Hero Motor - Leader in two wheeler

Stock Opportunities Not-so-Hidden Gems
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Hi, This is my first attempt to analyze a company. I would request @hitesh2710 and @Yogesh_s to review the thread and provide feedback if there is any other information that needs to be added to the analysis.

Description- Hero motor is world number two-wheeler manufacturing company which started in 1984 in joint collaboration with Honda. It started with first bike CD 100 in 1985. It launched many bikes after that in different segments like 100, 125, 150, 225 cc etc. I believe most successful launch was Splendor which became very popular. Currently its products are available in 37 countries. Company has 5 manufacturing unit in India in - Gurgaon, Daruhera, Haridwar, Neemrana,Vadodara. Company has two global manufacturing unit - one in Villa Rica, Colombia – has a capacity of 80,000 units per annum and another one was recently opened in Bangladesh with installed capacity of 150,000 units per annum

Story- We don’t have good public transport in India. I don’t see public transport being developed fully for next 10-15 year in small cities and villages. So there will be need for motorcycles/scooters to commute to work or within city. Hero motor is trusted name in two wheeler like we have Maruti in cars. Also company seems to be adapting to what is changing in India. E.g. Company is working to build motorcycle for emission norms, electric vehicles, setting up R&D in Germany, looking to expand to more countries outside India.

Financials-

Current Market Cap(15-March-2019) - 54,642 Cr

D/E - 0

PEG - 1.12

Free cash flow - +ve

image

SWOT Analysis-

Strength

  1. Market leader in two wheeler mainly in motorcycle
  2. Number 1 company in two wheeler with 30+ year of experience
  3. Consistent ROE and ROCE for last 10 years

Weakness

  1. Low promoter holding. Not sure if it should be considered as weakness. But it seems weakness for shareholders like me
  2. Not enough variety of bikes - I didn’t mean in term of capacity. I meant company should think about youth and design sports bike. Company just setup one R&D unit in Germany. Hopefully we will start seeing sporty models in next few years.

Opportunity

  1. Export - company started with Sri lanka and Nepal and expanded to South/Central America and Africa.
  2. Currently company is number one in motorcycle mainly in 100 and 125cc segment. But I think it can try to come up with new models in scooter too and gain market share

Threat -

  1. Increase in petrol price will reduce demand. Also monsoon, interest rates, unemployment etc can also impact the demand.
  2. Government has come up with emission norms in order to reduce pollution. So company has to align its strategy to accommodate that. Company seems to be thinking in that direction and have invested in Ather Energy(e-vehicle manufacturing company)

Price- Based on DCF valuation, it seems company is good buy around 2600 rs.

Conclusion - Initially I thought it as great company which can grow 15-20% annually. But i think it is a good company which can grow high single digit in coming years. I think motorcycle demand will still be there for next 10-15 year mainly in tier 2 and tier 3 cities and villages. Low promoter holding is still a concern.

Disclosure - I have small holding in Hero motors.

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Hi @kumars1672, go through this article,

This gives market stand as of may 2018

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Hero Moto is a company that is labelled cyclical and still manages to grow atleast in high single digits. The problem with valuing the company is the kind of terminal value it can fetch 10 years down the line.
It seems marketmen are viewing that in a few years it could slow down significantly and hence currently the valuations it has historically fetched have shrunk somewhat from the 18-19 PE to current 15-16 kind of multiples.

Rest of the numbers are fantastic and if we dont put the label of Hero on top of the numbers, and someone were to guess the type of company based only on numbers alone a lot of guys would label it as an FMCG company.

Problem as said before is that future growth and runway is a matter of concern and thats where probably perception reality mismatch might be there.

Since July 2018 the price has been stuck in a range of 2600-2700 on the downside and 3200-3300 on the upside. I think till growth comes back the range is likely to remain and can be exploited for trading sort of purpose.

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I agree that it is cyclical business. But I think motorcycle industry still has lot of potential and Hero is the leader. Also I think their R&D center in Germany will also help in launching new model. Though it will take some time as they recently set up R&D center in Germany. I bought it mainly because it is market leader in automobile and available on low PE as comparative to historical pe. I will not rate it as great company. But I think it is a good company with high single digit growth available for next 5 years.

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Thanks for the analysis. How do you compare Hero with Bajaj? On valuation wise both looks similar. Bajaj has upper hand on the premium segment. But they are not in scooter segment.

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My views on hero are from a long term perspective.

On a valuation front it is quite rare for a company with such metrics and track record to trade at such a valuation with an attractive yield as well.

I have taken 3 valuation models.

  1. Dhandho IV

  • Assumptions: FCF growth for year 1-3= 10%, year 4-6= 8% & year 7-10= 5%, exit multiple= 10x and a discount rate of 14%. the IV valuation works out to ~42000cr.

  • Assumptions on higher range- FCF growth for year 1-3=12%, year 4-6=10% & year 7-10=5%, exit multiple= 15x and a discount rate of 14%, the IV valuation works out to ~54000cr

  1. DCF

Assumptions- FCF years 1-5= 12%, years 6-10= 10%, discount rate 12%, DCF valuation= ~47000cr.

  1. Ben Graham (EPS x (8.5+2G) G is avg growth rate for 7-10 years

Lower range assumptions- PE at 0% growth= 8.5x, Long term growth rate= 5%, valuation= ~54500cr

Upper range assumptions- PE at 0% growth= 8.5x, Long term growth rate 7%, valuation= ~ 66000cr

Assuming a discount rate of 14% the company is still trading close to its lower range of valuations.

Taking a 12% DCF as well, it trades close to its current valuation. I think assumptions are quite conservative considering they have grown FCF at some 20% cagr for the last 5 or so years. A 3.5% yield is added kicker.

Even if the company grows is FCF in high single digits for the next 5-10 years we could see a simple 15% cagr and dividends provide us a margin of safety coupled with the high discount rate assumed in the valuation. They also sit on cash equivalents of some ~6000cr.

The company in my view should be able to achieve a high single digit growth in earnings due to its high ROCE inspite of it paying out ~50% as dividends as per screener data.

Investments in ather energy and working on the EV front is an additional boost for the company in the long run. I think if we take a 5 year plus view they should do quite well.

They seem to be getting aggressive now and seem to have realised the lost opportunity in the scooter and premium bike segments.

All in all risk reward seems to in favour at first glance!

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Heromotocoro is a great business at the moment and has been investor friendly over the years. Personally, I used to rate it above Bajaj Auto as an investment.

But the situation has changed a lot. Heromotocorp is growing but slower than the competition. This situation will gradually lead to lower cash flows with intense competition. The reason for the slow growth is lack of newer and better models. They have not had a single unique product since parting ways with Honda.

Additionally, their gamble with Buell USA went bad. Buell filed for Bankruptcy. Investment in Atherton energy is uncertain to reap benefits looking at the state of EV vehicles in the country.

The feather in the cap currently is Destini scooter which has brought in good volumes. I suggest they also bring in a 150cc scooter fast for brand building.

IMHO, Heromotocorp needs to buyout a major brand like HarleyDavidson, Ducati or even Hyosung to stay relevant. Otherwise, the time is not far when Bajaj, TVS, Honda and even Suzuki might overtake Heromotocorp.

For now, I would stay away from Heromotocorp due to their lack of any newer technology and know-how to build newer bikes. They cannot sustain the rural sales into the future.

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When I value Hero Motocorp, I am looking at three possibilities. 1) No sudden disruptions and ICE engines are the norm. Hero keeps 35% marker share or is able to grow 2) Disruption happens very slowly and Hero is able to keep the current 35% market share. 3) Disruptions happen rapidly and Hero loses market share in the next 2 decades. Terminal value becomes negligible.

Possibility#1 and #2 can be valued and we can come up with a probability of this happening. If we don’t get this right, we will not be able to value this company. So we may want to take a lot of time to understand the probability of EV replacing ICE in a rapid fashion. If the change is very slow, Hero will be able to mitigate the risk in my opinion.

Motorcycle range is expected to be at least 80 km ideal rating as it can go down with age and abuse. People would also expect top speed to be at least 80 kph and that would reduce range. That would require at least 3 kwh battery. This will get us to a price range of around 1lakh for a motorcycle. This is significantly higher than a low-mid level motorcycle. Hence we need a 50% reduction in battery price to be able to compete with ICE. Consumers don’t like to pay upfront for the fuel (battery). Hence price has to match ICE counterparts and ensure that their is no range anxiety.
ES011_Japan_Li-Ion_batt_opt
We can clearly see from the above graph that price may not decrease very easily due to speculation and resistance. Similarly price of oil may reduce and create much more resistance for change. If we look at this pattern, it is clear that any further reduction in price will be sustained only after a decade and hence a 50% drop in price may take 2 decades unless there is a new technology that can pack more density. Hence the probability for ICE (Internal Combustion Engine) to sustain dominance until 2035 (for low middle motorcycle) is almost 80%.

Hence we can value the company based on our comfort level of this probability. I expect my cash flows (from dividend) as the only income for the next 15 years and a terminal value of zero as part of probability #3. I will add a 20% margin of safety as per my confidence level. I will also add a 5% cagr growth until we reach terminal value. My value is around 1500 and after MoS, it comes to 1200. If I expect it to be stable until 2040, value comes to be 2100 before MoS.

If I see any possibility of abnormal growth, these valuation metrics need to be altered.

Since I expect Hero to be able to adapt to EV, I may need to add some terminal value.

Disclosure: No investment but interested

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There is https://heroelectric.in/about-hero-electric/ . Not a subsidiary but does use the hero brand. It belongs to Hero Eco group https://heroeco.com/

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I think the market at present is discounting the strength of the Hero brand and its ability to make a strong comeback. Their newly launched scooters are doing good. Their rural distribution network is unmatched.

Though the 2 wheeler market is super competitive with Hero consistently losing market share to Honda, Bajaj and TVS due to the scooterisation trend, I think their work on developing scooter models (Destino, Duet) and investment in Ather Energy (albeit expensive) are likely to yield good results.

The situation is challenging no doubt but I think Hero mgmt is aware of company’s position (that is it’s not complacent) and is taking steps to ensure future growth.

To this end, their R&D centre in Jaipur for new product development, hiring of former BMW executive and putting him in charge of R&D, investment in EV development are steps in the right direction. Then developing and relaunching the premium bikes is another good step in my opinion to challenge the dominance of Bajaj in 150cc+ segment.

Also, Hero is currently expanding its production capacity by another 18 lacs units per annum over existing 90 lacs through its Andhra plant. And subsidiaries like Hero fincorp which provide additional incentives for the 2W ecosystem to remain in partnership with Hero Moto.

International forays into Latin American (Columbian plant capacity to double to 150K pa) and neighbouring Asian countries (Bangladesh plant) should bode well too!

Disc. : invested but monitoring closely due to excessive competition in the space.

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I didn’t analyze Bajaj in detail. I agree that Bajaj is leader in premium segment. But I think Hero is catching up on that as their 125cc segment is selling more than 100cc now. I think once Hero come up with new refreshing models in 150cc and higher category, it can take market share from Bajaj. Valuation wise both are same. But as you mentioned, Hero is in both scooter and motorcycle. So there are chances of getting more market share in scooter from TVS.

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I agree about valuation part. It is attractive on valuation. Probably one can start buying in small quantity and buy more on dip. I also think company is considering about electric vehicle and introducing new models considering their investment in Ather energy and R&D center in Germany. Electric vehicle might be far from reality as infrastructure setup will be required along with electric vehicle. I dont think we are ready for that in next 2-3 years.

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Just came across this by the founder CEO of Ather Energy.
The infra is being spread quite rapidly across Bengaluru and though their electric scooters are a bit pricey at ₹1.25 lacs, costs and prices should come down as they scale.

Screenshot_20190317-081614
Screenshot_20190317-0816141080×1920 580 KB

I think Hero should own majority of this company (currently it owns 33%).

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My neighbor is hosting one

Screenshot_2019-03-17-08-38-41
Screenshot_2019-03-17-08-38-411440×2880 748 KB

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The question is, whether HeroMotocorp will be able to retain or gain market share?

It has the best distribution channel, so whatever technology comes around, Hero will soon adapt, and fill the channels. It has the brand and funding.

Currently, Bajaj Auto too has depressed sales. Maybe it has to do with the overall slow economic condition. At the grassroot level, ours was a cash based economy, which after demonetization has had a tectonic shift.

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I heard in the news that Hero motor, Honda and Eicher motor may reduce production by 15% due to slow down in the demand while Bajaj auto is planning to keep the production steady. Maruti has recently done this in car segment. It seems there is less demand in next few months in two wheeler space too.

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If we expect the growth to be 5% cagr as it was in the past, we don’t need to look at short term volatility in segment volume growth. If one is buying a stock, he needs to understand if market growth of 5% is acceptable and if his company will lose or gain market share.

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seems good times to start adding stocks

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Feb two wheeler sales analysis in detail:

https://www.team-bhp.com/forum/motorbikes/207728-february-2019-two-wheeler-sales-figures-analysis.html

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It is going to be a $5B Market Cap by 2021-2025. This means that the higher tide is going to lift everyone.

So, the question really is “What do we buy when it comes to Vehicles”.

As the Per Capita Income levels go up, imagine the situation of China. What is going to happen is that the ICE is going to migrate to Hybrid which is then going to migrate to EV. That means, it will be like the PCs with Intel Processors. Every so often the disruption of the market will force people to buy new models esp. with the new generation that replaces products quickly.

Main thing is that we OWN the Basket, and not individuals. So, my strategy is as follows:

  1. Know that this is a Cyclical Market.
  2. Know that the Macro is great with people owning more vehicles.
  3. Buses, Trains and Planes will continue to compete with the need for people to ‘move around’.
  4. Bajaj Auto, Hero, Maruti, Eicher, and TaMo should be purchased.
  5. Watch the chart patterns and get off the train with some trading positions, keeping some LT positions in tact.
  6. Don’t imagine that any of these will NOT be affected by Honda, Toyota, Ford, GM, Tesla, Nissan, Hyundai and many others.
  7. Everyone is looking at China and India.
    8 Don’t forget the Hybrid and EV will create a lot of Junk ICE vehicles which will price itself down for the lower middle and lower class of folks that are walking to work right now.
  8. And, finally, make this sector just one of many sectors you own.

Hope this 360 degree view helps. I only do Macro picture and Chart analysis for all of my stock investing, so all of the FA based analysis above really helps, which is what I use for selecting what to invest in, and when is decided with other Macro and TA factors.

KKP

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