Hero MotoCorp:

Hero MotoCorp, headquartered in New Delhi, is the world’s largest two-wheeler manufacturer for 19 years in a row and holds a dominant share of 35.70% in the Indian two-wheeler market.

The company since its founding in 1984 until 2010 was known as Hero Honda, a joint venture between the Hero Group and the Honda Motor Company (Japan). This joint venture was incredibly fruitful for both as Hero Group brought out the most from their manufacturing and distribution bases using Honda’s superior technological prowess.

However, as the company grew, this unified vision started faltering due to multiple issues.

Red highlighted boxes indicate the party which initiated the event

These differences eventually culminated in the termination of the joint venture in 2010 and the company was renamed to Hero MotoCorp Ltd.

About Hero MotoCorp:

Hero MotoCorp manufactures and sells motorcycles and scooters globally (most of their sales are domestic). The company is known widely for their marquee brand ‘Splendor’.

The company has 8 manufacturing facilities (6 domestic, 2 abroad) and 2 R&D facilities (1 domestic, 1 abroad). The company is primarily dominant in the northern and eastern parts of India, this is substantiated from the fact that only 1 of the 6 domestic facilities is in southern India while the rest are in the north.

In today’s world, its incredibly important to be ‘visible’ and ‘accessible’ to the end consumer. Hero MotoCorp has over 9000+ touchpoints globally (7267 are in India) which makes it incredibly accessible especially across the Indian hinterland. The company has launched ‘hpgmart.com’, an online one-stop shop for their product offerings and allied spare parts.

The company’s primary strategy over the years has been to dominate the entry and deluxe motorcycle segments and it has been successful in doing so by a wide margin.

As of today, the company has attempted to break into the Premium segment but has been pushed back by its competitors several times. I believe that the reason for this could be the strong ‘brand image’ association of Hero MotoCorp with the Entry and Deluxe segments.  Their foray into the faster growing Scooter segment has been quite choppy and the company has been unable to fortify its market share from which it can attempt to grow.

Strategic Domestic Investments and Tie-ups:

Hero MotoCorp Basic Financials:

The company is near debt free (BV D/E = 3%, the debt is due to lease liabilities) and has strong free cash flow generation abilities as is evident from its large regular dividend payouts. Its ample cash reserves have allowed the company to tide through the Covid-19 pandemic and extend strong support to its distributors and the entire supporting ecosystem.

Industry Analysis:

The Indian two-wheeler industry has had a tough time over the past few years. The downturn of the industry was accentuated by the Covid-19 pandemic coupled with a transition to BS-VI regulations. In the quarter gone by, nearly all the domestic two-wheeler manufacturers posted stellar sales numbers (units sold). However, this was driven by the pent-up demand (demand delayed to the lockdowns) as well as the timely arrival of the festive season. Thus, I believe this is a short-term surge in sales and should be treated accordingly.

On a broader basis, the industry is witnessing increasing adoption of electric two-wheelers. This is likely to change the market shares of each company as this segment starts growing. I believe that the technological change and the allied infrastructure for the segment will grow slowly thereby providing ample time for the companies to adapt to these changes.

In terms of the pandemic, there has been murmur of increasing demand due to the importance of ‘personal mobility’. I do not buy into this concept due to two reasons:

Hence, I do not see any structural changes in the industry due to the pandemic. However, there will be structural changes due to the increasing adoption of electric two-wheelers.

All in all, the Indian two-wheeler industry is no longer a growth story. It is an industry that is nearing maturity and hence high growth is likely to remain elusive.

Growth Drivers for Hero MotoCorp:

Increasing Rural Incomes and Rising Affordability

The company primarily sells its entry and deluxe segments in rural and semi-urban northern India and most of this demand is driven by ‘new customers’ unlike the urban areas where it is driven by the ‘replacement’ demand.

Hence, good monsoons and increasing incomes due to positive government acts should aid growth.

Absence of Public Transportation in Rural Areas

Rural public transportation connectivity is poor and hence the need for personal mobility will persist for several years considering the vastness of rural India.

Distribution and Brand Strength

The company has a vast network of dealerships and touchpoints which makes the company more accessible and visible in rural India when compared to its peers. It also has over 25,500 retailers who stock their spare parts thereby allowing for better after-market service.

Entry and growth into different markets

Risks for Hero MotoCorp:

Increasing Costs to End Customer

Since Hero MotoCorp primarily caters to consumers who are highly price sensitive, the company may face difficulty in transferring the increased costs due to BS VI transition.

The two-wheeler insurance premiums are expected to rise in the forthcoming years (has been pushed forward by atleast 1 year due to the pandemic) and hence these increased costs to be borne by the customer may affect Hero MotoCorp more than its competitors.

Competition from a tranche of competitors across segments

Any expansion by Hero MotoCorp into other segments will be met with retaliatory measures by other able competitors. I have done a competitor analysis in depth below.

Furthermore, the entry segment has been subjected to price cuts across competitors and this could pose a risk. However, the price cutting has not been debilitating and the industry as a whole has been able to maintain margins.

Quicker than expected adoption of electric two-wheelers and allied infrastructure either by an existing competitor or a new entrant thereby leading to technological obsolescence (upheaval)

Since the technologies used in electric vehicles are different, the company’s current infrastructure will need to be revamped / modified and this could increase near-term costs drastically and render some assets entirely worthless. However, the adoption will be faster in the semi-urban and urban markets rather than the rural market. Hence, this does offer some extra breathing space to Hero MotoCorp and their investment in Ather should help mitigate these risks as well as their in-house EV development.

However, this threat is applicable for all companies.

Competitive Landscape:

The interactions with competitors are of prime importance in understanding the landscape and rules of this business.

Although there are several competitors I have decided to try to map and understand the strategies that might be deployed by the following:

The competitors in this industry directly vie for the end consumer and hence each wants to protect their own turf at the very least, and then attempt to grow market share gradually.

The two-wheeler market is segmented as; Entry level Motorcycles, Deluxe Motorcycles (100cc, 125cc), Premium (150cc +), and Scooters.

Core Market – The segment of the market that the company has entrenched itself in and is more likely to vigorously defend against competitors

Potential Target Markets – Market Segments / Geographies that the company is likely to attempt to enter/ (grow in) as a natural progression for the company and not as a retaliatory measure against the moves of other competitors

Indian Two-Wheeler Market Share (FY 20):

Now that we have laid the basic framework of the positions of the competition, let us try to forecast what may happen as Hero MotoCorp attempts to enter the potential target markets.

Hero MotoCorp’s ambitions and likely stance:

Hero MotoCorp – Royal Enfield:

Royal Enfield is a ‘brand’ that sells on the ‘experience’ of riding a Royal Enfield and has a brand pull that allows for higher margins compared to its peers. However, its core market is relatively small and doesn’t have much overlapping with Hero MotoCorp’s core or target markets. Hence, I expect minimal interaction between the two. The Hero MotoCorp-Harley Davidson partnership on the surface seems like competition, however, the target user market is different (in terms of customer affluency).

Hero MotoCorp – TVS Motor:

As Hero MotoCorp pushes into the scooter segment, it will face retaliation from TVS. However, the entry of Hero MotoCorp and the retaliation of TVS will be limited due to,

Hero MotoCorp – Honda:

Post the termination of Hero Honda in 2010, Honda on its own has been an incredibly strong competitor. It has an expansive product portfolio that spans the Deluxe, Premium, and Scooter segments. Honda is undoubtedly a market leader when it comes to delivering superior technologies at attractive prices. This has enabled the company to grow leaps and bounds in the urban and semi-urban areas. As Hero MotoCorp looks to grow in these areas, it is likely to face incredibly stiff competition from Honda.

I believe that retaliation would occur through product-for-product launches rather than aggressive undercutting of prices.

Hero MotoCorp – Bajaj-Auto:

Bajaj-Auto has significant exports (over 40% of total sales) compared to Hero MotoCorp’s (2.5% of total sales). Thus, Bajaj-Auto derives a significant chunk of revenue from a market where it currently does not compete with Hero MotoCorp.

Hero MotoCorp has attempted to enter the Premium segment multiple times but has been pushed back by the likes of Bajaj-Auto (also owns KTM) and TVS Motor. However, I believe that Bajaj-Auto’s strong financial muscle will be used to grow their exports rather than aggressively compete for market share domestically in the entry segments.

The two-wheeler market is naturally segmented by geographies (region-wise as well as [Urban, Semi-Urban, Rural]), consumer needs (travel, leisure, experience), and customer affluency. Hence, this has allowed nearly all the market participants to grow in their respective core markets. Their interactions do occur frequently as is evident from yearly changes in market share as well as temporary pricing pressures in some segments.

The operating margins for most of these companies have been relatively stable and this shows that there has not been a debilitating effect of competition on the margin front. Thus, I conclude that we will see controlled competition which will arise not by bellicose price wars but by aggressive product-for-product launching.

The company has lost market share in the overall industry due to the faster growth in the scooter and premium segments, segments that the company failed to break into. However, with a growing market, it is incredibly hard to maintain the same market share as earlier.

The company’s legacy business of Motorcycles (Entry & Deluxe) has been largely protected by the company.

Valuation:

Market Size and Revenues:

I have adjusted base numbers of FY 21 since it has been an odd year which saw sales plummet during the lockdown and skyrocket in the quarter gone by.

Revenue Per Vehicle sold for Hero MotoCorp

I expect Hero MotoCorp’s market share to decline to 33.83% in the Terminal Year and Revenue per bike sold to increase by 1.73% annually.

Margins:

Operating margins (LTM) have dropped to 11.6% due to the impact of Covid-19. I expect margins to go back to stable margins of 14%.

Tax Rate:

Company’s marginal tax rate across the valuation is 25.17%.

Reinvestment:

The company’s reinvestment has been low historically. Sales to Capital ratio will improve towards 2.1 by the Terminal Year.

Discount Rate:

The beta moves towards 0.9 (I expect two-wheelers to become more non-discretionary going forward and hence I allow for a terminal stable period beta of less than 1.)

The company’s capital structure is optimal and hence there is no change in the debt ratio.

India will become less risky as a country and hence the Equity Risk Premium will decline in the Terminal Year.

Terminal Year:

I expect the growth rate in the industry to match the risk-free rate. I make this consideration because ‘new demand’ will reduce slightly, and replacement demand will pick up.

The company’s ROC has been exceptional, well beyond its cost of capital over the years despite competition from peers. The industry is nearing maturity and hence due to lack of high growth opportunities, newer entrants may not enter. This will limit competition largely within the existing companies and hence I allow the company to earn a Terminal ROC of 11.34% (2% higher than its terminal cost of capital).

Intrinsic Valuation:

Conclusion:

Hero MotoCorp has been the global leader in the two-wheeler segment for over a decade. However, in recent times, the company has kept losing ground to its competitors and has fallen behind in terms of new innovative product launches.

A large part of my valuation rests on the case that the company is able to reduce the hemorrhaging of market share. On an intrinsic valuation basis, the company seems to be overvalued by about 32% as of today!

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