Hero Honda: Dividend Stock for Long Term Investment

hero_honda_logoHero 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.

Trend Analysis

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.

Hero Honda Montors - Trend Analysis

Hero Honda Montors - Trend Analysis

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

Qualitative Analysis

  • 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

Summary…

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).

Hero Honda - Return Characteristics

Hero Honda - Return Characteristics

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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12 Responses to “Hero Honda: Dividend Stock for Long Term Investment”

  1. khalid says:

    Hi
    Very good analysis, appreciate your hard work yo collect all those data in one place and presentation is excellent.
    I have a bike of hero honda and some stocks also in my portfolio, but I don’t understand that why you don’t have stocks in your portfolio and at what level of p/e ratio you would consider to enter in this stock /
    khalid

    • TIP Guy says:

      Hi Khalid,

      Like you and me, there a many other folks who think HeroHonda is good investment. Therefore, it is already priced at premium or priced right to hold.

      If I wanted to buy HeroHonda, my personal fair value range is Rs. 537.1 to Rs. 673.2. It is included in my analysis above. Beyond this I am not willing to pay because then my potential returns are reduced. All my analysis will show the fair value range.

      As I have many times on this blog, there are lots of things I like, but I am not going to pay a premium for them. If I get it a price I am wiling to pay, I take it. OR look for other options.

      Best Wishes,

  2. The only thing that worries me about waiting for the fair value of 537-573 to happen is that there are usually good reasons why the price gets lowered to that level. In other words, if you do get that low a price, chances are you have to do the analysis again since the circumstances have changed.

    My approach to such stocks is to wait and try to get it 20-30% lower which occurs due to market fluctuations and not because of the company doing badly.

    I shall consider buying the company if I can get it at a div yield of 2.5 -3% which will be around Rs. 800-1000?

    • TIP Guy says:

      Hello Student,

      Yes you are right, if it goes down to that level it may or could be due to extraordinary reasons. And yes, analysis has to be done again. I do not do it once and get ready. I do review it multiple times at different time frames. In addition, market fluctuations is what value investors (including me) are waiting to happen 😉

      Best Wishes,

  3. leonard says:

    Is this company available on a US exchange?

  4. Arun says:

    Hi,
    Good analysis. There’s one part of analysis which is numberical in nature and you’ve done an excellent job. What of the qualitative analysis? Hero Honda is completely depedent on Honda for all technology and that to me is a long term concern. Can the company survive if/when Honda pulls the plug? We’re seeing some of the struggles TVS motors is going through. However, the company has developed its own technology and whether it succeeds or not time will tell. But HH does not have anything today that it can bank upon.

    • TIP Guy says:

      You have a very good point. No, I did not ignore this aspect. Purposefully, I try to avoid going into qualitative aspects because it is a never ending discussion. By never ending, I mean qualitative analysis is very hard to judge, analyze, or put into proper context. Whichever way you put it (my expectation, my assumption, or my belief); if company’s strategy (which is qualitative) is correct it will get reflected in its performance. And I look of consistency rather than flash in the pan.

      Before a strategic qualitative analysis or judgment can be passed on either HH or TVS, we need to look at certain set of metric on which a comparison can be made. These could be management, execution, product, branding, market perception, etc. If I can recall correctly, you are talking about TVS-n-Suzuki partnership. Suzuki’s partnership with Maruti seems to be working fine. Just because it did not work with TVS, does not mean Maruti is in trouble down the road. At a basic level, HH management executes well, it is growing, its profits are growing, and it has enviable market positioning. In summary, it definitely has a better product and better brand image than TVS. HH management works in unison with its partner Honda. In my opinion, the TVS management was (or is) very ambitious and have head butting mentality. Management needs to work in unison with its partner. One fine day, it cannot work independently on technology development, even when partnership is on. Although we may not know all details, usually, there is a reason why its market share is at a distant third (way behind HH and Bajaj). One may attribute temporary fall in market share to unseen events, but perennially remaining in bottom group tells a different story.

      I am not saying HH is a great company or TVS is absolutely trash. Who knows what will happen in future. HH partnership can surely break up or TVS may likely become a great success story. That’s what I mean by never ending discussion. As individual investors, we would be making mistakes to look at “qualitative aspect alone” or “projected scenarios”. So what do individual investors do? Look at numbers and go backwards and see why they look so good? Usually there is a reason for numbers to be consistently good or consistently bad.

      Hope this helps!!

      Best Wishes,

  5. Arun says:

    Thanks, TG for the clarification.

    Inspite of what I wrote, I have HH [bought at ~300 5-6 years ago] and no TVS motors. So much for putting your money where your [mouth] response is 🙂

    Completely happy with HH all these years – just being paranoid about when/if Honda decides to divorce Hero.

    Thanks,
    Arun

  6. M.Seshagiri says:

    Dear Sir,
    This is a very fine and informed discussion. I do not know if this is still open (the last entry was almost 3 years ago) but if it is, I wish to congratulate both you (for your analysis) and the other participants in the discussion. I am just a learner in this field and today I read a fine illustration with a good moral, much like a Panchatantra story.

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