Hero Honda reported 3Q EPS at Rs15.04, up 9% y-o-y, slightly below our estimate of Rs15.48.
What was impressive during the quarter was the 80bps sequential improvement in its operating margin compared to our expectation of 20bps decline.
We believe that the margin improvement was largely from lower raw material prices compared to previous quarter, as the company started reaping in the benefit of declining steel and aluminium prices (together accounting for 20% of its revenue).
The company also benefited by retaining a part of the 4% CENVAT cut implemented in November, by selectively cutting prices on its models.
The two-wheeler industry volumes declined 15% during the last 3 months, in line with our channel checks findings that had revealed significant weakness in consumer sentiment post festive season.
We expect the industry volumes to remain flat over the next 6-9 months, and forecast a recovery only in 2HFY10.
We expect that the recovery will be driven by gradual return of liquidity into the two-wheeler loan market, as recent cuts in repo rate and CRR begin to percolate down in the form of cheaper and easier auto loans.
The road ahead
The 9% y-y EPS growth in the current quarter reaffirms our thesis that the 44% EPS growth seen during 3QFY08-2QFY09, will be difficult to sustain. We see weak industry fundamentals to weigh down on the company’s earnings.
We forecast an EPS growth of 6% in the next 2 quarters. We maintain our HOLD rating on the stock and TP of Rs815, based on 12x FY10 EPS.
We remain impressed by the strong company fundamentals, 160bps market share improvement in last 3 months and margin gains during the quarter.
Hero Honda’s growing market share, better product quality and significant rural exposure ensures that the company is in a position to emerge stronger from the current crisis. Significant dips in the stock can be viewed as entry points for a longer time-horizon.