 3,904.9 0.0 3,904.9 3,994.7 200.0 959.1 772.6 0.0 1,615.3 11,446.5 2014-15P 6,592.4 0.0 0.0 132.4 2,571.3 332.9 11,446.5

2015-16P 4,255.9 0.0 4,255.9 5,056.3 200.0 1,075.2 866.1 0.0 1,810.8 13,264.4 2015-16P 7,686.1 0.0 0.0 132.4 2,882.5 373.2 13,264.4
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ICRA Equity Research Service

Hero MotoCorp Limited

Annexure III: Cash Flow Estimates Cash Flows (Rs. Crore) EBITDA Less: Taxes Changes in Net Working Capital Net Interest Charges Cash flow from operating activities Investments Capital expenditure Cash flow from investing activities Equity Raised / (Buyback) Loans Raised / (Repaid) Others (Including Extra-ordinaries) Dividend Cash Flow from Financing activities Cumulative cash flow Opening Cash Balance Closing Cash Balance

2011-12A

2012-13E

2013-14P

2014-15P

2015-16P

3,635.2 525.1 (2,162.4) (21.3) 926.4 1,064.5

(427.7)

3,284.5 411.0 (1,818.6) (11.9) 1,042.9 460.4

(295.4)

3,520.4 574.7 (236.8) (12.7) 2,696.1 374.6

(1,700.0)

3,884.3 814.0 147.8 (13.6) 3,204.5 (745.4)

(1,050.0)

4,354.5 1,037.0 426.3 (14.6) 3,729.2 (1,061.7)

(850.0)

1,029.4 0.0 0.0 0.0 (1,039.1) (1,039.1) 916.8 71.5 76.8

1,062.0 0.0 0.0 0.0 (1,044.4) (1,044.4) 1,060.5 76.8 181.0

(428.5) 0.0 0.0 0.0 (1,401.8) (1,401.8) 865.9 181.0 150.0

(1,516.8) 0.0 0.0 0.0 (1,359.1) (1,359.1) 328.6 150.0 200.0

(1,911.7) 0.0 0.0 0.0 (1,817.5) (1,817.5) (0.0) 200.0 200.0

ICRA Equity Research Service

Hero MotoCorp Limited

COMPANY PROFILE Hero MotoCorp Limited (HMCL), formerly Hero Honda Motors Limited, is the worlds largest two-wheeler (2W) company in terms of sales volumes, a position that it has been holding for the last ten consecutive years. HMCL was promoted as a joint venture (JV) between the Hero Group of the Munjal family and Honda Motor Company (HMC, Japan), with each holding around 26% equity stake in the company. However, in December 2010, the management of HMCL signed a new licensing agreement with HMC. The Hero Group and HMC agreed to restructure their respective equity positions in HMCL, as part of which, the Hero Group bought out the entire 26% of HMCs stake in HMCL. HMCL has three manufacturing facilities located at Gurgaon (Haryana), Dharuhera (Haryana) and Haridwar (Uttarakhand) with an aggregate capacity to produce 7.0 million vehicles per annum as of March 31, 2012. HMCL offers motorcycles in all the three 2W segments: CD Dawn and CD Deluxe in the Entry segment; Splendor, Passion, Super Splendor, Glamour and Ignitor in the Executive segment; and Achiever, Hunk, CBZ Xtreme, Impulse and Karizma in the Premium segment. Splendor and Passion are the two largest selling 2W brands in the country. The company made its debut in the scooters segment in January 2006 with the launch of Pleasure in the ungeared scooters segment and launched a new scooter Maestro in March 2012. GRADING POSITIVES Market leadership, strong brand equity, professional management, high operating efficiency and established scale economies. Strong financial profile characterised by healthy margins, high profitability and cash generation. Potential upsides to our estimates: (1) HMCL sustains its current market share, leveraging its brand equity, product performance and distribution strengths; (2) industry growth exceeds our estimates over the medium term despite existing concerns on macro-economic scenario; (3) HMCL betters the margins estimated by us via sustained business growth and increases in operating efficiency even in the face of competitive and cost pressures. GRADING SENSITIVITIES Key sensitivities to our estimates include: (1) inflation in input costs not being neutralised by price increases because of competitive pressures; (2) high concentration on Executive segment; (3) intensifying competition from global players; (4) ability to develop in-house technical capability or form alternate technical tie-ups with external institutions.

ICRA Equity Research Service

Hero MotoCorp Limited

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Hero MotoCorp Limited