fra - final report with conclusion

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Financial Reporting and

AnalysisHero Honda Motors LtdDheeraj Arora PGP27078

Dilip Singh PGP27079

N. Mahesh PGP27092

Senthil Kumaar PGP27098

Punit Shukla PGP27101

Rachit Sharma PGP27102Sairam Kandaswami PGP27113

Submitted to

Prof. Manoj Kumar

Section B

29th September, 2011

Indian Institute of Management, Lucknow


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Table of Contents

1. Annual Report Disclosures ......................................................................................................... 3

2. Corporate Governance Disclosures ............................................................................................ 3

3. Comparison of Schedules ........................................................................................................... 4

4. Revenue Recognition ................................................................................................................. 4

5. Deferred Taxes ........................................................................................................................... 5

6. Depreciation and Amortization .................................................................................................. 6

7. Inventory Valuation .................................................................................................................... 6

8. Fixed Asset Accounting.............................................................................................................. 6

9. Ratio analysis .............................................................................................................................. 7

10. Conclusion ................................................................................................................................ 11

Appendix A........................................................................................................................................ 12

Appendix B ....................................................................................................................................... 13

Appendix C ....................................................................................................................................... 14


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1.Annual Report DisclosuresItem Hero Honda Bajaj Auto Ltd

Balance Sheet Disclosures

Technical Know How

Bad Debts

Voluntary Retirement Expenditure

Profit and Loss AccountDisclosures

Exceptional Items

Energy Consumption and Conservation Measures

General Disclosures

Stock Market information

Abridged Profit and Loss Statement

manufacturing facilities

Remuneration of Executive Directors

Comparing the mandatory and voluntary disclosures made by the two companies, we can say that Bajaj Auto

Ltd appears to be more transparent than its peer. One important difference between the two is that BAL

balance sheet includes the Technical Know How in its balance sheet under the heading Application of Funds,

thus attributing the future economic benefits of the R & D expenditure, which is generally quite high in

automobile sector.

Another important difference is the provision for bad debts being included in the BAL balance sheet.

Apart from these disclosures, there is a small difference between the way general info is reported in the

annual reports of the two companies: Hero Honda Motors Ltd discloses the stock market data, dividend

payments, stock market listings, fluctuations in the share price and shareholding pattern in the company, This

is because the general movement in the share price is good for them and they want to highlight this fact to

the share holders and investors. On the other hand, Bajaj Auto provides an abridged Profit and Loss

Statement in its annual report, thus helping to form an idea of the operating profitability of the company.

2. Corporate Governance DisclosuresWhen we compared the Corporate Governance Disclosures of the two companies, Hero Honda clearly hasbetter CG Disclosures. The disclosures made by Hero Honda that are not present in Bajaj Auto Ltd are:

Shareholding percentages for the members of the board Roles and terms of reference for Audit committee Details of information to be provided to the board Risk management activities Tasks performed by each board committee


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Code of conduct of the organisation with regard to Insider Trading Means by which information to be provided to the media and other regulating bodies

The Corporate Government Disclosures point that the Hero Honda is more closely governed by the Munjral

family, evident by two facts: lesser number of independent Directors and absence of Employee Stock

Options Plan in the company. Also, the non-executive directors of the board are paid 0.1% of profits in HeroHonda.

Although most of the extra information provided by Hero Honda wont make that big a difference to

investors, but still, these detailed disclosures would make the annual reports look more credible.

3. Comparison of SchedulesBoth Hero Honda and Bajaj declare more or similar schedules apart from a few minor differences. Bajaj gives

a proper classification of Other Liabilities as into Advances received against Orders, Annuities payable to

VRS optees, Investor Education protection Fund and Temporary Overdrafts, thus helping the investorunderstand the liabilities of a company better and realise and predict the companys performance in future

years better. The inclusion of a provision for losses that can be incurred in derivative hedging instruments

makes the Bajaj balance sheet more credible and closer to the reality.

On comparing the schedules related to Other Income, inclusion of the technical know-how fees received or

Royalty received by Bajaj Auto Ltd makes the company look technologically more advanced than Hero

Honda. Similarly, break down of the Interest received on long term investments by Bajaj gives an insight into

the Companys investment strategy.

4. Revenue RecognitionThe revenue recognition policies employed by both companies are quite similar, barring a few fine points, as

shown below:

Item Hero Honda Motors Ltd Bajaj Auto Ltd

Domestic Sales Point of dispatch of finished goods to the customer On dispatch from the point of sal

Export Sales On the date of the Mates receipt On the date of the Mates receipt

Sale of investments

Accrued Interest

Accrued Dividend

Service income

Sale of scrap


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The policies of both the companies are conservative. The underlying fact to this is that BAL has been in the

automobile industry for a very long time and due to the old policies, it is quite conservative. The companies

that followed BAL like Hero Honda, Suzuki, Yamaha chose their accounting policies similar to that of the

BAL. So, the revenue recognition policies of two wheeler manufacturing companies in India are generally

conservative in nature.

One important policy of Hero Honda is that Service income is recognized when the services are rendered.

This includes sales from the workshops, parts etc and is in line with the conservative nature of policies

adopted by them.

5. Deferred TaxesHero Honda Motors Ltd recorded Deferred Tax Assets worth INR 7.88 crores. The reason for the creation

of these deferred tax assets has not been clearly disclosed by Hero Honda. A portion of these assets,

amounting to INR 1.38 crores is on account of timing differences in accrued expenses and the remaining

portion has been attributed to Other Sources.

It has also recorded Deferred Tax Liabilities worth INR 160.63 crores which are mainly attributed to timing

differences in depreciation and amortization. A small portion of the deferred tax liabilities have been

attributed to OtherSources which have not been disclosed by the company.

For the same period, Bajaj Auto Ltd recorded Deferred Tax Assets amounting to INR 324 crores. The reason

for the creation of these deferred tax assets is attributed to a variety of reasons i.e.

Voluntary Retirement Scheme Inventory valuation Diminution in the value of investments Provision for bad and doubtful debts Provision for decrease in value of investments Provision for privilege leave etc.Taxes, duties etc.Amortization of premium / discount on acquisition of fixed income securitiesAdjustments on account of gratuity provisions

In the same period, it has recorded Deferred Tax Liabilities amounting to INR 270.2 crores. These have been

attributed to timing differences in depreciation and amortization. Both companies have not recorded

operating losses in its previous financial years and so there has been no balancing out of any operating losses

against the deferred tax assets of the current period. Also, both companies have not included any footnotesregarding the recognition of deferred taxes in the respective annual reports.

Bajaj Auto Ltd takes into account the degree to which the deferred tax assets are likely to materialize in the

future periods. This has been clearly stated in its Deferred Taxation Policy. Hero Honda Motors, on the other

hand, has not provided any such details in the annual report.


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6. Depreciation and AmortizationHero Honda Motors Ltd accounts for fixed assets at the cost of acquisition less accumulated depreciation.

This cost is inclusive of freight, duties, taxes and other incidental expenses. The assets are depreciated using

the Straight line method at a rate of 5.28% per annum which is in accordance with the guidelines laid out in

the Companies Act.

Also, assets that cost less than INR 5,000 are fully depreciated in the year of purchase by Hero Honda

Motors Ltd. Leasehold land is amortized over the period of the lease by Hero Honda Motors Ltd.

Bajaj Auto adopts the same policy with regard to depreciation of fixed assets and leasehold land. In addition

to this, Bajaj Auto also provides details on depreciation of assets that are sold, discarded or demolished within

the year.

Both companies adopt moderate policies with regard to depreciation of fixed assets, which is in line with

requirements as laid out by the regulatory authorities. There have been no changes in the depreciation policies

of the two companies in the past few years and the contribution of depreciation expenses to the overall

expenses in the income statement has been more or less constant. As there has been a significant increase in

the profit after tax for both companies over the same period, it can be said that the companies have not used

depreciation policies to record higher or lower net income in the current financial period.

7. Inventory ValuationHero Honda Motors Ltd values inventory i.e. Raw materials, work-in-progress and finished goods at lower of

cost and net realizable value. For determining cost, raw materials and components are valued using the

weighted average cost while the finished goods and work-in-progress are valued by adding the material costs,

share of labor and manufacturing overhead. Stores and Tools are valued at cost arrived at on weightedaverage basis.

Bajaj Auto Ltd values the finished stock and work-in-progress at cost or net realizable value whichever is

lower. However, raw materials and components arrived at on weighted average basis or lower of cost and net

realizable value. Goods in transit are valued at actual cost incurred till the date on which it is recorded i.e. the

date of the balance sheet.

The implication of the assumption regarding lower of cost or market for valuing inventory is that the

companies would book the inventory at the market value if the prices of the inventory are to plummet in the

near future as against booking inventory using weighted average or FIFO method.

8. Fixed Asset AccountingHero Honda Motors Ltd follows the revaluation model of accounting for its fixed assets and other

investments. The fixed assets are physically verified every three years and according to the company, the

frequency of the verification is reasonable with regard to the size of the company and nature of the assets.


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The company has not disclosed the details about the verification process i.e. the authority carrying out the

verification, coverage of the verification etc. Also, as there has been no revaluation of the fixed assets in past

few years, no particular reasons are provided for which revaluation is carried out. There has been no change

in the revaluation and impairment policy for Hero Honda Motors in the past few years.

Bajaj Auto Ltd also follows the revaluation model of accounting for its fixed assets and other investments.

However, no revaluation has been done on any of the fixed assets belonging to Bajaj Auto. The company has

not provided any details regarding the policies adopted in determining the need for revaluation. Also, no

information has been provided regarding the authority verifying the need for revaluation or the frequency of

the verification process.

Investments made by Bajaj Auto in its subsidiary PT. Bajaj Auto Indonesia have been revalued and

corresponding impairment losses have been booked as a diminution in the value of the investments. The

diminution in the value of investments has been adjusted against a provision created from the general reserve.

The details regarding the revaluation have been provided by Bajaj Auto as a part of the footnotes and are

adequate.

In the Indian two wheeler segment, TVS Motor Company has revalued its fixed assets in the financial year2008-09. There was also diminution in the value of investments which was recognized as an impairment loss

for the year. No particulars have been provided regarding the category of fixed assets that have been revalued

and only the net value of the revaluation has been added/deducted from the total assets. The losses occurred

owing to restatement of external commercial borrowings attributable to plant and machinery.

9. Ratio analysisLiquidity ratio: These are the ratios that help to evaluate a companys ability to meet its short term financial

obligations. A companys ability to convert assets to cash is essential to meet the payment demands of its

creditors.

i. Current ratio:Company FY 09-10 FY 08-09

Hero Honda 0.7 0.63

Bajaj Auto Limited 0.69 0.84

The current ratio of Hero Honda has been above 0.65 from 2006 onwards. Bajaj has also had a

ratio of around 0.8 except for 08-09. Companies like TVS which are the in the two wheeler

segment have had ratio above 1 from 2007 onwards. To further ascertain the ability of company

to meet its short term obligations quick ratio is to be looked at.

ii. Quick ratio:Company FY 09-10 FY 08-09Hero Honda 0.48 0.23



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The quick ratio of Hero Honda is lesser than some its competitors in the segment. Bajaj and

TVS have had quick ratio above 0.5 for nearly all years from 05-06. The higher quick ratio for

Bajaj and TVS indicates that they are in better position to meet their short term obligations

compared to Hero Honda.

iii.

Days inventory:

Company FY 09-10 FY 08-09

Hero Honda 11.66 12.01


Hero Honda had Inventory turnover ratio of 31.3 and 30.38 for 09-10 and 08-09 respectively.

The days inventory of Honda is however less than TVS motors for which this value is 20 days.

Thus Hero Honda is better than other companies as its inventory has moved out faster

compared to its competitors( This value is lesser than that of car manufacturers like Maruti

Suzuki which have it around 28 days). It can be said that Hero hondas inventory is more liquid

than other companies in the industry.

iv. Days sales:Company FY 09-10 FY 08-09Hero Honda 2.99 6.62


Hero Honda has days sales value which is much lower than Bajaj and TVS limited. Thus Hero

Honda is able to get payments from its dealers much earlier than its competitors. This would also

reduce the cash conversion cycle for the company there reducing the companys dependence on

credit.

v. Days Payable:Company FY 09-10 FY 08-09Hero Honda 27 27.18


The days payable of Hero Honda is lesser than Bajaj and TVS. Both Bajaj and TVS have days

payable above 45 days which indicates that these companies have been able to use credit more

effectively. Moreover as both TVS and Bajaj are healthy companies financially the higher days

payable also indicates better relationship with their suppliers.

vi. Cash conversion cycle:Company FY 09-10 FY 08-09Hero Honda -12.35 -8.55

Bajaj Auto Limited -25.09 -15.46


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A negative value for cash conversion cycle ensures that the company always has excess cash due

to the business model of the company. The negative value has been mainly due to the ability of

the companies to make their purchases on credit basis with high days payable. Moreover in some

cases the customers place orders and pay token payments for the vehicles in advance. This

negative cash conversion cycle helps the company to meet its short term obligations with lesser

dependence on external credit sources.Bajaj auto limited has better cash conversion cycle as its value is more negative compared to that

of Hero Honda. TVS also has cash conversion cycle in the range -10 to -22 in the last five years.

This difference is mainly due to the lower value of days payable for Hero Honda.

vii. Debt equity ratio:Company FY 09-10 FY 08-09Hero Honda 0.016 0.018


Debt to equity ratio underlines the aggressiveness with which the company has used debt tofinance its operations. Hero Honda has used debt very conservatively as shown by the ratio

(highest has been 0.08 in 06-07).TVS has been very aggressive in using debts and this ratio has

been above 1 in 09-10 and 08-09 (least being 0.72 in 06-07). Aggressive usage of debt by a

company will result in higher ROE only when the company is able to use funds effectively and is

able to generate more returns than the rate of interest.

viii. ROE:Company Hero Honda Bajaj Auto

ROE 52.76% 58.15% 29.51% 58.15%

Both companies exhibit a fall in ROE of around ~6%, the reasons for which can be analysed

using the Du-Ponts 3 ratio analysis. On breaking up the ROE into Du-Ponts 3 ratios, we find

the ratios to be

Company Hero Honda Bajaj Auto

Net Profit Margin 14.17% 10.28% 14.14% 7.33%Asset Turnover 1.82 2.01 1.41 1.52

Financial Leverage 2.05 1.43 2.92 3.15

The Primary factor for decrease in ROE is seen to be the higher Financial Leverage ratio, which

shows that the companies are more debt-based than before. As can be seen from the Vertical

Size Analysis, Current Liabilities increased from ~26% to ~48% for HH Motor Corp from

2008-09 to 1009-10, which is almost a 200% increase.


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ix. Profit Margins:Company Hero Honda Bajaj Auto

Gross Profit Margin 24.01% 20.58% 32.99% 27.64%Net Profit Margin 14.17% 10.28% 14.14% 7.33%

The profit margins have increased for both companies by some margins, more notably for Bajaj

Auto Limited. The increase is seen across Gross Margin as well as Net Margin which indicates

that the material (and other COGS) expenses have been cut down to achieve this increase. Also,

a point to note is that Bajaj has caught up with HH in terms of Net Profit Margin, by cutting

down on other expenses.

x. ROCE (Return on Capital Employed):Company Hero Honda Bajaj Auto

ROCE 63.74% 40.12% 60.13% 33.17%

This ratio gives a clearer picture of the reasons for decreasing ROE of the companies. ROCE is

calculated as EBIT/(Total AssetsCurrent Liabilities) and shows that the Return on Long Term

Liabilities has increased meaning the companys capital investments have become more

profitable, but nonetheless if ROE has decreased, it is due to the Current Liabilities which have

increased disproportionately.

xi. Price to earnings ratio: The ratio has been calculated on 31 March,2010 and 31 March,2009 forthe respective financial years.

Company FY 09-10 FY 08-09Hero Honda 17.42 16.89


Closing price

Company FY 09-10 FY 08-09Hero Honda 1948.90 1072.1


The share prices of TVS, Bajaj and Hero increased in FY 09-10 owing to the recovery from

the financial meltdown of the previous year.Both Bajaj and TVS (11.07 for Fy 09-10 and

8.64 for FY 08-09) have had lower P/ E ratios. The higher P/E ratio of Hero Honda

indicates higher investor confidence in the company.


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10. ConclusionIt is found that with regard to disclosures in the annual report, Bajaj Auto Ltd has more transparent policies.

This will result in more confidence on the part of the investors when considering the company for future

investments.

With regard to Corporate Governance, Hero Honda Motors has included disclosures regarding various

factors like tasks to be performed by various committees set up by the company, the code of conduct within

the organization etc. This implies a more robust corporate governance framework being employed by Hero

Honda Motors. This would result in greater investor confidence in the future of the company. As the other

disclosures in the annual report in which Bajaj Auto has fared better are not as important as corporate

governance, we can safely recommend Hero Honda Motors with regard to these factors.

In the comparison of schedules, it was found that Bajaj Auto provides more details about the individual items

in its balance sheet. This provides more information to the investor about the long term plans of the

company. Also, when comparing the deferred taxation policies of the two companies, Bajaj Auto has

provided more information about the items causing timing differences.

Key Ratios influencing Investor decisions

The better level of disclosures provided by Bajaj Auto Limited, in combination with the lower PEratio suggest that Bajaj Auto is undervalued compared to Hero Honda Motors Limited, and can

provide better returns if invested in.

The profit margin for Bajaj has gone up in 2009-10 and is similar as Hero Hondas profit margin(Gross margin is higher for Bajaj), which indicates a better operational efficiency of the company to

earn profits through.

A higher ROE means Bajaj Auto is in a better position to convert equity invested in it to Sales (andhence Profits), making it a better company to invest in.Moreover, Bajaj is a relatively new entrant into the motorcycle industry, which now contributes significantly

to its performance and hence seems a better proposition than Hero Honda for an investmentsimilar risk

levels, but better future returns seem likely in case of Bajaj.

Hence, we suggest Bajaj Auto Limited from the Investors perspective.


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Appendix A

Common Size Statement Analysis

Hero

Item on B/S or P/L Statement 2009-10 2008-09

Cash Equivalent 22.0% 3.6%

Acc Rec 1.3% 2.4%

Inventories 5.0% 5.3%

Other Current Assets 5.3% 5.2%

Total Current Assets 33.6% 16.5%

PPE 19.5% 27.4%

Other Long Term Assets 46.8% 56.0%

TOTAL ASSETS 100.0% 100.0%

Current Liabilities 48.3% 26.2%

Long Term Debt 0.5% 1.0%

Other Long Term Liabilities 2.3% 2.7%

Preferred Share 0.0% 0.0%

Total Equity Capital 48.9% 70.1%

TOTAL LIAB & EQUITY 100.0% 100.0%

Net Sales 100.0% 100.0%

Cost of Sales 76.0% 79.4%

Other Expenses 6.2% 6.4%

Interest Expense -0.1% -0.3%EBT 18.0% 14.5%

Taxes 3.8% 4.2%

Extraordinary Items 0.0% 0.0%

NET INCOME 14.2% 10.3%


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Appendix B

Balance Sheet and Income Statement

Hero Bajaj

Item on B/S or P/L Statement 2009-10 2008-09 2009-10 2008-09

Cash Equivalent 19072.12 2195.72 1014.1 1368.7

Acc Rec 1083.88 1499.38 23473.6 17238.8

Inventories 4364.04 3268.34 4462.1 3388.4

Other Current Assets 4605.78 3171.48 1059.7 1256.8

Total Current Assets 29125.82 10134.92 30009.5 23252.7

PPE 16919.54 16790.44 15211.1 15480.9

Other Long Term Assets 40547.54 34321.3 40215.2 20080.8

TOTAL ASSETS 86592.9 61246.66 85435.8 58814.4

Current Liabilities 41813.5 16040.7 42749.7 24375.6

Long Term Debt 475.37 599.97 13385.8 15700

Other Long Term Liabilities 1977.88 1671.49 16.9 41.9

Preferred Share

Total Equity Capital 42326.15 42934.5 29283.4 18696.9

TOTAL LIAB & EQUITY 86592.9 61246.66 85435.8 58814.4

Net Sales 157581.6 123191.2 120434.8 89322.6

Cost of Sales 119749.34 97838.08 80704.4 64634.7

Other Expenses 9703.82 7852.02 13944.3 12845.9

Interest Expense -206.2 -316.8 59.8 210.1

EBT 28334.64 17817.9 25726.3 11631.9

Taxes 6004.15 5148.18 7084 3035.9

Extraordinary Items 1615 2051

NET INCOME 22330.49 12669.72 17027.3 6545

ROE 52.76% 29.51% 58.15% 35.01%

Net Profit Margin 14.17% 10.28% 14.14% 7.33%

Asset Turnover 1.82 2.01 1.41 1.52

Financial Leverage 2.05 1.43 2.92 3.15

Gross Profit Margin 24.01% 20.58% 32.99% 27.64%

Net Profit Margin 14.17% 10.28% 14.14% 7.33%

Return on Capital Employed 63.74% 40.12% 60.13% 33.17%

Interest Coverage -138.41 -57.24 429.21 54.36


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Appendix C

Cash Flow Statement

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