Strengths Re-assessed

India's largest two-wheeler manufacturer, Hero Honda, has had one of its worst years in FY07 when profits declined yoy in over a decade. That year, it was faced with one of the worst margin pressures brought on by rising commodity prices, mounting competition and cost hikes to usher in new-engine-technology products. Being the market leader that already ushered in "quantum-core" engine change in its bikes, HH would see the sharpest growth from the coming festival season, bringing growth back to two-wheelers with better performance expected ahead. We reiterate Outperformer.

Highlights

Expect growth to return in H2 FY08:

Lack of sales momentum in the April-May marriage season indicates that sales have been postponed for a more opportune time. The base has now been sufficiently corrected -- and the coming festival season will spur growth back to double-digits.

HH’s market share never lost:

Hero Honda has been able to maintain an almost statuesque 41.4% market share or thereabouts in the last three years in spite of major upheavals in the industry. It can therefore post the smartest recovery.

Vendor-base proximity of Uttaranchal plant - key differentiator:

Hero Honda suppliers would be least disturbed and well integrated to provide significant cost gains.

Return ratios stabilise:

We expect RoCEs to stabilize at around the 34% mark on the back of tax savings from its new plant in Haridwar. A 34% RoCE by itself is one of the best in the industry.

Valuation:

At the CMP, the stock is available at valuations of 13.8x FY08E and 10x FY09E EPS of Rs 47.8 and Rs 66.2 respectively. Expect consensus earnings upgrades, leading to re-rating. Re-iterate OUTPERFORMER.