ICRA EQUITY RESEARCH SERVICE

HERO MOTOCORP LIMITED

Q3, 2011-12 Results Update
Revenue growth remains strong
In Q3 2011-12 the sales volumes of Hero MotoCorp Limited (HMCL) at 1.6 million units, revenues at Rs. 5,983.6 Crore and Profit before Tax (PBT) at Rs. 723.8 Crore were in line with our estimates. While HMCL recorded a volume growth of 18.1% (YoY) in 9m 2011-12, we expect the growth to taper off to ~13% for the full year 2011-12, given the higher base of H2 2010-11. The volume growth of 11.3% posted by HMCL in Q3 2011-12 (YoY) is already much lower than the 20%+ volume growth (YoY) recorded by it in the last four consecutive quarters. Our interaction with select vendors of HMCL also suggests that the companys volume growth in Q4 201112 may be negative on QoQ basis. HMCLs EBITDA margins at 15.0% in Q3 2011-12 were around 50 basis points higher than our estimates as the company managed to further increase the share of production of its Haridwar plant, where it enjoys superior profitability as compared to its other two plants at Gurgaon and Dharuhera. Going forward, the direction of commodity price movement, besides HMCLs ability to sustain the scale required to absorb the additional expenses being incurred for creating a new corporate brand, introduction of new models, building of R&D capability, exploring overseas markets for exports would be key risks to our margin estimates. We retain the fundamental grade of 5/5 assigned to HMCL, considering the two-wheeler (2W) industrys steady growth prospects over the medium term in relation to other automobile segments, 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.

Industry: AUTO

January 20, 2012

ICRA Online Grading Matrix Valuation Assessment A 5 4 3 2 1
Fundamental

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 FY12 EPS Estimate (x) *As on January 20, 2012 1,947 19.97 38,874 2,250 1,376 50% 0.66 18.4

Current Valuations
20 18 16 14 12 10 8 6 4 2 0

Assessment

C 5/C

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

18.4 16.7
15.0 10.7

Q3 2011-12 Results
Revenues: HMCLs Q3 2011-12 Net Sales at Rs. 5,983.6 Crore grew by 16.9% YoY
and 3.4% QoQ, supported by 11.3% YoY and 2.9% QoQ increase in sales volumes and 5.0% YoY and 0.5% QoQ increase in average realizations.

9.5

8.7

2011-12P

2012-13P
Price/ Earnings EV/ EBITDA

2013-14P

EBITDA Margins: HMCLs EBITDA margins at 15.0% in Q3 2011-12 declined

marginally by 15 basis points (bps) QoQ but increased by 454 bps YoY. The YoY expansion in HMCLs core EBITDA margins, however, was relatively lower at 194 bps YoY on exclusion of the estimated royalty payments made by HMCL to its erstwhile partner Honda Motor Company (HMC, Japan) in Q3 2010-11.

Source: ICRA Onlines Estimates

Shareholding Pattern (December 31, 2011)

Others, 9%

Net Profits: HMCLs Q3 2011-12 PAT at Rs. 613.0 Crore grew by 42.9% YoY and
1.6% QoQ. Overall, HMCLs revenues and PAT touched a record high in Q3 201112. Key Financials
Operating Income (Rs. crore) EBITDA Margin (%) PAT Margin (%) EPS (Rs.) EPS Growth (%) P/E (x) P/BV (x) RoE RoCE EV/EBITDA FY11A 19,245.0 12.9% 10.0% 96.5 -13.6% 20.2 13.1 60.0% 72.1% 15.6 FY12P 22,589.2 14.1% 9.3% 105.6 9.3% 18.4 9.7 60.5% 72.7% 10.7 FY13P 24,981.4 14.2% 9.3% 116.8 10.7% 16.7 7.5 50.8% 62.4% 9.5 FY14P 27,396.2 14.2% 9.4% 129.4 10.8% 15.0 6.0 44.4% 54.1% 8.7

Foreign Institutions, 34% Domestic Institutions, 5%

Indian Promoter Group, 52%

Share Price Movement (18 months)

Source: Company, ICRA Onlines Estimates A: Audited; P: Projected

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ICRA Equity Research Service

Hero MotoCorp Limited

HMCLs market share improves in Q3, 2011-12 HMCLs share in the domestic 2W market improved to 45.3% in Q3 2011-12 from 44.2% in Q2 2011-12. This was driven by improvement in HMCLs domestic market share in both the motorcycle and scooter segments. Overall, HMCLs domestic market share remains in line with its historical average of ~45%. (Refer Chart 1 and Chart 2). 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. We also expect the cessation of the JV agreement between the Hero Group and HMC to have significant medium to long term implications for the competitive landscape in the 2W industry. 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 or forming alternate technical tie-ups with external institutions to maintain a contemporary product portfolio. At present though, HMCL has added the 150 cc on-road off-road bike Impulse in its portfolio and is set to add two more products viz., , 125 cc bike Ignitor and 110cc scooter Maestro over the next few months which should enable it to sustain its market position over the short to medium term.
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

6.0

50%

2.0

48%

5.0
million units (Nos.)

48% 46%
44% 42% 40% 38%
million units (Nos.)
1.5

47%
46%

4.0
3.0 2.0 1.0

45% 1.0
44% 43% 42% Q2 FY11 Source: SIAM Q3 FY11 Q4 FY11 Volumes Q1 FY12 Q2 FY12 Q3 FY12 Market Share 41%

0.5

0.0
2006-07 Source: SIAM 2007-08 Volumes 2008-09 2009-10 Market Share 2010-11

36%

HMCLs revenue growth momentum to sustain, although base effect likely to moderate the growth rate We expect the 2W industry to maintain a sales volume CAGR of 10-12% over the period 2011-16 and HMCLs net sales to grow at a CAGR of 10-11% during the above period. The volume growth of the 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 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 and proposed capacity expansion push in the form of setting up new plants 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 expected to remain steady over the short term
Chart 3: Quarterly Trend in HMCL's Revenues and Margins
7,000
6,000 5,000

16%
14% 12% 10% 8%

4,000
3,000 2,000 1,000 Q2 FY11 Q3 FY11 Q4 FY11 Q1 FY12 Q2 FY12 Q3 FY12

6%

4% 2%
0% Net Margins

Net Sales EBITDA Margins Source: Company Results, ICRA Online's Estimates

We expect HMCLs margins to hold steady over the short term in view of expected rise in proportion of vehicles produced at the Haridwar plant, which is more cost efficient as compared to the companys Gurgaon and Dharuhera plants. While we expect HMCLs EBITDA margins to remain in the region of 14.1% in 2011-12 (12.9% in 201011) due to discontinuation of royalty charges, other factors including intensifying competition leading to diminished pricing power, expected increase in R&D and marketing expenditure and higher amortization charges are likely to restrict expansion in net margins.
2

Rs. Crore

ICRA Equity Research Service

Hero MotoCorp Limited

In addition, 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 October 19, 2011), HMCLs stock price has declined by 5.8%, S&P CNX Nifty has declined by 1.8% and the BSE Auto Index has declined by 2.0%. We find HMCLs current valuation (18.4 times FY12E earnings and 16.7 times FY13E earnings) to be at a premium to that of its peers as well as compared to the broader indices. We believe that HMCLs current valuations factor in the strong PAT growth recorded by the company over the last three quarters; the relatively greater clarity now about the business and financial implications on HMCL due to the cessation of its JV agreement with HMC; and the possible upside due to growth in future export volumes. 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. Also the 2W segment is expected to maintain its steady performance, unlike the weaker performance expected from other automobile segments/ other sectors due to the prevailing macro-economic headwinds. 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^ FY12E Price/ Earnings EV/ EBITDA Price/ Sales Price/ Book Value Price/ Cash Flow 18.4 10.7 1.7 9.7 FY13E 16.7 9.5 1.6 7.5 Bajaj Auto Limited# FY12E 14.5 11.5 2.3 7.0 FY13E 13.2 10.3 2.0 5.4 NSE S&P CNX Nifty Index# FY12E FY13E 14.5 9.8 1.6 2.3 10.1 12.5 8.7 1.4 2.0 8.8 BSE Auto Index# FY12E 12.2 7.2 0.8 3.1 7.7 FY13E 10.6 6.2 0.7 2.5 6.6

12.6 11.6 14.2 12.8 ^ICRA Onlines Estimates based on share price as on January 20, 2012 #Bloomberg Consensus Estimates as on January 20, 2012

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 Q3, 2011-12 5,983.6 5,983.6 895.1 298.7 723.8 613.0 20.0 30.7 45.7 Q2, 2011-12 5,784.3 5,784.3 873.7 278.5 724.5 603.6 20.0 30.2 44.2 15.1% 10.4% Q3, 2010-11 5,118.2 5,118.2 533.1 56.0 (79.8) 508.0 429.0 20.0 21.5 24.3 10.4% 8.4% QoQ% 3.4% 3.4% 2.4% 7.2% -0.1% 1.6% YoY% 16.9% 16.9% 67.9% 433.7% 42.5% 42.9%

EBITDA Margin 15.0% PAT Margin 10.2% 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

2009-10A 15,758.2 0.0 15,758.2 27.9% 2,679.8 191.5 2,488.4 11.1 354.5 2,831.7 0.0 2,231.8 0.0 2,231.8 199,687,500 128.6 111.8 121.4

2010-11A 19,245.0 0.0 19,245.0 22.1% 2,485.7 402.4 2,083.3 28.2 429.5 2,484.6 -79.8 1,927.9 0.0 1,927.9 199,687,500 122.0 96.5 116.7

2011-12P 22,589.2 0.0 22,589.2 17.4% 3,182.7 979.3 2,203.3 30.2 475.4 2,648.5 0.0 2,108.0 0.0 2,108.0 199,687,500 52.8 105.6 154.6

2012-13P 24,981.4 0.0 24,981.4 10.6% 3,555.7 1,029.7 2,526.0 32.4 532.8 3,026.4 0.0 2,333.1 0.0 2,333.1 199,687,500 58.4 116.8 168.4

2013-14P 27,396.2 0.0 27,396.2 9.7% 3,899.4 1,087.4 2,812.1 34.7 574.7 3,352.1 0.0 2,584.1 0.0 2,584.1 199,687,500 64.7 129.4 183.9

2009-10A 1,658.8 48.1 1,706.9 3,925.7 1,907.2 108.4 436.4 307.9 122.6 8,515.2 2009-10A 3,465.0 0.0 66.0 152.8 1,111.4 2,122.5 8,515.2

2010-11A 4,080.3 125.1 4,205.4 5,128.8 71.5 130.6 524.9 559.1 218.4 10,838.7 2010-11A 2,956.1 0.0 32.7 246.8 1,426.8 4,778.6 10,838.7

2011-12P 4,534.5 100.0 4,634.5 4,611.5 80.0 153.3 606.9 656.3 252.4 10,994.8 2011-12P 4,010.0 0.0 0.0 350.3 1,649.5 4,380.4 10,994.8

2012-13P 4,903.1 100.0 5,003.1 5,067.4 90.0 169.5 669.9 725.8 281.4 12,007.1 2012-13P 5,176.6 0.0 0.0 468.6 1,820.8 3,872.0 12,007.1

2013-14P 5,314.1 100.0 5,414.1 5,632.5 100.0 185.9 734.6 795.9 309.3 13,172.4 2013-14P 6,468.6 0.0 0.0 599.7 1,996.8 3,366.2 13,172.4
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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

2009-10A 2,679.8 591.6 1,354.1 (11.1) 3,431.3 (557.0) (204.1) (761.1) 0.0 (12.5) 0.0 (970.1) (982.5) 1,687.6 219.6 1,907.2

2010-11A 2,485.7 382.8 2,943.3 (28.2) 5,017.9 (1,203.0) (2,718.6) (3,921.7) 0.0 (33.3) (79.8) (2,636.6) (2,749.7) (1,653.4) 1,907.2 71.5

2011-12P 3,182.7 437.0 64.1 (30.2) 2,779.5 517.3 (700.0) (182.7) 0.0 (32.7) 0.0 (1,847.2) (1,879.9) 716.9 71.5 80.0

2012-13P 3,555.7 575.0 18.0 (32.4) 2,966.3 (456.0) (690.0) (1,146.0) 0.0 0.0 0.0 (1,102.0) (1,102.0) 718.4 80.0 90.0

2013-14P 3,899.4 636.9 65.7 (34.7) 3,293.5 (565.1) (790.0) (1,355.1) 0.0 0.0 0.0 (1,220.1) (1,220.1) 718.4 90.0 100.0

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 nine 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 6.15 million vehicles per annum as of March 31, 2011. HMCL offers motorcycles in all the three 2W segments: CD Dawn and CD Deluxe in the Entry segment; Splendor, Passion and Glamour in the Executive segment; and Achiever, Hunk, CBZ Xtreme, 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. Overall, HMCL has consistently outperformed its domestic 2W peers in the past, making steady gains in market share. 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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