CFA Institute Research Challenge

HERO MOTOCORP

Presentation By Indian Institute of Management Tiruchirappalli Figure Source: insightssuccess, HMCL Annual Report Hero is the world’s largest two wheeler manufacturer

Company Overview Hero Motocorp

8.8 35 6500+ Million units Countries Customer worldwide Touchpoints Source: HMCL Annual Report, CRISIL Research Icon source: , Iconexperience, Flaticon, Iconarchive, Hero Motocorp A 2 Motorcycles dominate the Indian two wheeler market

Market Size INR 848 Bn

($13 Bn) [2017] Industry Industry Segmentation by Volume Two Wheeler Volume Sales Overview (in Mn units) 17.6 7 % CAGR Premium 23% 16.5 (>150 CC) 16.0

33.37% Executive 14.8 54% (110 CC - 135 66.63% CC) 13.4 Economy 23% (<100 CC)

2012-13 2013-14 2014-15 2015-16 2016-17 Scooters Motorcycles

Source: 1$=66.12 Moneycontrol, HMCL Annual Report, CRISIL Research A 3 Investment Summary INR 4,503 Upside Target Price BUY 22% HERO MOTOCORP INR 3,685 Closing Price: January 12th, 2018

Strong Foresighted & Leading Favorable Macro Competitive Proactive Operating & Scenario Positioning Management Financial Metrics

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Improving Road Low total cost of Management initiative Sustainable Operations Infrastructure, Increase ownership, widest to invest in future through LEAP Program, in per capita income, distribution & service growth markets, Seek Green Vendor Increasing Institutional network, strong brand collaborations for Development Initiative Credit Availability perception superior technology Corporate Governance 4 Icon Source: Game-icons, Global Conductor, Imprint Source: Student Research, Bloomberg, BSE, HMCL Annual Report, Student Research e.g. EV score – 2.75/10 A Two wheeler is the preferred mode of transportation in India

High traffic density Low Per Capita Income Ease of commutation Low Total Cost of Ownership

Icon Source: Iconarchive, Free-icons-download, Iconfinder, cosmicrage.deviantart Source: RBI, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 5 Two wheeler penetration to rapidly increase as the per capita income rises 70,000

60,000 US

50,000 Austria Germany 40,000 Japan GDP Per Capita (in $) Italy 30,000 Spain (nominal)

20,000

Brazil 10,000 China (excl electric 2W) China (incl electric 2W) Malaysia Colombia Thailand Kenya Sri Lanka 0 INDIA Indonesia Vietnam 0% 5% 10% 15% 20% 25% 30% 35% Source: IMF, Ambit Capital Industry Report, Student Research 2W Penetration

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 6 Rural infrastructure push and increased institutional credit will drive rural demand

Infrastructure push from Government Increased Institutional Credit Availability

Rural Road Construction Two-Wheeler Finance Market (in 000' Kms) INR 391 Billion [2018] 15% CAGR 47.4 48.8 36.4 36.3 3% decline in interest rate in 25.3 5 years 24.2 32% Y-o-Y Growth Increased Focus towards Retail loans

2013 2014 2015 2016 2017 2018P INR 243 Billion [2017]

Source: Ministry of Rural Development, Student Research Source: HDFC,, CreditScape CRISIL Research, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 7 Rising real income will increase spending capability in the economy

Government committed to Central Bank target to sustain double farmer income by 2022 inflation level within 2% to 6%

Average minimum crop prices: Year Wise Trend Inflation Trend last 6 years (in INR/quintal) 3,478 Percentage 14 14.8% CAGR 12

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1,739 8 1,599 1,625 1,672 1,481 1,208 6 6%

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2 2% 0 2012 2013 2014 2015 2016 2017 2022P 2011-01 2012-01 2013-01 2014-01 2015-01 2016-01 2017-01

Source: Ministry of Rural Development, Economic Survey of India Source: OECD, Student Research FY18 Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 8 Low total cost of ownership in a price sensitive market

Consistent Mileage Low Total Cost of Ownership

Hero commands maximum resale Value (in INR) Low Maintenance 45,000

40,000 19%

Long Product Life 35,000

30,000

Easy Availability of 25,000 Spares 20,000 Bajaj Discover TVS Star City Honda Yuga Hero Passion Source: Primary research- consumer survey Appendix 38 Source: Bike4Sale Icon Source: Free-icons-download

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 9 Deeply entrenched in growth markets of Cluster A states

Cluster A 5000 Cluster B Cluster C CAGR 8% 4000 58% CAGR 8% 3000 Presence in Indian Market CAGR 11%

2000 Per Capita Income (nominal$) Income Capita Per

1000 0% 5% 10% 15% 20% 25% 30% 35% 40% 7% 2W Penetration

Figure Source: Mapchart.net Source: HMCL Bajaj Auto TVS Annual Report, Crisil Research, Ambit Capital Industry Report

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 10 Demonstrated ability to introduce winning and lasting products

Product Extension

Splendor Splendor + Splendor Pro

Launch: 1994 Launch: 2007 Launch: 2011 Top 5 Motorcycle Brands by Sales New Product Introduction 3.0 25% 23.5% 2.5 20% Splendor Passion 2.0 50% 15% 12.6%

1.5 Market share Percentage share Market

High mileage Replicated Million in Volume Sales 10% 1.0 8.1% Splendor virtues 6.8% 6.7% Durability 5% Targeted youth 0.5 Longevity and urban 0.0 0% Hero Splendor Hero Deluxe Hero Passion Honda Shine Hero Glamour Source: Crisil Research, www.siamindia.com Icon Source: Icon archive

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 11 Hero has built foothold in future growth markets

Increasing International Presence (No. of Countries)

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35 Indian GDP 29 Growth: 7% FY19E 22 19

Hero’s Presence FY 14 FY 15 FY 16 FY 17 FY 20P (35 countries)

Note*: This map is just for representation of presence of the firm under review and does not represent the actual geographical Source: HMCL Annual Report, World Bank, https://mapchart.net/world.html, boundaries of any country or continent Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 12 Countering headwinds, seizing opportunity and moving faster

Lack of Technology post split with Honda Aggressive Capacity expansion

Global Alliances Installed Capacities and Capacity Utilization Design Engines Engg. 10 100% 1.2 Mn 9 81% 85% Tech for Premium EBR 8.8 81% 8 80% CIT, Jaipur 59% Fuel Tech Magneti Marelli 7 0.6 Mn 67% Engine Dev AVL Austria 6 5.9 60% 5.4 5 0.4 Mn 4 3.6 40% 3 Electric Vehicle units) MN (in Capacity 2 1.5 20% Percentage Rate Utilization 1 Acquired 30% stake in 0 0% Ather Energy Hero Bajaj TVS Honda Yamaha

Ather S340 Installed Utilization

Icon source: Iconfinder, Ather Energy Source: HMCL Annual Report, Bloomberg, Crisil Research, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 13 Hero focuses on continuous improvement in efficiency across the supply chain

Automation Cost as a % of Sales in key

business Percentage Percentage areas 84.0% 3.5%

82.0% 3.0%

Digitisation 80.0% 2.5%

across 78.0% 2.0% supply chain 76.0% 1.5% Optimized utilization of 74.0% 1.0% logistics 72.0% 0.5% network 70.0% 0.0% FY15 FY16 FY17 FY18 FY19 FY20

Total Cost as % of Net Sales Selling & Distribution Expenses

Source: HMCL Annual Reports, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 14 Strong efficiency measures boosts ROCE for Hero

70 Reduction in Cash Conversion Cycle Y-o-Y Hero commands the highest ROCE 60 (in Days)

50 Hero 35.7% 40

30 TVS 25.6% 20

10 Bajaj 25.3% 0 FY14 FY15 FY16 FY17 -10 Honda 14.9% -20 -17 -18 -21 -30 Day Sales Outstanding Days Inventory Outstanding -26 Yamaha 12.9% -40 Accounts Payable Turnover Days Cash Conversion Cycle

Source: HMCL Annual Reports, Bloomberg, BSE, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 15 Healthy growth expected in Revenues, EBITDA and Net Profit

Projected Projected Hero’s projected Revenue segment size By average selling market share projections volume price Valuation Summary Revenue Projections (in billion INR) Ratio Analysis Projections

FCFE Percentage 600 40% 37% 16% CAGR 555 36% 36% 36% 35% 34% 506 35% 500 Multiples 431 30% 400 380 346 25% 308 Sensitivity 17.8% 17.9% 300 20% 16.4% 15.0% 15.5% 16.1% Analysis 15% 200 10% 12.3% 12.3% 10.9% 10.9% 11.3% 11.0% 100 5%

0 0% FY17 FY18P FY19P FY20P FY21P FY22P FY17 FY18P FY19P FY20P FY21P FY22P

Source: Bloomberg, HMCL Annual Report, Student Research Non Cash ROE EBITDA Margin PAT Margin

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 16 High ROCE and higher free cash flows make this a promising investment

Free Cash Flow Profile BCG Matrix (INR billion) Percentage Valuation 65 40.0% High 37.1% 34.4% Summary 60 35.6% 35.5% 35.2% 35.0% 55 FCFE 50 30.0% 45 40 25.0% Growth Multiples 35 20.0% 30 Sensitivity 25 15.0% Analysis 20 15 10.0% Low 2017-18 E 2018-19 P 2019-20 P 2020-21 P 2021-22 P High Market share Low FCF RoCE WACC

Source: BCG, Bloomberg, HMCL Annual Report, Student Research Figure Source: rfid-locker.co

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 17 Strong valuation across multiples and DCF

Valuation EV/EBITDA Summary P/E Multiple DCF Multiple FCFE 33.3% 33.3% 33.3%

Multiples INR 4503

Sensitivity INR 5016 INR 4229 INR 4265 Analysis

BUY 1 Year Target Price: INR 4503 [22% Upside]

Source: Bloomberg, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 18 Sum of the parts valuation predicts high intrinsic value

Key Assumptions Beta 1.1 Valuation Risk free rate 7.47% Summary Market Return Expected 12.13% Standalone Valuation Market Risk Premium 4.66% FCFE INR 772 Billion Cost of Equity 12.60% Terminal Growth Rate 5.50% Multiples

Sensitivity INR 4265 Analysis INR 853 Billion Per share Cash & Cash Associates Subsidiary Equivalents Valuation Valuation INR 59 Billion INR 23.9 Billion INR 0.7 Billion

Source: RBI, Bloomberg, HMCL Annual Report, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 19 Peer Valuation using P/E, EV/EBITDA shows stock is undervalued

Domestic Market Relative Multiples Market Cap Est P/E Company Name (in Billion Current P/E ratio EV/EBITDA Valuation INR) Year FY19 FY19 Summary Median 21.7 19.2 15.0 TVS MOTOR CO. LTD. 204.6 43.9 32.9 20.8 FCFE BAJAJ AUTO LTD. 811.8 21.7 19.2 15.0 MARUTI SUZUKI INDIA LTD. 1817.2 29.5 24.9 17.9 MAHINDRA & MAHINDRA LTD. 643.4 16.4 13.5 9.4 Multiples

Sensitivity Analysis EV/EBITDA P/E INR 5016 INR 4229 Multiple Multiple

Source: Bloomberg, BSE,, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 20 Valuation is most sensitive to Raw material cost and Realization Assumptions 71.8% Probability of BUY Base Case: INR 4503 Input Factors Sorted By Sensitivity

Valuation 4,100 4,300 4,500 4,700 4,900 Summary Raw Material Cost FCFE Realization Per Unit 3923 4192 4214 4308 4399 4447 4493 4577 4628 4643 4919 Multiples (Price In INR) Valuation Football Field Base Case: 4503 Market Share Sensitivity Analysis DCF 2341 4803

FY19 EV/EBITDA 3859 6033

FY19 P/E 3185 5149 Source: Bloomberg, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 21 Customer preference shift, raw material price fluctuations pose threat to Hero’s position

Currency Fluctuations Changing customer

Risk Matrix HIGH preference

Customer Technology Changes in Risk

Preference Interest rates PROBABILITY

Political Increase in raw MEDIUM Raw Stability material cost Labour Union Material Strikes

Technology LOW Risk LOW MEDIUM HIGH IMPACT

Operational Risk Market Risk Financial Risk

Source: Bloomberg, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 22 Customer preference is moving towards scooter segment

Number of New Product Launches Next Year Percentage Increasing Scooter Segment 40%

35% Risk Matrix 30% 25% Hero’s share Customer 20% 4 Preference 15% 10% Raw 5% 1 1 Material 0% 0 0 FY14 FY15 FY16 FY17 FY18 Bajaj Auto Ltd. Hero TVS Motor Co. HMSI India Yamaha Technology Scooter Segment Share HMCL scooter market share MotoCorp Ltd. Ltd. Risk Scooter

Gained 3% market Non geared share in last fiscal Icon source: Alamy vehicles Source: CRISIL Research with recent launches Source: NDTV Auto, CRISIL Research, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 23 Exposure to commodity prices

Cost Segregation 100% Raw Material Cost Index 227 230 225 220 218 218 220 211 210 Risk Matrix 201 200 191

Customer 190 Preference 180

Raw 170 Material Total 2011 2012 2013 2014 2015 2016 2017 2018P Composition Technology 8% Risk 11% Cold Rolled Steel Hot Rolled Steel 45% Aluminium Ability to pass on Effective cost Sufficient margins 17% Flat Steel the price increase control measures to absorb the Plastics to customers in place price shock Source: GlobalEconomy.com, Crisil Research, Student Research 18%

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 24 Electric vehicles to take half of global auto market by 2030

High Potentials Best-in-Class HIGH Stricter Emission Netherlands China Norms Risk Matrix UK USA Japan Germany Customer Preference India

Raw EV Market Growth EV Market Material Technology LOW Hesitators Pensioners Risk SMALL LARGE EV Market Size Investment in Ather JV with Magneti Energy Marelli Icon Source: Br-vexels (EV start up) (Next gen fuel technology) Source: GlobalEconomy.com, HMCL Annual Report, Student Research

Favorable Competitive Foresighted & Leading Operating Valuation Investment Dynamics Positioning Proactive Management & Financial Metrics Risks A 25 Investment Summary Upside INR 4,503 Reasons to Invest Target Price Risk Snapshot 22% Favorable Macro Shift in Customer Scenario Preference INR 3,685 Strong Closing Price: January 12th, 2018 Competitive Exposure to Positioning Commodity Prices Foresighted & Electric Vehicle Proactive BUY Risk Management HERO MOTOCORP Leading Operating Stricter emission & Financial norms Metrics EV/EBITDA P/E DCF Multiple Multiple

INR 4265 INR 5016 INR 4229 26 Source: Student Research, BSE, Bloomberg A Thank you!

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