After a steady rise in profit margins in the last six quarters, stiff competition and cost pressures have dragged down margins of Hero Honda Motors Ltd in the June quarter. The drop in margins has come as a huge negative surprise. The company’s operating profit margin stood at 15%, 300 basis points (bps) lower on a year-on-year (y-o-y) basis and 330 bps lower on a quarter-on-quarter (q-o-q) basis. Analysts had expected margins to decline by 100-200 bps q-o-q.
The sharp decline in margins was almost entirely accounted for by an increase in raw material costs, which rose to around 71% of net sales from 68% in the year-ago period and 67% in the preceding quarter. Prices of steel and tyres have been rising and have hit the margins of most auto companies in the June quarter. The company has said that switching over to new emission norms also added to the expenditure. Earlier this month, some analysts had expressed disappointment that the company had increased prices only in June, which they felt, would not offset cost pressures.
Also See Negative Surprise (Graphic)
This could perhaps be due to stiff competition from its competitor, Bajaj Auto Ltd. In the last few months, Hero Honda’s share in the motorcycles market has receded. According to analysts, Hero Honda’s share in domestic markets has fallen from 58.5% at the end of fiscal 2010 to 54.7% in June. On the other hand, Bajaj Auto’s share is up from 24.3% to around 26%. Even though Hero Honda’s share has fallen, it has still managed to report its highest-ever quarterly sales of 1.23 million vehicles, up 10% on a y-o-y basis and 4% on a q-o-q basis. As a result, net sales registered a 12% y-o-y growth to Rs4,264.6 crore.
But due to a drop in margins, net profit for the quarter fell by 2% on a y-o-y basis to Rs491.7 crore. It was significantly lower than consensus estimates of around Rs580 crore, based on a poll by Bloomberg. With profit coming in at around 15% lower than estimates, the stock is likely to correct when market resumes on Friday.
The outlook for sales volumes during fiscal 2011 looks promising at around 5.3 million vehicles, which implies a 15% growth rate over the previous fiscal. Although margins would be better in the September quarter owing to the softening of raw material prices, they are still estimated to be lower by at least 100 bps on a y-o-y basis.
Hero Honda’s shares have underperformed both the BSE Sensex and the BSE Auto Index in the last one month. The stock discounts estimated fiscal 2011 earnings by around 16 times and it’s interesting to note that Bajaj Auto, which used to trade at a discount for a long period, now gets a similar valuation. That’s because of the latter’s higher growth rates currently, and its relatively better margin performance thanks to its diversification with three-wheelers. The margin shocker in the June quarter could impact Hero Honda’s valuation further.
Graphic by Yogesh Kumar/Mint
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