SSKI: Hero Honda Q1 - margin disappointment

SSKI maintains a 'NEUTRAL' rating on the stock.

Hero Honda's Q1FY07 net sales grew by 19.6% yoy to Rs 23.6 bn, on the back of 19.8% yoy growth in volumes to 823,692 units. Operating margins were lower by 260bps qoq and 220bps yoy at 13.5% due to discounts offered by the company and sharp surge in input costs during the quarter.

Net profit grew by 16.3% yoy to Rs 2.38 bn aided by higher other income and lower effective tax rate of 30.5%.

We believe, the decline in OPM during the previous quarter was unusually sharp and going forward margins are likely to improve from their present levels (though lower yoy).

We have lowered our FY07 and FY08 margin estimates by ~5% to factor in the higher than expected decline in Q1FY07 margins. We expect the company's earnings to grow at a CAGR of only 7.2% over FY06-08 to Rs50.4 in FY07 (Rs52.8 earlier) and Rs56.0 in FY08 (Rs58.9 earlier).

We believe there could be a positive surprise on the earnings front resulting from lower tax rate for the company due to tax benefits from the proposed new plant in Rajasthan.

The stock trades at EV/EBITDA of 7.5x and P/E of 12.9x FY08E. Hero Honda is the market leader in the two-wheeler industry with 46% market share in the motorcycle segment.

Notwithstanding the pressure on the company's margins and lower earnings growth, valuations appear reasonable at current levels.

We maintain our NEUTRAL rating on the stock.

A SSKI Research Report.