HERO HONDA: FINANCIAL RISK ANALYSIS

ABHIJIT SAMANTA
International School of Business & Media; Kolkata
1

METHODOLOGY:The industry we have taken for this project is the Automobile Industry. HERO HONDA MOTORS LTD. is the company we have taken for doing this project. The competitors are 1. 2. 3. 4. TVS Motor Company Ltd. Bajaj Auto Ltd. LML. Ltd. Kinetic Motor Co. Ltd.

For all of the above mentioned companies we calculated the Regression Beta, Beta Unlevered and the Bottom up Beta and did the required analysis. We also analyzed how the risk varies because of financial leverage for various companies. The source of information we used are listed below. a. Prowess Software. b. Nifty website. www.nseindia.com c. Hero Honda Motors Ltd. website. www.herohonda.com We took last five year data on monthly basis from November 2004 to October 2009. The data includes market return, companies return, debt to equity ratio, sales and net income of the above mentioned companies.

Calculation of Regression Beta:-

Refer to Annexure 1 in the excel file. Sl. No. 1 2 3 4 5 Name of Company Hero Honda Motors Ltd. Kinetic Motor Co. Ltd. LML Ltd. TVS Motor Co. Ltd. Bajaj Auto Ltd. Regression Beta
0.5538 1.1996 1.2794 1.2680 2.1399

Regression Beta denotes the companys risk. For Hero Honda regression beta is 0.5538 it means if the market returns changes by 1% the companys return will be changing by 0.5538%.
2

More the value of Companys regression beta more risky the firm is from the investment prospective. According to the above table Hero Honda is comparatively less risky company and Bajaj Auto Ltd. is comparatively more risky firm as beta is 2.1399. However this may not be a reliable data for Bajaj Auto Ltd. as we did not have the complete information for Bajaj Auto Ltd. These regression betas we are calculating form the past or historical data. The market return in the future may not be like the past. That is why the calculated risk though this procedure is not a very good risk forecasting. In fact beta will have some statistical standard error. If it is more we definitely cannot use it for future risk forecasting. However incorporation of Standard Error is done later.

Regression Analysis:-

Refer to Annexure 2. By doing the regression analysis we can create the following chart and do the following interpretation. Company R square Intercept (Adjusted)
1.78614068 -2.05303075

S.E of Slope / Beta Intercept

0.928256 2.310596 0.55382025 1.19960613

S.E of Beta
0.092636 0.230588

Hero Honda 0.37061201 Motors Ltd. 0.30641091 Kinetic Motor Co. Ltd. 0.34849039 LML Ltd. TVS Motor 0.46005312 Co. Ltd. Bajaj Auto 0.45877037 Ltd.

-3.41262027 -2.04456221 6.75412189

2.246698 1.77453 3.770663

1.27935805 1.26802393 1.07750029

0.224211 0.177091 0.274484

Co-relation: - Co relation is denoted by the correlation coefficient which is here r square. It denotes the variation of firms share return with respect to the return of market For Kinetic Motor the value is minimum and for TVS Motors the value is maximum. This implies that variation of Kinetic Motors share return with market return is comparatively less and vice versa for TVS Motors.
3

The Intercept: - It is firms share return when the market return is zero. More the value of intercept less risky the firm is. Here Hero Honda and Bajaj Auto has positive value that denotes these firms has some positive share return even when the market share is zero. The remaining companies have this value negative means their shares return is negative when the market share is zero. Bajaj Auto is having the highest intercept here. N.B: - Bajaj Autos data may not be right as it is having incomplete data base. Slope or Beta: - As we had analyzed earlier that Hero Honda is having the minimum risk and LML. Ltd. is having the maximum risk. However incorporation of Standard Error is very important in this approach. Incorporation of Standard Error (S.E): - Some times when the s.e is very high for a company this implies that the value of Beta is largely deviated form the actual value. In this case we dont take the regression beta for making decision hence we take Bottom up Beta.

Unlevered Beta: -

Refer to Annexure 3. By the previous approach we can calculate the regression beta. But this regression beta or the risk of the firm is having two components. 1. Business risk and 2. The market risk. The regression beta is not actually a good measurement for forecasting the companys risk. The better approach is to calculate the Bottom up Beta. We calculate the unlevered beta for finding out industrys average beta. In other word to find out the industrys average business risk. Here we calculate the whole automobile industries average business risk. The formula for unlevered beta is. Beta unlevered = Beta regression / [1+ (1-t)*D/E] Equity ratio. t= tax rate i.e. 33.36%, D/E = Debt to

Company

Regression Beta

Debt. Equity (2005) 0.140 11.690 2.840 0.300 0.760

To tax rate ratio 33.36% 33.36% 33.36% 33.36% 33.36%

Beta unlevered 0.5066 0.1365 0.4423 1.0568 1.4205

Industries Average Business risk.

Hero Honda Motors Ltd. Kinetic Motors Co Ltd. LML Ltd. TVS Motor Co. Ltd. Bajaj Auto Ltd

0.5538 1.1996 1.2794 1.2680 2.1399

0.7125

If we look toward regression beta of all the companies. Hero Honda, Kinetic, LML are having lower business risk than the average market risk and TVS and Bajaj Auto are having more business risk than the average market business risk. However this interpretation is not very much dependable hence we calculate the Bottom up beta in the next approach.

Bottom up Beta: -

Refer to Annexure 4. Our main target is to forecast the beta depending on the historical data base. Now we calculate the regression beta this is not a very good approach of forecasting because. 1. As we calculate it form regression it corporate with standard error. 2. It is completely based on historical data. Now comparatively better way in solving this problem is to calculate the Bottom up beta. This bottom up beta provides a more reliable way of forecasting the companys risk. The formula for calculating this is . Bottom up beta = avg. market unlevered beta*[1+ (1-t)*D/E] t=tax rate.

Company

Regression Beta

Standard Error.

D/E Ratio.

Bottom Up Beta

Hero Honda Motors Ltd. Kinetic Motors Co Ltd. LML Ltd. TVS Motor Co. Ltd. Bajaj Auto Ltd

0.5538 1.1996 1.2794 1.2680 2.1399

0.092636 0.140 0.230588 11.690 0.224211 2.840 0.177091 0.300 0.274484 0.760

0.7790 6.2632 2.0610 0.8550 1.0734

Here if the standard error is very high for the firm then we must opt for the bottom up beta. Here Bajaj Auto ltd. is carrying a comparatively high s.e so here we should opt for bottom up beta.

Sensitivity Analysis: Refer to Annexure 5.

D/E (2005) 0.140 11.690 2.840 0.300 0.760 -3.6067 -2.5537 -1.5006 -0.4475 0.6055 1.6586 2.7116 ratio. Bottom Beta 0.7790 6.2632 2.0610 0.8550 1.0734 -1 -0.5 0 0.5 1 1.5 2 6 Up

3.7647 4.8177

2.5 3

Here the blue font colored area continues with the sensitivity analysis of d/e ratio to bottom up beta. With the increasing D/E ratio the bottom up beta also increases. When bottom up beta is zero D/E ratio is -1.5006. This means in present scenario (2005) in the automobile industry if any companys D/E ratio is 1.5006. It will be having zero risk. But theoretically any companys D/E ratio cannot be negative. So any probability for any automobile company of having zero risk may not be there. In other words every automobile company will have at least some amount of risk.

Variation of Risk and financial leverage: -

Refer to Annexure 6. The main source of the business risk is sales volume and the cost structure. In some cases sales volume and cost of two firms remains same. But their risk varies. The simple answer for this question is the cost structure of the different firms. The business risk also varies with the cost structure of the company. In the excel sheet it is shown how there is variation of beta with sales and net income of the five companies. In this case the slope is the degree of total leverage.