Rating Rationale
September 30, 2016 | Mumbai
Hero Motocorp Limited
Rating Reaffirmed 
 
Governance and Value Creation Rating CRISIL GVC Level 1 (Reaffirmed)
* The common independent director on the Boards of CRISIL and Hero MotoCorp Ltd did not participate in the rating committee meeting for this rating exercise.

CRISIL has reaffirmed its Governance and Value Creation (GVC) rating of 'CRISIL GVC Level 1' on Hero MotoCorp Ltd (HMCL). The rating indicates that the company's capability with regard to corporate governance and value creation for all its stakeholders is the 'Highest'1 .

HMCL has strong corporate governance practices with more than 50% of the board members being independent. The competency of the board is high as the board members are well-known experts in their respective fields with high integrity and competence. The board provides adequate oversight on the functioning of the management and directions on important strategic matters. The effectiveness of the board is reflected in the fact that HMCL has remained the market leader in motorcycles despite separation from its technology partner, Honda Motor Co (HMC) in December 2010; the company had a dominant market share of 39% in fiscal 2016 in the two-wheeler segment and 52% in the motorcycle segment; it has remained the market leader in the domestic motorcycle segment for over a decade. Furthermore, HMCL has undertaken initiatives to improve the functioning of the board; these include spacing out the audit committee and board meetings, and a reasonable increase in compensation paid to the board members. Besides, it has commenced the process of evaluation of the contribution of board members through the Nomination and Remuneration Committee; CRISIL believes evaluations give the board an opportunity to achieve better performance, increase effectiveness and accountability, and highlight best practices.

However, CRISIL believes that, increasing participation of some of the Independent Directors in the sub-committees of the board, presence of a lead independent director, segregating the positions of Chairman & managing director (MD) and chief executive officer, a forum for independent directors to meet frequently, and adherence to a fixed schedule for board meetings, may help further enhance the board's performance. Besides, some of the independent directors have also served on the board and its various sub-committees for a fairly long period of time. A defined rotation policy for independent directors will be desirable. Additionally, improvement in the quality of recording of discussions at the board meetings will also be desirable.

HMCL has a strong and independent audit committee. Besides overseeing the company's financial reporting and disclosures, the committee set up in 1987, reviews in detail the risk management and mitigation policies implemented by the company and monitors related-party transactions. HMCL's transactions with related parties, including purchasing from group companies and interest rates on inter-corporate deposits extended to group companies, have been on an arm's length basis. The recent setting up of Risk Management Committee is enabling HMCL's board identify and monitor the risks, and initiate necessary action. HMCL has also undertaken steps to improve its internal controls and streamline its internal processes by setting up an internal audit team.

HMCL follows good disclosure standards, as is evident from the management discussion and analysis section of its annual report. The section carries detailed discussion on the risks the company faces. HMCL has also set up an investor relations team, which has led to frequent information dissemination to the investors. Furthermore, HMCL has a code of conduct for all its employees, including directors and senior management. The company also discloses its dividend policy in its annual report. However, dissemination of information on its website can be improved; for instance HMCL can include an investor calendar with dates for analyst and institutional investor meetings, analyst meet presentations and improve the ease of locating items on the website by placing them under relevant heads. Further, HMCL can include the evaluation criteria for independent board members on its website and also update its website on a frequent basis to enable equitable and timely sharing of information.

HMCL has created enormous value for its stakeholders. Its equity holders have been rewarded with high economic value addition and dividend payout, over the past few years. The company's share price has consistently outperformed the benchmark indices. Furthermore, HMCL's debt holders are well protected, as is reflected in CRISIL's highest credit ratings of 'CRISIL AAA/FAAA/Stable/CRISIL A1+' on the company's debt instruments. 

However, CRISIL believes that HMCL will have to significantly ramp up its Research & Development (R&D) capabilities to meet the growing challenges from competitors in the two-wheeler segment. The company has undertaken steps in this direction by setting up a state of the art indigenous R&D centre in Rajasthan. HMCL also has a modest presence in the premium motorcycle segment. Since the premium segment is growing at a faster rate as compared to the industry, introducing new models and market share in the premium segment will remain a key focus area for HMCL; the bankruptcy of its technology partner, Eric Buell Racing (EBR), has set back new launches in the premium segment by at least a year. On the export front, the difficult business environment in Africa and Latin American countries has led to lower than expected off-take for HMCL. CRISIL believes that HMCL's senior management will need to enhance oversight in the area of exports to enable the company achieve its export targets.

HMCL has a track record of fulfilment of its corporate social responsibilities and it pays high taxes. The company is among the largest employers in the automobile sector in India, with over 7600 employees. It has also played a pivotal role in developing the backward regions of Dharuhera in Haryana, and Haridwar in Uttarakhand, through social projects. Over the medium term, HMCL is setting up new greenfield plants at Halol in Gujarat and Chittor in Andhra Pradesh, which will further enhance employment opportunities in these states. The company's pay scales continue to remain higher than industry standards. CRISIL believes that increased employee engagement and career planning for employees will moderate HMCL's employee attrition rate, which has risen in recent years. CRISIL also believes that HMCL needs to evolve a succession plan, in order to ensure smooth functioning of operations in the event of exit of key management personnel.

About the Company

HMCL, formerly Hero Honda Motors Ltd, was jointly promoted by the Munjal family based in Ludhiana, Punjab, and HMC in 1984, and began manufacturing motorcycles in 1985. HMCL has four plants, one each in Dharuhera, Gurgaon in Haryana, Haridwar, and Neemrana in Rajasthan, with a combined manufacturing capacity of 8.2 million units per annum. The capacity is expected to increase to 9.0 million by fiscal 2017 after the commissioning of the plant in Halol.

In fiscal 2011, HMC agreed to transfer its entire shareholding of 26% in the company to the Munjal family, bringing an end to the joint venture (JV) between the two promoter groups. HMCL also entered into a new licence agreement on January 1, 2011, with HMC, giving HMCL the right and licence to manufacture, assemble, sell, and distribute certain products and their service parts under HMC's Intellectual Property Rights. During fiscal 2012, in view of the separation of the JV partners, the company's name was changed to the present one. In August 2016, the Munjal family announced the second round of restructuring, which led to the exit of Mr Sunil Kant Munjal (brother of Mr Pawan Munjal) from the executive responsibilities and board of HMCL.

For fiscal 2016, on a consolidated basis, HMCL reported profit after tax (PAT) of Rs.30.50 billion (Rs.23.64 billion for fiscal 2015) on net sales of Rs.286.14 billion (Rs. 275.38 billion).

1 Please refer to rating definitions of the CRISIL governance and value creation ratings.

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