HERO HONDA:

FINANCIAL RISK
ANALYSIS

ABHIJIT SAMANTA
International School of Business & Media; Kolkata

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METHODOLOGY:-

The industry we have taken for this project is the Automobile Industry. HERO HONDA
MOTORS LTD. is the company we have taken for doing this project. The competitors are

1. TVS Motor Company Ltd.

2. Bajaj Auto Ltd.
3. LML. Ltd.
4. Kinetic Motor Co. Ltd.

For all of the above mentioned companies we calculated the Regression Beta, Beta Unlevered
and the Bottom up Beta and did the required analysis.

We also analyzed how the risk varies because of financial leverage for various companies.

The source of information we used are listed below.

a. Prowess Software.
b. Nifty website. www.nseindia.com
c. Hero Honda Motors Ltd. website. www.herohonda.com

We took last five year data on monthly basis from November 2004 to October 2009. The data
includes market return, companies return, debt to equity ratio, sales and net income of the
above mentioned companies.

Calculation of Regression Beta:-

Refer to Annexure 1 in the excel file.

Sl. No. Name of Company Regression Beta

1 Hero Honda Motors Ltd. 0.5538
2 Kinetic Motor Co. Ltd. 1.1996
3 LML Ltd. 1.2794
4 TVS Motor Co. Ltd. 1.2680
5 Bajaj Auto Ltd. 2.1399

 Regression Beta denotes the company’s risk. For Hero Honda regression beta is 0.5538 it
means if the market returns changes by 1% the company’s return will be changing by
0.5538%.

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  More the value of Company’s regression beta more risky the firm is from the investment
prospective. According to the above table Hero Honda is comparatively less risky
company and Bajaj Auto Ltd. is comparatively more risky firm as beta is 2.1399.
However this may not be a reliable data for Bajaj Auto Ltd. as we did not have the
complete information for Bajaj Auto Ltd.
 These regression betas we are calculating form the past or historical data. The market
return in the future may not be like the past. That is why the calculated risk though this
procedure is not a very good risk forecasting. In fact beta will have some statistical
standard error. If it is more we definitely cannot use it for future risk forecasting.
However incorporation of Standard Error is done later.

Regression Analysis:-

Refer to Annexure 2.

By doing the regression analysis we can create the following chart and do the following
interpretation.

Company R square Intercept S.E of Slope / Beta S.E of Beta

(Adjusted) Intercept
Hero Honda 0.37061201 1.78614068 0.928256 0.55382025 0.092636
Motors Ltd.
Kinetic 0.30641091 -2.05303075 2.310596 1.19960613 0.230588
Motor Co.
Ltd.
LML Ltd. 0.34849039 -3.41262027 2.246698 1.27935805 0.224211

TVS Motor 0.46005312 -2.04456221 1.77453 1.26802393 0.177091

Co. Ltd.
Bajaj Auto 0.45877037 6.75412189 3.770663 1.07750029 0.274484
Ltd.

 Co-relation: - Co relation is denoted by the correlation coefficient which is here r square.

It denotes the variation of firm’s share return with respect to the return of market
For Kinetic Motor the value is minimum and for TVS Motors the value is maximum.
This implies that variation of Kinetic Motor’s share return with market return is
comparatively less and vice versa for TVS Motors.

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  The Intercept: - It is firm’s share return when the market return is zero. More the value
of intercept less risky the firm is. Here Hero Honda and Bajaj Auto has positive value
that denotes these firms has some positive share return even when the market share is
zero. The remaining companies have this value negative means their share’s return is
negative when the market share is zero. Bajaj Auto is having the highest intercept here.
N.B: - Bajaj Auto’s data may not be right as it is having incomplete data base.

 Slope or Beta: - As we had analyzed earlier that Hero Honda is having the minimum risk
and LML. Ltd. is having the maximum risk. However incorporation of Standard Error
is very important in this approach.

 Incorporation of Standard Error (S.E): - Some times when the s.e is very high for a
company this implies that the value of Beta is largely deviated form the actual value. In
this case we don’t take the regression beta for making decision hence we take Bottom up
Beta.

Unlevered Beta: -

Refer to Annexure 3.

By the previous approach we can calculate the regression beta. But this regression beta or the
risk of the firm is having two components. 1. Business risk and 2. The market risk. The
regression beta is not actually a good measurement for forecasting the company’s risk. The better
approach is to calculate the Bottom up Beta.

We calculate the unlevered beta for finding out industry’s average beta. In other word to find out
the industry’s average business risk.

Here we calculate the whole automobile industries average business risk.

The formula for unlevered beta is.

Beta unlevered = Beta regression / [1+ (1-t)*D/E] t= tax rate i.e. – 33.36%, D/E = Debt to
Equity ratio.

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Company Regression Beta Debt. To tax rate Beta Industries
Equity ratio unlevered Average
(2005) Business risk.
Hero Honda Motors Ltd. 0.5538 0.140 33.36% 0.5066
Kinetic Motors Co Ltd. 1.1996 11.690 33.36% 0.1365
LML Ltd. 1.2794 2.840 33.36% 0.4423
TVS Motor Co. Ltd. 1.2680 0.300 33.36% 1.0568
Bajaj Auto Ltd 2.1399 0.760 33.36% 1.4205 0.7125

If we look toward regression beta of all the companies. Hero Honda, Kinetic, LML are having
lower business risk than the average market risk and TVS and Bajaj Auto are having more
business risk than the average market business risk. However this interpretation is not very much
dependable hence we calculate the Bottom up beta in the next approach.

Bottom up Beta: -

Refer to Annexure 4.

Our main target is to forecast the beta depending on the historical data base. Now we calculate
the regression beta this is not a very good approach of forecasting because.

1. As we calculate it form regression it corporate with standard error.

2. It is completely based on historical data.

Now comparatively better way in solving this problem is to calculate the Bottom up beta. This
bottom up beta provides a more reliable way of forecasting the company’s risk.

The formula for calculating this is .

Bottom up beta = avg. market unlevered beta*[1+ (1-t)*D/E] t=tax rate.

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Company Regression Beta Standard Error. D/E Ratio. Bottom Up Beta

Hero Honda Motors Ltd. 0.5538 0.092636 0.7790

0.140
Kinetic Motors Co Ltd. 1.1996 0.230588 6.2632
11.690
LML Ltd. 1.2794 0.224211 2.0610
2.840
TVS Motor Co. Ltd. 1.2680 0.177091 0.8550
0.300
Bajaj Auto Ltd 2.1399 0.274484 1.0734
0.760

Here if the standard error is very high for the firm then we must opt for the bottom up beta.

Here Bajaj Auto ltd. is carrying a comparatively high s.e so here we should opt for bottom up
beta.

 Sensitivity Analysis: -

Refer to Annexure 5.

D/E ratio. Bottom Up

(2005) Beta
0.140 0.7790
11.690 6.2632
2.840 2.0610
0.300 0.8550
0.760 1.0734
-1
-3.6067
-2.5537 -0.5
-1.5006 0
-0.4475 0.5
0.6055 1
1.6586 1.5
2.7116 2

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 3.7647 2.5
4.8177 3

Here the blue font colored area continues with the sensitivity analysis of d/e ratio to bottom up
beta. With the increasing D/E ratio the bottom up beta also increases. When bottom up beta is
zero D/E ratio is -1.5006.

This means in present scenario (2005) in the automobile industry if any company’s D/E ratio is -
1.5006. It will be having zero risk. But theoretically any company’s D/E ratio cannot be
negative. So any probability for any automobile company of having zero risk may not be
there. In other words every automobile company will have at least some amount of risk.

Variation of Risk and financial leverage: -

Refer to Annexure 6.

The main source of the business risk is sales volume and the cost structure. In some cases sales
volume and cost of two firms remains same. But their risk varies. The simple answer for this
question is the cost structure of the different firms. The business risk also varies with the cost
structure of the company.

In the excel sheet it is shown how there is variation of beta with sales and net income of the five
companies. In this case the slope is the degree of total leverage.