Annual Report Analysis

Hero Honda Motors Ltd

Another good year
BSE Code 500182 Company background
NSE Code HEROHONDA Hero Honda Motors Ltd (HHML), established in 1984, is a joint venture between
Bloomberg Code HH@IN Hero Group, the world’s largest bicycle manufacturers and the Honda Motor Company
Market Cap Rs110bn of Japan. Today it is the world’s largest two-wheeler manufacturer. Hero Group
CMP Rs553 belongs to the Munjal family and came into existence in 1956. It manufactured bicycle
52week H/L 597/320
components in the early 1940’s and later became the world’s largest bicycle
Face Value Rs2
manufacturer.

Share Holding Pattern HHML manufactures a range of motorcycles with brands like CD Dawn, Splendor,
Shareholding pattern (%) Passion, CBZ, Karizma and Ambition. It is the market leader in two-wheelers and its
Government 55.0 Splendor range of bikes is the largest selling motorcycle in the country.
Institutional 32.4
Public 11.2
Others 1.4 Industry scenario
The two-wheeler industry thrives in developing countries especially in densely populated
countries like India. With income levels rising, customers are opting for entry-level
Share Price Chart motorcycles than scooters. The two-wheeler industry grew 11.6% yoy to 5.64mn
units in FY04 from 5.05mn units in FY03. The share of motorcycles in total two-
wheeler sales continues to improve (76.6% from 74.4% in 2002-03) while that of
geared scooters continues to be on the decline.

In terms of volumes, two-wheelers constitute nearly 80% of the vehicles produced in

India. However, in value terms, they account for 25% approximately of the total
vehicle production. HHML is the market leader followed by Bajaj Auto and TVS
Motors, in that order.

Table: Market share in motorcycles

(%) FY04 FY03
HHML 48 44
Bajaj Auto 24 24
TVS Motor 16 18
Yamaha 6 8
Others 6 6
Source: SIAM

In two-wheelers, HHML’s market share stood at 37% during FY04. In the premium
segment, the company enjoyed a 14% market share for the same period.

December 22, 2004 1

 Annual Report Analysis

Higher volumes, lower realizations

HHML registered a 14.4% yoy growth in net sales to Rs58.3bn in FY04, similar to
the growth rate achieved in FY03. The key difference however, was the significant
fall in realizations in FY04 compared to FY03. While volumes increased by 23.4%
yoy in FY04, net realizations declined by 7.4% yoy during the same period.

Chart: HHML sale volumes and growth

2,500 50
2,070
2,000 1,678 40
1,425
1,500 30
1,030
1,000 762 20
500 10

- 0
FY00 FY01 FY02 FY03 FY04

Volumes ('000's) Growth in sales

LHS – Volumes in 000’s, RHS – Volume growth (%)

Source: Company data

The company launched 5 new models in FY04 to increase its share in the motorcycle
market. CD Dawn in April 2003, Karizma in May, Passion Plus in September 2003,
Splendor+ in October 2003 and Ambition 135 in January 2004. The company sold
over a million units of its Splendor range and 0.5mn units of CD Dawn in FY04. The
company enjoys a customer base of nearly 10mn.

FY04 witnessed export growth of 72% yoy mainly led by success of new models.
CD Dawn, Splendor+ and Passion Plus led to increase in exports by 87%. Besides
providing support services to Sri Lanka, Bangladesh and Columbia, the company
established its presence in new markets like Sierra Leone and Philippines for
motorcycles and components respectively.

Operating profit growth 14.9%, OPM at 16.6%

The company was able to marginally improve its operating margins by 7bps to 16.6%
in FY04 in spite of increase in steel prices and other input costs. The 104bps increase
in raw material cost was offset by a 108bps decline in other expenditure. The lower
other expenditure was due to reduction in advertising and revenue spends by the
company in FY04, which declined by 12.3% yoy. In contrast, raw material cost
increase was a result of a 7.3% yoy rise in cost of steel sheets and 15.3% yoy rise in
cost of components in FY04. Change in sales mix too contributed to higher raw
material cost.

December 22, 2004 2

 Annual Report Analysis

Significant additions to investment portfolio

HHML added Rs3.7bn to its investment portfolio in FY04, a 31.2% yoy growth
from FY03. This has been the trend for the company in the last few years. HHML has
been adding over Rs4bn on an average in the last three years, witnessing a CAGR of
78.8% from FY01 to FY04.

Table: HHML’s Investment portfolio (As on March 31, 2004)

(Rs mn) FY04 FY03
Non-trade
Unquoted
MF Debt 550 -
MF MIP 5,961 -
MF Liquid 926 1,940
Quoted
MF Equity - 105
Quoted
Equity shares 738 -
Unquoted
Equity shares 18 -
Quoted
Bonds 1,613 -
Trade
Unquoted
Equity shares 35 35
Source: Annual report

The company recorded 67.2% yoy increase in its other income, which stood at
Rs1.8bn in FY04 compared to Rs1.1bn in FY03. Investments in mutual funds and
quoted bonds resulted in the high other income component for the company. Other
income accounted for an EPS of Rs9 before tax during the period under review. This
resulted in high incremental PBIDT growth of 20.8% yoy.

Another year of net interest earnings

HHML continues being a zero debt company in FY04. The company has unsecured
loans to the tune of Rs1.7bn on account of sales tax deferment from the State
Government of Haryana, which resulted in an interest payment of Rs17mn in FY04.
The company earned a net interest of Rs13.5mn compared to Rs10.2mn in FY03.

December 22, 2004 3

 Annual Report Analysis

Capacity expansion and R&D expenses

HHML added to its gross fixed assets at a higher rate compared to sales growth. The
company utilized Rs500mn for expansion of its manufacturing facilities in FY04.
Depreciation charged for the year was marginally on the higher side as the company
follows a straight-line method of depreciation.

Table: HHML’s capacity and production information

FY04 FY03
Installed capacity (Units) 2,250,000 1,800,000
Actual production (Units) 2,064,698 1,680,277
Utilization rates (%) 91.8 93.3
Motorized two-wheelers with 350cc engine capacity
Source: Annual report

The company has two plants, one at Dharuhera and the other at Gurgaon. The
Dharuhera plant manufactures CD 100, CD 100ss and CD Dawn motorcycles while
the Gurgaon plant manufactures the others. Splendor is manufactured at both the
plants.

Chart: HHML’s productivity index (Units)

350
288
300
233
250 202 192
200 168 175
131 150
150 119 124

100
50
0
FY00 FY01 FY02 FY03 FY04
Dharuhera Gurgaon

FY99 – Base year (100)

Source: Annual report

By making additional investments in flexible CNC machines and automation, the

capacity at these plants is now in a position to increase its production levels.

Table: HHML’s R&D spend

(Rs mn) FY04 FY03 yoy (%)
Capital 74.3 15.6 376.3
Recurring 93.3 69.7 33.9
Total 167.6 85.3 96.5
Source: Annual report

December 22, 2004 4

 Annual Report Analysis

Efficient working capital management

During the year, the company initiated a new receivables policy, which helped bring
down the debtor levels. Debtors declined by 69% yoy to Rs438mn in FY04, resulting
in debtor days falling to 2.7 days during the same period compared to 10.1 days in
FY03.

Inventories declined by 6.3% yoy to Rs1,882mn, which resulted in lower inventory

days at 11.8 days in FY04, compared to 14.4 days in FY03. This follows the
company’s trend of consistently lowering the proportion of inventories in total assets
over the years, shown in the chart below.

Chart: HHML’s inventory trend

2,050 30.0
2,000
25.0
1,950
20.0
1,900
1,850 15.0
1,800
10.0
1,750
1,700 5.0

1,650 0.0
FY01 FY02 FY03 FY04
Value (Rs mn) % of total assets

LHS – Inventory (Rs mn), RHS – Inventory as % of total assets (%)

Source: India Infoline Research

The only anomaly was the increased levels of loans and advances during the year.
FY04 witnessed huge increase in loans and advances by 117.4% yoy to Rs2.4bn
compared to a 20.7% yoy decline in FY03. These were on account of advances
recoverable to the tune of Rs2,246.6mn, which increased from the previous year
level of Rs981.4mn. This was partly on account of inter-corporate deposits given by
the company during the year.

Creditor days increased to 68.5 days in FY04 compared to 54.3 days in FY03.
Creditors grew by 44.2% yoy to Rs10.9bn in FY04 due to the healthy reputation
enjoyed by the company. On account of this, the company continued to enjoy a
negative working capital during the year.

December 22, 2004 5

 Annual Report Analysis

Healthy cash flow from operations

HHML’s cash from operations rose by 29% yoy to Rs10.7bn in FY04 compared to
Rs8.3bn in FY03. The company funds their expansion from this cash and does not
need to raise any external loans for the purpose. The net profit margin increased to
12.5% during FY04, higher by 110bps compared to FY03.

Chart: HHML’s rising net profit margin (NPM)

8,000 13.0

7,000 12.0

6,000 11.0

5,000 10.0
4,000 9.0

3,000 8.0

2,000 7.0
FY01 FY02 FY03 FY04
Net Profit NPM

LHS – Net profit (Rs mn), RHS – NPM (%)

Source: India Infoline research

Dividend percentage hiked once again

Continuing with the trend of increasing the dividend percentage paid each year, HHML
declared 500% final dividend to add to the 500% interim dividend during the year.
This took the total dividend tally to 1000% in FY04, which translates into Rs20 per
equity share for the year.

Table: HHML’s dividend record

FY01 FY02 FY03 FY04
Total dividend# (Rs mn) 660 3,497 4,055 4,505
Dividend (%) 150 850 900 1,000
Payout ratio (x) 27 76 70 62
# Including corporate dividend tax
Source: Company data, India Infoline Ltd

Key ratios
FY00 FY01 FY02 FY03 FY04
ROCE (%) 45.1 54.5 86.7 89.0 81.8
RONW (%) 43.3 39.2 67.5 67.4 64.0
EVA (Rs mn)* 1,190 1,550 3,740 4,810 5,690
Market Capitalization (Rs mn) 38,740 28,160 66,700 37,580 97,970
WACC (%)** 17.5 15.9 12.3 11.3 13.9
* Economic Value Added
** Weighted Average Cost of Capital
Source: Company data, India Infoline Ltd

December 22, 2004 6

 Annual Report Analysis

Outlook
During the year, HHML renewed its technical collaboration with Honda Motor
Corporation of Japan for another 10 years up to 2014. This will give HHML access
to Honda’s technology for another 10 years for developing new products. HHML
plans to launch two motorcycles in FY05 and a scooter with the technology provided
by Honda.

Growing competition, price undercutting, rising steel prices and other input costs
continue to pose a threat. Reduction in import duties for imports could also pose a
threat for the higher end bikes.

The company mentions in the annual report that the next three years for the two-
wheeler industry are positive but volatile. The company is planning to further increase
its capacity to meet the growing demand for motorcycles. It is considering setting up
a third plant for its products.

December 22, 2004 7

 Annual Report Analysis

Income statement
Period to FY01 FY02 FY03 FY04
(Rs in mn) (12) (12) (12) (12)
Net Sales 31,687 44,627 50,976 58,310
Operating expenses (27,670) (38,009) (42,560) (48,644)
Operating profit 4,017 6,617 8,415 9,667
Other income 221 852 1,082 1,809
PBIDT 4,238 7,469 9,497 11,475
Interest (25) (15) (17) (17)
Depreciation (443) (510) (634) (733)
Profit before tax (PBT) 3,770 6,944 8,846 10,725
Tax (1,301) (2,315) (3,038) (3,441)
Profit after tax (PAT) 2,469 4,629 5,808 7,283

Balance sheet
Period to FY01 FY02 FY03 FY04
(Rs mn) (12) (12) (12) (12)
Sources
Share Capital 399 399 399 399
Reserves 5,893 6,458 8,211 10,989
Net Worth 6,292 6,858 8,610 11,388
Loan Funds 665 1,164 1,343 1,747
Total 6,957 8,022 9,953 13,135
Uses
Gross Block 6,147 7,045 7,863 9,169
Accd Depreciation (1,798) (2,235) (2,784) (3,458)
Net Block 4,349 4,811 5,079 5,711
Capital WIP 190 97 92 177
Total Fixed Assets 4,539 4,907 5,171 5,888
Investments 2,882 7,258 11,930 15,651
Total Current Assets 3,792 5,267 4,774 5,097
Total Current Liabilities (4,457) (9,512) (11,929) (13,501)
Net Working Capital (665) (4,245) (7,155) (8,404)
Miscellaneous expenditure 202 102 7 -
Total 6,957 8,022 9,953 13,135

December 22, 2004 8

 Annual Report Analysis

Cash flow statement

Period FY02 FY03 FY04
Year to (Rs mn) 03/02 03/03 ’03/04
Net profit before tax and extraordinary items 6,944 8,846 10,725
Depreciation 510 634 733
Interest expense 15 17 17
Operating profit before working capital changes 7,469 9,497 11,475
Add: changes in working capital
(Inc)/Dec in
(Inc)/Dec in sundry debtors (574) (418) 977
(Inc)/Dec in inventories 202 (226) 127
Inc/(Dec) in sundry creditors 3,192 739 3,352
Inc/(Dec) in other current liabilities 1,863 1,678 (1,780)
Net change in working capital 4,682 1,773 2,676
Cash from operating activities 12,151 11,270 14,151
Less: Income tax (2,315) (3,038) (3,441)
Misc expenditure w/off 100 95 7
Net cash from operating activities 9,937 8,327 10,717
Cash Profit 9,937 8,327 10,717
Cash flows from investing activities
(Inc)/Dec in fixed assets (879) (897) (1,451)
(Inc)/Dec in Investments (4,376) (4,672) (3,721)
Net cash from investing activities (5,255) (5,569) (5,172)
Cash flows from financing activities
Inc/(Dec) in debt 500 178 404
Direct add/(red) to reserves (567) (0) 0
Interest expense (15) (17) (17)
Dividends (3,497) (4,055) (4,505)
(Inc)/Dec in loans & advances (464) 290 (1,299)
Net cash used in financing activities (4,043) (3,604) (5,417)
Net increase in cash and cash equivalents 639 (846) 128
Cash at start of the year 451 1,090 243
Cash at end of the year 1,090 243 371

December 22, 2004 9

 Annual Report Analysis

Key ratios
FY01 FY02 FY03 FY04
(12) (12) (12) (12)
Per share ratios
EPS (Rs) 12.4 23.2 29.1 36.5
Div per share 3.0 17.0 18.0 20.0
Book value per share 31.5 34.3 43.1 57.0
Valuation ratios
P/E 0.0 0.0 0.0 14.1
P/BV 0.0 0.0 0.0 9.0
EV/sales 0.0 0.0 0.0 1.8
EV/ PBIT 0.1 0.0 0.1 9.7
EV/PBIDT 0.1 0.0 0.1 9.1
Profitability ratios
OPM (%) 12.68 14.83 16.51 16.58
PAT (%) 7.8 10.4 11.4 12.5
ROCE 54.5 86.7 89.0 81.8
RONW 39.2 67.5 67.4 64.0
Liquidity ratios
Current ratio 0.9 0.6 0.4 0.4
Debtors days 4.9 8.2 10.1 2.7
Inventory days 22.9 14.6 14.4 11.8
Creditors days 42.1 56.0 54.3 68.5
Leverage ratios
Debt / Total equity 0.11 0.17 0.16 0.15
Component ratios
Raw material 109.5 69.4 68.09 69.12
Staff cost 5.2 3.8 3.22 3.19
Other expenditure 19.6 12.0 12.19 11.11
Payout ratios
Dividend Payout Ratio 26.7 75.5 69.8 61.9

Published in December 2004. © India Infoline Ltd 2003-4.

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December 22, 2004 10