Concerns over Hero-Honda split recede

While the formal announcement of the termination of the joint venture agreement between Hero Group’s 26-year-old joint venture with Honda is sketchy on the details, analysts believe the deal is likely to be welcomed by the markets as some of the apprehensions of high royalty payments seem unfounded. While the deal was announced after the market closed, the scrip jumped 3.71 per cent to Rs 1,681.

In the short term, analysts don’t expect much to change, as the existing models as well as technology for new models will continue to flow through a fresh licensing agreement. But whether the Hero group will be able to build its own R&D from scratch quickly or tie up with a new technology player could decide the fortunes of India’s largest motorbike maker. Both Bajaj Auto and TVS Motors struggled to get their act together after they split from their JV partners, with Bajaj taking nearly four years to make a dent in the commuter segment with its Discover brand.

In addition to technology, the other key issues are royalty payments, exports and the impact of higher R&D investments. While the Hero Honda management said royalty payments (currently at 2.6 per cent of sales) will gradually decrease over a period of time, how Hero Honda will compensate Honda for new bikes is not clear. The JV break-up will help Hero Group to scout for new markets overseas (two-wheeler exports are growing at 15 per cent annually), which it was hitherto unable to do, and will be a definite plus. With the break-up, analysts expect the R&D spend for Hero Honda to move up from 0.23 per cent currently and closer to the levels of TVS (2.3 per cent of sales) and Bajaj Auto (1.17 per cent of sales). This could have a 6-7 per cent impact on the earnings per share. While Hero Honda has cash to invest in expansion and R&D, the market would also be keen to know how the promoters will be able to cough up Rs 8,500 crore to buy Honda’s stake.

Though Honda officially becomes the fourth competitor in a market which continues to be dominated by the top three players, Hero Honda’s over 4,500 service centres and deep understanding of customer/market attributes will be a definite advantage over its rivals. Analysts believe it will be a long ride ahead for Honda to make a dent in Hero Honda’s strongholds in the executive segment, where it dominates with a 70 per cent share.

At the current price, the stock trades at 14 times its FY12 EPS of Rs 119.