Introduction

The two wheeler industry has been on a strong growth trajectory in the past years. Easy availability
of retail finance with low down payment schemes, increasing household incomes and launch of more
stylish and fuel-efficient motorcycles, had enabled the industry to grow at a rapid pace till 2006-07.
After a decline of 4.5% during 2007-08, the two wheeler industry grew by a modest 5% during 2008-
09. Domestic motorcycle sales marginally grew by 1% while exports recorded a growth of 24%.
However, in the long term, the growing population, increased level of economic activity, increasing
women workforce, rising trend in self-employment, emergence of satellite towns and growth in rural
economy will lead to higher growth in the industry. The current penetration level of two wheelers in
the country is still low at 7%, which offers considerable scope for growth. Keeping this background
in mind, we thought it would be interesting to compare two dominant players in the two-wheeler
industry, Hero Honda and TVS Motor Company Ltd.

Hero Honda is a joint venture between India's Hero Group and Honda Motor Company, Japan which
is the world's single largest two wheeler company. Over 20 million Hero Honda two wheelers tread
Indian roads today. Hero Honda bikes currently roll out from its three globally benchmarked
manufacturing facilities. Two of these are based at Dharuhera and Gurgaon in Haryana and the third
state of the art manufacturing facility was inaugurated at Haridwar, Uttarakhand in April this year.
Hero Honda's extensive sales and service network now spans over 3000 customer touch points.

TVS Motor Company is the third largest two-wheeler manufacturer in India and one among the top
ten in the world, with annual turnover of more than USD 1 billion in 2007-2008, and is the flagship
company of the USD 4 billion TVS Group. The company has 4 plants - located at Hosur and Mysore
in South India, in Himachal Pradesh, North India and one at Indonesia. The company has a
production capacity of 2.5 million units a year.

Hero Honda is the torch-bearer of the two-wheeler industry and currently sells more two-wheelers
(specifically motorcycles) than the second, third and fourth placed two-wheeler company put
together. While TVS is a much smaller diversified conglomerate with presence in motorcycles,
mopeds, scooters and three-wheelers. Thus we wanted to see whether size is crucial for profitability
and whether being diversified has any advantages as compared to firms concentrated in particular
segments. These were some of the important reasons why we chose these two companies.

We studied the two-wheeler industry for a period of six years from 2004 to 2009. Our major sources
of data are the annual reports and the financial statements. For a view on the two-wheeler market as a
whole, we have used a few resources which are given in the references.
Chapter 1 – Sales Trends

(INR Crores) FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

TVS Motors
2820.21 2875.91 3234.96 3854.96 3219.5 3670.92
Sales

Growth (y-o-y) 1.98% 12.48% 19.17% (16.48%) 14.02%

Hero Honda
5832.42 7421.65 8713.98 9899.96 10331.8 12319.1
Sales

Growth (y-o-y) 27.25% 17.41% 13.61% 4.36% 19.23%

Sales Growth

TVS Motors
TVS Motors showed a healthy growth in sales from FY 2004 to FY 2007 due to a booming
automobile industry and rising demand, with sales rising from Rs. 2820 Cr in FY 2004 to Rs 3219.5
Cr in FY 2007. Due to the global recession, and the high interest costs and interest rates, the auto
mobile industry was severely impacted in FY 2008, resulting in a sharp drop in TVS’s sales of
16.5%. 2 Wheeler sales jumped back again in FY 2009, with a rise in sales of 14.02% for TVS. Thus
TVS has had a healthy increase in turnover from FY 2004 to FY 2009, except for FY 2008, when it
was impacted due to the global recession and slackening demand.
Corresponding 2-wheeler sales figures from The Society of Indian Automobile Manufacturers
(SIAM) indicate that that the 2 wheeler sales in the industry fell from 7,872,334 units in FY 2007 to
7,249,278 units in FY 2008 thus indicating the slackening demand due to adverse financial
conditions in FY 2008

Hero Honda
Hero Honda has been a dominant player in the Indian 2-wheeler industry and has had healthy sales
growth with sales rising from Rs. 7421.6 Cr in FY 2005 to Rs 12319.12 Cr in FY 2009, but as
compared to TVS, its sales growth numbers have progressively declined from 27.25% in FY 2005 to
4.36% in FY 2008. Hero Honda being the marquee player in the industry has been able to withstand
the slackening demand in FY 2008 and shown positive sales growth during FY 2008 as compared to
TVS, which had a negative sales growth during the corresponding period. Sales got a tremendous
boost in FY 2009, with a sharp jump in sales of 19.2% for Hero Honda in FY 2009

Chapter 2 – Profitability Analysis

TVS Motors

TVS Motors FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

EBIT Margin 6.37% 4.24% 3.42% 1.29% (1.66%) 0.43%

Profit Margin
(Net Profit / Net 4.91% 4.78% 3.62% 1.73% 0.99% 0.85%
Sales)

Asset Turnover 2.09 1.97 1.94 1.49 1.61

Return on
10.02% 7.13% 3.34% 1.47% 1.36%
Assets
Return on
21.94% 16.19% 8.46% 3.9% 3.81%
Equity

Looking at the Profitability ratios of TVS Motors, we see that the Net Profit margin has significantly
decreased from 4.91% in FY 2004 to 0.85% in FY 2009. Thus margins have been squeezed for TVS
from 2004 onwards. Asset Turnover values have also decreased significantly from 2.09 in FY 2005
to 1.61 in FY 2009, implying decreasing volumes and inefficiencies in turning over assets. Thus
doing a Du-Pont Analysis we see that the Return on Assets has taken a severe hit from 10.02% in FY
2004 to 1.36% in FY 2009, due to both margins being squeezed as well as volumes decreasing. But
the large hit in margin is the dominant factor affecting return on assets. Return on Equity has also
progressively decreased from 21.9% in FY 2005 to 3.81% in FY 2009 due to the significant hit in
margins.

Hero Honda

Hero Honda FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

EBIT Margin 15.55% 14.49% 14.34% 10.44% 11.51% 12.41%

Profit Margin
(Net Profit / Net 12.5% 10.92% 11.15% 8.67% 9.37% 10.4%
Sales)

Asset Turnover 2.49 2.43 2.44 2.32 2.29

Return on
27.19% 27.08% 21.13% 21.73% 23.85%
Assets
Return on
61.58% 55.46% 38.3% 35.48% 37.77%
Equity

Hero Honda on the other hand has also had a slight contraction in its margins, with EBIT margin
levels decreasing from 15.5% in FY 2004 to 10.44% in FY 2007 and then increasing for two
consecutive years in FY 2008 and FY 2009 before reaching 12.41% in FY 2009. Net Profit Margin
levels have decreased from 12.5% in FY 2004 to 10.4% in FY 2009, but have shown no persistent
trend, with net profit margins increasing and decreasing in subsequent years. Having a look at Asset
Turnover values, we see that Asset Turnover has marginally decreased from 2.49 in FY 2005 to 2.29
in FY 2009, indicating that volumes have decreased slightly and that there is only a slight drop in
efficiency of turning over assets. Analysing the Return on Assets values we see that ROA figures
have decreased from 27.19% in FY 2005 to 21.13% in FY 2007, before rising for two consecutive
years to 23.85% in FY 2009. Thus we see that the ROA trend closely mirrors the Net Profit Margin
trend, indicating that Hero Honda plays more of a margin game, with volumes more or less constant.
Return on Equity (ROE) values have taken a large hit with ROE values decreasing from 61.58% in
FY 2005 to 37.77% in FY 2009.
Chapter 3 - Liquidity Ratios
Section 1

Current FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

Ratio

TVS 1.00 1.12 1.31 1.37 1.62

Hero

Honda 0.37 0.53 0.62 0.71 0.49

For TVS, the current ratio is constantly increasing, which is a good indicator that management’s
efforts are increasing the ratio. Even during the recession time of FY2008, the ratio increased as a
result of better management of liabilities. For Hero Honda, the values are always less than 1 and
much less than TVS’ current ratios. None the less, both firms show values that are less than the rule-
of-thumb indicator. “Total outstanding dues of creditors other than small scale industrial
undertakings” increased in 08, bringing down the current ratio value for Hero Honda. The drop in the
current ratio of Hero Honda, from FY 2008 to FY 2009 is due to a steep increase in the current
liabilities and this increase can be attributed to an entry in the balance sheet called ‘Other Liabilities’.

Section 2

Quick Ratio FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

TVS 0.54 0.51 0.68 0.65 1.04

Hero

Honda 0.23 0.38 0.43 0.47 0.33

By rule of thumb, the quick ratio should ideally be 1:1. This condition is not met by Hero Honda.
TVS has managed to attain this ratio in FY 2009.

As expected, because of the downturn, the quick ratio of Hero Honda has decreased in FY 2007. The
difference in current ratios for different years of Hero Honda is not seen in the quick ratio. This
shows that the difference in the trend for the current ratio and quick ratio is due to the inventories.
This implies that Hero Honda has a better inventory management.

Section 3

Inventory
FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
turnover
Ratio

TVS 12.24 10.57 10.09 8.16 10.07

Hero

Honda 32.34 34.65 35.32 30.85 33.51

The inventory management of TVS does not appear to be good. Instead of an increase in the values,
we see a decrease from FY 05-08. In FY 09, there is a slight improvement. But, there is still room for
improvement. There is a 19.1% dip in the ratio for FY08 as compared to FY 07 which may be
attributed to a drop in COGS (~14%).

Hero Honda has a good inventory turnover ratio. In the FY 08, there is a positive change of 3% in
COGS. But, there has been a dip in the ratio showing that inventory management is not good.

In comparison to TVS, Hero Honda has a much better inventory management strategy.

Section 4

Debtor
FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
turnover
Ratio

TVS 66.53 69.76 45.46 32.31 27.25

 Hero

Honda 111.31 70.21 40.09 32.66 55.07

Generally, a debtor ratio indicated a better debt collection strategy of the company. But, in the
current case, it may indicate that the companies became more willing to sell on credit than they were
before. This is substantiated by the fact that the increase in the accounts receivables is mainly due to
increase in unsecured short term debtors which may indicate credit line to customers. The debtor
turnover ratio for TVS has been decreasing since FY 06. The increase as compared to FY05 is due to
the higher sales growth without corresponding increase in debtors.

The debtor turnover ratio for Hero Honda was at a very good value in FY 05, but there has been a
considerable decrease ever since.

Comparatively, Hero Honda has a much better debt turnover ratio indicating that their strategy of
debt collection is much more effective than TVSs.

Section 5

Average
inventory FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
holding
period

TVS 29.40 34.06 35.69 44.11 35.75

Hero

Honda 11.13 10.39 10.19 11.67 10.74

The average inventory holding period for TVS has been on the rise since FY2005. Particularly in
FY08, there has been a greater inventory holding period which could be attributed to the decrease in
sales during recession leading to more inventories for more time.
For Hero Honda, the period had been decreasing from FY05 till FY07. There was an increase in the
value during FY08 due to the dip in sales owing to the recession. But, in FY2009, probably due to
better inventory management, the value of the inventory holding period has come down.

In comparison to TVS, hero Honda has a much better inventory management strategy.

Section 6

Operating FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

cycle

TVS 34.82 39.22 43.61 55.25 48.96

Hero 14.37 15.52 19.17 22.69 17.28

Honda

The operating cycle for both the companies has increased in FY08 due to an increase in both
inventory holding period and debt collection period owing to the recession.

That the inventory management of Hero Honda is much better than that of TVS can be clearly seen
from the values in the table.

Chapter 5 – Capital Market Analysis

The P/E ratios of major players in the two wheeler industry are given below

P/E FY 2005 FY 2006 FY 2007 FY 2008 FY 2009

TVS Motors 4.24% 3.42% 1.29% (1.66%) 0.43%

 Hero Honda 4.78% 3.62% 1.73% 0.99% 0.85%

Bajaj Auto 2.09 1.97 1.94 1.49 1.61

Chapter 6 – Cash Flow Statement Analysis

TVS Motors

For TVS Motors, analysing the cash flow statement of the firm from FY 2005 to FY 2009, we see
that TVS generates a large amount of cash from operating activities, signifying a higher earnings
quality. It has had a significant negative cash flow in investing activities from FY 2004 to FY 2009
signifying that the company is investing heavily in its plant, machinery and capacity expansion. Also
the company has a smaller proportion of positive cash flows from financing activities (except for FY
2006 and FY 2007 when financing cash flow contributed a large proportion) indicating that the
company is able to generate cash from loans availed after disbursing interest and dividend payments.
But the net increase in cash and cash equivalents is still negative and contributing towards a negative
cash balance, indicating a cash crunch for the company. From FY 2005 to FY 2009 (except for FY
2008 and FY 2006), cash flow from operating activities is significantly greater than net profit of the
firm, indicating a higher earnings quality and indicating that the firm has been growing with
increasing cash from operating activities. As “cash is king” increasing cash from operating activities
signify that the firm has been growing. In FY 2008, operating cash flow was significantly smaller
than Net Profit, indicating a lower earnings quality for FY 2008.

TVS Motors
FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
(INR Cr)

Net Profit 138.49 137.57 117.00 66.60 31.77 31.08

CFO (cash flow

from operating 197.53 288.82 105.49 120.09 6.33 161.56
activities)
CFI (cash flow
from investing (342.18) (246.46) (297.0) (228.84) (106.3) (204.3)
activities)
CFF (cash flow
from financing 16.77 27.29 141.99 170.96 (5.12) 20.62
activities)
 Dividend
35.75 37.7 35.22 35.21 4.17 19.46
payment
Dividend %
18.1% 13.1% 33.38% 29.32% 65.87% 12.04%
(Dividend/CFO)

Dividend payments for TVS have followed no specific trend and dividend payments have been in
manageable proportions with respect to cash flow from operations. Only in FY 2008, when operating
cash flow was strained, the company chose to pay out dividend close to 66% of their operating cash
flow, indicating excessive dividend payment to keep shareholders happy.

TVS has typically funded its expansion plans from the surplus cash generated from operating
activities, secured loans, unsecured loans, sale of investments. Surplus cash from operating activities
have been the dominant contributor to financing of capacity expansion and plant and machinery
purchasing/upgradation plans of the country.

Hero Honda

Hero Honda
FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009
(INR Cr)

Net Profit 729.02 810.47 971.34 857.89 967.88 1281.76

CFO (cash flow

from operating 972.93 746.83 936.08 625.05 1,211.78 1,359.03
activities)
CFI (cash flow
from investing (376.38) (562.85) (323.49) (273.13) (781.01) (861.19)
activities)
CFF (cash flow
from financing (583.63) (203.51) (471.23) (474.34) (432.33) (499.93)
activities)
Dividend
550.60 202.55 396.32 396.11 339.47 379.41
payment
Dividend %
56.59% 27.12% 42.33% 63.37% 28.01% 27.91%
(Dividend/CFO)

The cash flow statements of Hero Honda show an overall increase in the net profit over the six
financial years considered except for a dip in the profits in FY 2007 owing to recession. From FY
2004 to FY2009, the cash flow from operating activities has remained at a value greater than the net
profit excepting for FY 2005 and FY 2007. This proves the fact that Hero Honda’s quality of
earnings is significantly high. From FY 2004 to FY 2009 Hero Honda has consistently shown a
negative value for cash flow from financing activities which is constituted by tax, dividends and
interest payments and repayments for long term borrowings. So, we can infer that financing for
investment activities is mainly derived from the cash from the operating activities.

The net increase in cash and cash equivalents for all the six years is positive contributing towards the
positive cash balance. Hence, the company is free from cash crunch. The trend of increase in the cash
flow from operating activities leads to the inference that the firm has seen a healthy growth for the
past six years (except for FY 2005 and FY 2007 when the quality of earnings are low due to the cash
flow from operating expenses being lower than the net profit).

Hero Honda has no particular pattern for dividend payments. The percentage of dividend payment
was relatively high with 56.59% in FY 2004 and 63.37% in FY 2007. In the latter period, the
company witnessed a comparatively lower cash flow from operating activities, yet, the amount paid
as dividend was high.

Comparing the two companies, it can be seen that Hero Honda has a much better performance than
TVS. Also, for Hero Honda, there has always been a net increase in the cash and cash equivalents
whereas for TVS, for FY 2005, FY 2006, FY 2008 and FY 2009, there is a net decrease in the cash
and cash equivalents.

Chapter 7 – Accounting Quality, Earnings Quality, Auditor’s Report etc

TVS Motors

There are no major issues with the accounting quality and quality of earnings of the firm. Except for
FY 2006 and FY 2008, the cash flow from operating activities is significantly higher than net profit,
indicating higher earnings quality. There are miscellaneous expenditures that have not been written
off in earlier years and accrue on the balance sheet. But such accruals are very minimal and do not
affect the accounting quality in any significant way. During the period FY 2005 to FY 2009, there
have been no accounting policy changes. Depreciation method of “Written Down Value method” has
prevailed throughout the period of study. In FY 2006, there was a one-off reduction in liability of Rs
36.94 Crores consequent to pre-payment of deferred sales tax liability, but otherwise from FY 2004
to FY 2009 there have been no one-time/non-recurring items. There have been no regrouping of
items relative to previous years and no discontinued operations accounted for. The accounting
methods have neither been too aggressive nor have they been too conservative, they have been
moderate in nature. There have been no adverse findings in the auditor’s report except for some
disputed Wealth Tax, Sales Tax, Customs Duty, Excise Duty and Cess that have not been paid by the
company and are currently challenged in the court of law. The strong auditor’s opinion indicates
strong internal control procedures present in the company where no major weaknesses have been
witnessed.

Chapter 8 – Director’s Reports and MD&As

TVS Motors

Analysing the director’s report and MD&A’s report, the director elucidates various reasons for
profitability. In FY 2005, the director states that substantial reduction in the sales of two stroke
motorcycles increased dependence of the company on “Victor and Centra” brands of motorcycles
leading to higher promotion costs, combined with the higher input costs resulted in lower profits and
returns during 2004-05. We tried to corroborate this with the figures in the financial statements and
found that a rise in operating costs verified increase in higher input costs. But the statement on
“higher promotion costs” seemed more to be an “earnings excuse” as we found that advertisement
expense and promotional expenses were in line with sales and there were no significant promotional
costs which could have significantly impacted profitability.

In FY 2006 and FY 2007, the director states that despite an increase of 19% in turnover, profit was
lower mainly due to the steep increase in cost of various raw materials especially steel, aluminum,
copper and polymers. On verifying from the financial statements, raw material cost as a percentage
of revenue had gone up for both FY 2006 and FY 2007. Hence the director’s statement was justified.
The MD&A analysis also talks of intense competition and pressure on margins coupled with rising
interest costs as a reason for reduced profitability. We feel that “intense competition and inability to
pass rise in costs to consumers” is more of an “earnings excuse” to cover for other reasons.

In FY 2008, the MD&A analysis talks of reduced profitability due to reduced availability of retail
finance and resorting to high promotion costs to remain competitive in the market. In FY 2008, due
to the global recession, there was a liquidity crunch and retail financing was becoming scarce, thus
the statement on reduced retail financing is justified. But resorting to “high promotion costs” seems
to be more like an “earnings excuse” to cover up for disappointing sales.

IIM Bangalore 2010