This is a contrarian view to the general perception that Hero MotoCorp is a multi-bagger. This was first uploaded on SumZero in July 2014

1. THE EVERGREEN HERO ?
POSITIVES
 Stops paying royalty payments to Honda from second quarter of FY14-15
 Gains market share from its main competitor - Bajaj Auto
 Aggressively entering new geographies
 Investment in new capex and building its R&D capabilities
NEGATIVES
 El Nino affecting agricultural economy, reducing disposable income
 Honda making an impact in its traditional market with a larger portfolio
 Scooters targeting working women are selling very fast and Hero lacks a suitable product in
this segment
ROYALTY & LICENSE FEES - Divorces are costly !
Since the late 80's the company was operating as a joint venture with Honda Motors. Honda is the
world's largest motor cycle manufacturer, a distinction that it has maintained since 1959. Honda
brought in technical expertise along with its huge product portfolio and the local promoters- the
Munjal's brought in their distributor network and marketing expertise. However in 2011, with their
growing global ambition the two parted ways. Honda transferred its 26% stake in the company to the
Indian promoters and entered into a license agreement to give the Indian entity the right & license
over certain products under their IPR. The change in ownership was also reflected in the company's
name, which changed from "Hero Honda Motors Ltd" to "Hero MotoCorp Ltd"
As per the license agreement Hero Motocorp will pay royalties and license fee for the use of Honda's
IPR.
For manufacture,
assembly, selling and
distribution
Rs. 19,283.7 mn.
For Exports Rs. 5,509.6 mn.
TOTAL Rs. 24,793.3 mn.
The amount was capitalised as an intangible asset and was amortised over 42 months ending in June
30th 2014. After this the company will pay royalties on IPR for just the following four products.
 Maestro : A 109cc scooter which with its bold and stylish design is targeted at the male
customers
 Passion Xpro : This is their second largest selling bike after the Splendor
 Impulse: Introduced in 2008, this 149cc affordable dual-sport motor bike targets a very niche
segment in India
 Ignitor: Launched in 2012 this commuter bike, has a 125cc engine.
Royalties account to less than 5% of the total cost of these products.

2. EXPANSION PLANS - Bom dia!
Until 2011 Hero was restricted from expanding outside of Asia Pacific. It had set up an assembly unit
in Columbia and Bangladesh to cater to the local markets. However after the breakup, the company is
rapidly expanding its horizons. Last year the company exported 350,000 units to different countries.
By 2016-17 the company expects to reach a target of 1mn units in exports. This will roughly be
around 10% of their total unit sales. By 2020 they expect to reach 50 countries and set up
manufacturing or assembly units in at least 20 locations.
Last year their bikes were exported to the following countries
 Peru in Latin America
 Guatemala , Honduras & El Salvador in Central America
 Columbia in South America
 Kenya in East Africa
 Burkina Faso and Ivory Coast in West Africa
 Sri Lanka, Nepal and Bangladesh in Asia
Recently they have invested $ 70 mn in their upcoming Columbian facility , which will become
operational in 2016. It is also scouting for partners in Brazil.
Brazil is the largest market in Latin America with a market size of more than 2mn bikes per year , but
it has its own peculiarities. The engine needs to be modified to use ethanol. (more about this later.....)
At the same time in Bangladesh a manufacturing plant is being setup with a capital expenditure of
$23mn. Another $40mn will be invested over the next 5 years to make i t into a world class
manufacturing plant.
In Feb 2014 they rolled out 50 outlets in Turkey in partnership with Asya Makina. They are also
chalking out plans to enter the North American market with high end sports bikes. Thus their global
ambitions are well on track.
FINANCIALS - How do they stack up?
 The company has reported lower net profit margins, relative to what they achieved in the last
5 years.
 Lacklustre sales growth (% q-o-q) along with higher raw material and employee costs are
partly to blame for the lower margins.
 Also taxes are expected to rise higher in the coming quarters. The Haridwar plant which
manufactures around 35-36% of the overall production had a 100% tax exemption on all of its
profits. From FY14 the company will receive exemption on only 30% of the profits. This will
increase the tax rate from 16% to 24% odd.
 The silver lining over here is that according to SIAM ( the Indian auto industry association)
sales are finally seeing an uptick. And exports are also showing signs of a revival, in fact they
have chalked up a scorching pace.
 Another plus is that the company which had capitalised its final payments to Honda over a
period of 42 months, this ends on June-14. So depreciation as % sales falls to their pre-2011
levels. This should add Rs. 6 bn. to the bottom line

3. 20.0%
15.0%
10.0%
5.0%
0.0%
NP % of Sales
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Depreciation % of Sales
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
76.0%
74.0%
72.0%
70.0%
68.0%
66.0%
64.0%
62.0%
RM % of Sales
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
30.0%
20.0%
10.0%
0.0%
-10.0%
-20.0%
-30.0%
Sales growth q-o-q
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Taxes % of Sales
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
Employee Cost % of Sales
Q1 Q2 Q3 Q4
FY2009
FY2010
FY2011
FY2012
FY2013
FY2014
 As per company statements they have initiated a cost cutting exercise since April-13. The
program will be implemented in 5 "waves" leading to an annualized savings of Rs. 15 bn. by
2017. Cost savings will be 2-3% of revenues. In 2HFY13-14 the exercise resulted in savings
of Rs. 600-800 mn. To scale it up to Rs. 15 bn. in another 3 years will be quite a herculean
task.
 One interesting characteristic of the company and the two wheeler industry as a whole is that
it is almost debt free. The industry makes nil or very low interest payments in any financial
year. So any further capex will likely be made from internal accruals.

4. RESEARCH & DEVELOPMENT - Is the brahmashtra missing
In Indian mythology the brahmashtra was a secret weapon which could be used to completely
decimate the enemy. R&D is the secret recipe which differentiates the leaders from the also-rans.
Auto manufacturers need to constantly innovate to stay ahead of their competition. A cursory glance
at the R&D expenses of the company shows that it lags behind all its competitors.
036%
Expenditure as % of Sales FY13
1.22%
Hero MotoCorp Bajaj Auto TVS Motors
Even in absolute terms the company is far behind
FY13 (Rs. Mn) Hero
MotoCorp
1.65%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
Bajaj Auto TVS
Motors
Total R&D
Expenditure
862.10 2,385.90 1,317.50
To keep these numbers in perspective in FY2013 Honda invested 5.7% or $ 6.8 bn of their revenues
in R&D. ( $ 1 = Rs. 60.25 aprox)
But the company is planning to catch up with its competitors. As per management transcripts the
company is targeting an R&D expense of 1.2-1.5%. They are setting up a world class technology
R&D centre at Kukas, Jaipur. It is billed as India's largest integrated Two-wheeler Technology centre.
In 2012-13 they tied up with Engines Engineering for developing and designing new motorcycles and
scooters. They have also entered into an R&D tie-up with AVL of Austria for developing new engines.
They will be developing a new ethanol based engine for the Brazilian market. A tie up with Erik Buell
Racing (EBR) Inc. of the USA will be used to develop and launch high performance platform bikes for
the American market. To back this endeavour Hero has taken a 49.2% stake in the company for
$25mn. Another 60:40 JV with Magnetii Marelli SPA for setting up an autonomous development
centre will see them making an equity infusion of $8.5mn and a capital investment of $27 mn over the
next ten years.
COMPETITOR LANDSCAPE - losing the competitive edge ?
The company has a suite of 19 products with which it commands a 46% share in the overall two
wheeler segment and a 53.2% share in the motorcycle segment. The industry was going through a
bad patch for the last two years but there has been a revival in sentiments in the latter half of FY13-
14.

5. 650,000
600,000
550,000
500,000
450,000
400,000
Hero MotoCorp M-o-M Unit Sales
FY12-13
FY13-14
Except for Bajaj Auto which has shown a de-growth in its domestic sales, the industry is growing at a
scorching pace.
Since separating in 2011, HMSI (Honda Motorcycle & Scooters India Pvt Ltd) has posted more than
30% y-o-y growth in sales and its showing no signs of slowing down. The company ramped up its
manufacturing units in Haryana, Rajasthan and Karnataka to a total capacity of 4 mn units p.a.
Another 600k will be added by the year-end. A majority of the units produced are now exported, but
the company is making quick inroads into Hero's traditional markets. It has also re-launched CD 110
Dream in 3 colour variants and positioned it as Honda's most affordable 2-wheeler in India. It's ex-showroom
price in Delhi is 41k, which is less than the price of the latest Samsung smart phone!
Another interesting bike in its portfolio is the CB Shine- which is first 125cc bike to cross 30mn in unit
sales.
HMSI also has the distinction of manufacturing the highest selling scooter in India. Unit sales of their
automatic transmission scooter Activa were up 65%y-o-y , notching record sales of 179,956 units in
FY14.
Hero and the erstwhile Hero Honda had 48-50% of its sales coming from the rural hinterlands. And
Honda has taken the fight straight into its former partner's den. It has tied up with a number of 2-
wheeler financing companies with a rural focus. Their partners like Assam Gramin Vikas Bank, L&T
Finance holdings, Baroda Rajasthan Kshetriya Gramin Bank and Shivalik Mercantile Co-operative
Bank ensure simpler financing terms for their rural customers.
Yamaha Motors India which primarily manufactures scooters and high-end motorcycles (>149cc) also
reported stupendous growth figures in the last three months. Yamaha has a 7.5% share in the scooter
segment and expects to sell 30 mn. scooters (Alpha, Ray and Ray Z range) in FY14
Unit Sales (domestic) March April May
FY14 46,052 51,158 47,680
FY13 35,782 35,927 34,021
y-o-y Growth (%)* 29% 42% 40%
*The y-o-y sales figures should be taken with a pinch of salt.
Since FY13 was a particularly bad one for the entire auto
industry so the growth figures are over a very low base.
Similarly TVS Motors is reporting solid sales figures for this year. It also has a lot of goodwill in its
traditional markets. Last year when the government introduced excise duty cuts the company
promptly passed on the difference of Rs. 850-3500 to its customers.( In stark contrast Hero MotoCorp
has introduced two price hikes of Rs. 500-1500 )The chart below shows a massive increase in y-o-y
sales for TVS Motors

6. 450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
-
TVS MOTORS- Total Units Sold
FY13-14
FY12-13
Total Exports FY13-
14
While TVS Motors is showing healthy growth figures, Bajaj Auto disappointed many with their lack
lustre sales in the domestic market. However exports were the saving grace.
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
-
BAJAJ AUTO -Total Units Sold
FY13-14
FY12-13
Exports FY13-14
So how do these "maharthi's" (warriors in ancient Indian mythology) stack up against each other. Let's
look at their stock performance. The following chart is a plot of their normalised share price. So if on
8-Aug-2011 ( after ending the partnership with Honda) I had invested equal amounts in Hero
MotoCorp, Bajaj Auto, TVS Motors and an hypothetical portfolio of NIFTY stocks then my returns on
7-July-2014 would have been as follows
Beta*
1 month# 3 month# 1 year# Max#
(since 8-Aug-11)
Hero
Motocorp**
0.79 -2% 17% 58% 41%
Bajaj Auto** 0.96 7% 13% 23% 63%
TVS Motors 1.52 28% 74% 408% 212%
NIFTY 1.00 2% 15% 33% 52%
*Source: Reuters website
#1 month is 20 trading days, 3m is 60 trading days and 1 year is 250 trading days
**Hero Motocorp and Bajaj Auto are constituents of the NIFTY

7. 350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
08/Aug/11 08/Aug/12 08/Aug/13
Hero MotoCorp
Bajaj Auto
TVS Motors
NIFTY
TVS Motors has significantly outperformed not only the benchmark NIFTY but also both of its peers.
However unfortunately Hero MotoCorp is at the bottom of the pile.
It seems divorce was really bad for the company's stock.
INVESTMENT VIEW - hero or zero ?
Hero Motocorps are without doubt the largest motorcycle manufacturers in India, but will that be
enough ? Can they repeat the success of the past two decades.
Customers are demanding bikes with higher horsepower and better mileage. This is evident in the
rapid growth in sales of high end bikes. At the same time city commuters especially working women
are preferring auto transmission scooters. Then there is the spectre of looming drought ( the El Nino
effect ) Two wheeler sales growth in the rural regions are historically twice that in the urban areas.
And close to 43% of Hero's sales are from the rural areas. A dampening of demand in these areas will
have a negative impact on the company. Also an absence of any worthwhile products in the auto
transmission segment will impact it negatively.
Setting up factories and joint ventures with foreign partners in North and South America, Africa and
Asia is one of the components of its strategy to reduce its dependence on the local markets. But here
it will face stiff competition from the Chinese manufacturers. A worst case scenario is that as it
expands its reach into new markets it starts losing market share in the India. Bajaj Auto is already
showing signs of weakness.
A strong focus on technology is not a redeeming feature, unless you can deliver a few delight points
for the customer. It takes time to create an atmosphere which is conducive to innovation. For more
than two decades, Hero was backed with the technological might of the Japanese. Now on its own, it
is buying up what it does not have. It will be interesting to see the outcome of their joint ventures.
Our view is that the stock price has run up during the recent election rally and is over valued
A significant correction will result in the stock correcting by 18% from the current stock price.