Hero Honda Motors Limited (HEROHONDA) is India’s largest 2 wheeler motorcycle manufacturer in India. It has two manufacturing facilities at Dharuhera and Gurgaon in Haryana, which produce over 3 million bikes per year. It is has largest market share in excess of 50% in Indian two wheeler segment.
One notable aspect that I personally like about HEROHONDA is its positioning in the market segment. It satisfies the vehicular needs of large number of middle class in India. It is very well positioned in a sense that recessionary trend, slow down, or increase in oil price improves its sales and revenue. This is evident by relatively stable stock during this current market turbulence since Year 2009.
The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years i.e. from 2001 to 2008.
- Revenue: Increasing trend with average growth of 22% (SDev. 13%). Good observation.
- Earnings per share: Increasing trend with average growth of 24% (SDev. 31%). This shows it possibility of negative growth. Neutral observation.
- Net cash flow from operations: Overall, an increasing trend. For most part, the net cash flow is more or less equal to reported net profit. Neutral observation.
- Profit/Loss from operations: Consistently increasing trends in profits from its operations. Good observation.
- Reported net profit: Increasing trend. Good observation.
- Gross margins: A reducing trend. Current GM of 11.6% is less than historical average of 15% (stdev. 02.64%). A long term concern.
- Operating margins: A reducing trend. Current OM of 13.2% is less than historical average of 14.9% (stdev. 2.10%). A long term concern.
Quality of Dividends
In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. In is also an indirect way to gauging management’s policy vis-à-vis sharing the profits with common shareholders.
- Dividend per share: Chart 3 shows that stable dividend payments. However, it lacks growth. Neutral observation.
- Payout factor: This is ratio of dividends per share divided by EPS. It has a reducing trend and its now at 30%. Good observation.
- Dividend growth rate: In last eight years, dividends have grown at an average rate of 14%. This is less than EPS growth rate of 24%. Good observation.
- Ratio of cash from operations to reported net profit: This ratio is consistently around 1.0. Good observation.
- Ratio of profits from operations to reported net profit: This ratio is consistently more than one. Good observation.
- Ratio of Cash from operations to total debt: This ratio is consistently more than one. In fact, the corporation can be considered practically debt free based on its operational cash flow. Good observation.
Dividend Cash Flow vs. Risk Free Savings Cash Flow
Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 1.4% at current price of Rs. 1481.10; and (2) savings interest rate is 7%.
- Best case scenario: considering average dividend growth rate of 14.1% for last nine years, the dividend cash flow will be 0.35 times the cash flow from savings interest at the end of 10 years.
- Worst case scenario: considering low end of the expected dividend growth of 2.3%, the dividend cash follow will be only 0.13 times the cash flow from savings interest at the end of 10 years.
- In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 5.5% with average dividend growth of at least 10%. At this yield the buy price is Rs. 365.10.
Projected Beta-based Expected Return
I measured Beta for this stock’s risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected beta returns.
- The stocks three year Beta value is 0.41. This means this stock is relatively less volatile w.r.t. S&P CNX NIFTY index.
- The expected return is 10.5% relative to market index.
- Now factoring in 10.5% of expected return into the worst case dividend growth of 2.3% and current yield of 1.4%, the total cash flow is 2.1 times the savings interest rate.
Fair Value Calculation
I am continuing my analysis to estimate the fair value so that we can understand return characteristics for this investment.
- NPV price based on 15 year DCF: Rs. 1014.2
- Average high yield price calculated based on past 9 years: Rs. 380.6
- Pricing relative to 9 year average PE ratio: Rs. 929.2
- Pricing based on PE ratio of 12: Rs. 622.4
- Graham number: Rs. 414.8
The range of fair value is calculated as Rs. 537.1 to Rs. 673.2
- I like HEROHONDA as a company, its products, and its stable business model. Its market positioning is noteworthy vis-à-vis market share, quality of products, and future growth potential.
- It has a very low level of debts. It seems to appear that it is funding its growth from its own internal resources by utilizing higher earnings.
- It has had a very favorable dividend strategy in which it maintaining stable dividends.
- Considering the long term growth prospect of Indian economy and large low end of middle class, I believe TCIL is very well position for continued future growth.
- In addition, the oil prices are bound to increase in longer term i.e. average higher than last few years. This abodes good for HEROHONDA
I would like to buy shares of HEROHONDA for long term capital appreciation and stability of dividends. It appears to be a well managed company with rational and prudent financial management. Based on what I could read, I like the controlled approach towards growth without taking leveraged risk or messing with balance sheet.
The table below shows the return characteristics of the investment scenario for next 10 years (Note: this return characteristic is relative to savings cash flow and relative to index performance).
Having said good things about HEROHONDA I am still not buying it. I love Ferrari cars; unfortunately, it is not priced for me to buy. Similarly, I like this company. But it is not priced right for me to buy. Like me, there are many who think it is a good stock and hence it is already priced in. It is already trading at P/E ratio of 23. I will wait until it comes within my fair value range or look for another opportunity.
Full disclosure: No position at the time of this writing.
Disclaimer: This analysis is in the context of my long term investment philosophy. It is in line with my investment objectives and my personal risk profile. Please do your own research before making an investment decisions for HEROHONDA.
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