FINANCIAL MANAGEMENT

ASSIGNMENT
Du Pont analysis on HERO MOTO CORP. and HONDA
MOTORS

SIDHARTH ANAND
ROLL - 061
BBA - D

DuPont Analysis
What is DuPont Analysis?
The DuPont analysis (also known as the DuPont identity or DuPont model) is a
framework for analyzing fundamental performance popularized by the DuPont
Corporation. DuPont analysis is a useful technique used to decompose the
different drivers of return on equity (ROE). The decomposition of ROE allows
investors to focus on the key metrics of financial performance individually to
identify strengths and weaknesses.
KEY TAKEAWAYS
• The DuPont analysis is a framework for analyzing fundamental
performance originally popularized by the DuPont Corporation.
• DuPont analysis is a useful technique used to decompose the different
drivers of return on equity (ROE).
• An investor can use analysis like this to compare the operational
efficiency of two similar firms. Managers can use DuPont analysis to
identify strengths or weaknesses that should be addressed.
What DuPont Analysis Tells You
A DuPont analysis is used to evaluate the component parts of a company's
return on equity (ROE). This allows an investor to determine what financial
activities are contributing the most to the changes in ROE. An investor can use
analysis like this to compare the operational efficiency of two similar firms.
Managers can use DuPont analysis to identify strengths or weaknesses that
should be addressed.
There are three major financial metrics that drive return on equity (ROE):
operating efficiency, asset use efficiency, and financial leverage. Operating
efficiency is represented by net profit margin or net income divided by total
sales or revenue. Asset use efficiency is measured by the asset turnover ratio.
Leverage is measured by the equity multiplier, which is equal to average assets
divided by average equity.
DuPont Analysis Components
DuPont analysis breaks ROE into its constituent components to determine
which of these factors are most responsible for changes in ROE.
Net Profit Margin
The net profit margin is the ratio of bottom line profits compared to total
revenue or total sales. This is one of the most basic measures of profitability.
The profit margin can be improved if costs for the owner were reduced or if
prices were raised, which can have a large impact on ROE. This is one of the
reasons that a company's stock will experience high levels of volatility when
management makes a change to its guidance for future margins, costs, and
prices.
Asset Turnover Ratio
The asset turnover ratio measures how efficiently a company uses its assets to
generate revenue. Imagine a company had 100 of assets, and it made 1,000 of
total revenue last year. The assets generated 10 times their value in total
revenue; a normal asset turnover ratio will vary from one industry group to
another. For example, a discount retailer or grocery store will generate a lot of
revenue from its assets with a small margin, which will make the asset
turnover ratio very large. On the other hand, a utility company owns very
expensive fixed assets relative to its revenue, which will result in an asset
turnover ratio that is much lower than that of a retail firm.
The ratio can be helpful when comparing two companies that are very similar.
Because average assets include components like inventory, changes in this
ratio can signal that sales are slowing down or speeding up earlier than it
would show up in other financial measures. If a company's asset turnover rises,
its ROE will improve.
Financial Leverage
Financial leverage, or the equity multiplier, is an indirect analysis of a
company's use of debt to finance its assets. Assume a company has 1,000 of
assets and 250 of owner's equity. The balance sheet equation will tell you that
the company also has 750 in debt (assets - liabilities = equity). If the company
borrows more to purchase assets, the ratio will continue to rise. The accounts
used to calculate financial leverage are both on the balance sheet, so analysts
will divide average assets by average equity rather than the balance at the end
of the period.
DuPont Analysis vs. ROE
The return on equity (ROE) metric is net income divided by shareholders’
equity. The DuPont analysis is still the ROE, just an expanded version. The ROE
calculation alone reveals how well a company utilizes capital from
shareholders.
With a DuPont analysis, investors and analysts can dig into what drives
changes
in ROE, or why an ROE is considered high or low. That is, a DuPont analysis can
help deduce whether its profitability, use of assets, or debt that’s driving ROE.
Limitations of Using DuPont Analysis
The biggest drawback of the DuPont analysis is that, while expansive, it still
relies on accounting equations and data that can be manipulated. Plus, even
with its comprehensiveness, the DuPont analysis lacks context as to why the
individual ratios are high or low, or even whether they should be considered
high or low at all.
DuPont Analysis Interpretation:
It gives a broader view of the Return on Equity of the company. It highlights
the company’s strengths and pinpoints the area where there is a scope for
improvement. Say if the shareholders are dissatisfied with lower ROE, the
company with the help of DuPont Analysis formula can assess whether the
lower ROE is due to low-profit margin, low asset turnover or poor leverage.
Once the management of the company has found the weak area, it may take
steps to correct it. The lower ROE may not always be a concern for the
company as it may also happen due to normal business operations. For
instance, the ROE may come down due to accelerated depreciation in the
initial years.
The DuPont equation can be further decomposed to have an even deeper
insight where the net profit margin is broken down into EBIT Margin, Tax
Burden, and Interest Burden.
Now, To make investing decisions, many a times we want to compare the
business
models of companies in one sector to understand if we can explain the
differences in valuation and which company has better financial metrics.
Let us take an example,
Tata Motors Limited is an Indian multinational automotive manufacturing
company headquartered in Mumbai, Maharashtra, India. It is a part of Tata
Group, an Indian conglomerate. Its products include passenger cars, trucks,
vans, coaches, buses, sports cars, construction equipment and military
vehicles.
TVS Motor Company Limited is an Indian multinational motorcycle company
headquartered at Chennai, India. It is the third largest motorcycle company in
India with revenue of over ₹20,000Cr. In 2018–19. The company has annual
sales of 3 million units and an annual capacity of over 4 million vehicles.
Two Companies, Two Different Approaches
HERO MOTO CORP - Hero Motors is a
former moped and scooter manufacturer based in Delhi, India. It is a part of
multinational company Hero Motors Company, which also currently owns Hero
Motocorp (formerly Hero Honda) and Hero Cycles, among others. Hero Motors
was started in the 1960s to manufacture 50 cc two-stroke mopeds but
gradually diversified into making larger mopeds, mokicks and scooters in the
1980s and the 1990s. Noteworthy collaborators and technical partners
were Puch of Austria and Malaguti of Italy manufacturing Puch Maxi Plus and
Malaguti Centro respectively in India with updated engines.
Due to tightening emission regulations and poor sales, Hero motors has
transferred the manufacture of all gasoline-powered vehicles to Hero
Motocorp and transformed itself into an electric two-wheeler and auto parts
manufacturer.
HONDA MOTORS - Honda has been the world's largest motorcycle
manufacturer since 1959, reaching a production of 400 million by the end of
2019, as well as the world's largest manufacturer of internal combustion
engines measured by volume, producing more than 14 million internal
combustion engines each year. Honda became the second-largest Japanese
automobile manufacturer in 2001. Honda was the eighth largest automobile
manufacturer in the world in 2015.
Honda was the first Japanese automobile manufacturer to release a dedicated
luxury brand, Acura, in 1986. Aside from their core automobile and motorcycle
businesses, Honda also manufactures garden equipment, marine engines,
personal watercraft and power generators, and other products. Since 1986,
Honda has been involved with artificial intelligence/robotics research and
released their ASIMO robot in 2000. They have also ventured into aerospace
with the establishment of GE Honda Aero Engines in 2004 and the Honda HA-
420 HondaJet, which began production in 2012. Honda has two joint-ventures
in China: Dongfeng Honda and Guangqi Honda.
In 2013, Honda invested about 5.7% (US$6.8 billion) of its revenues in research
and development. Also in 2013, Honda became the first Japanese automaker
to be a net exporter from the United States, exporting 108,705 Honda and
Acura models, while importing only 88,357.
So, let’s compare the financial metrics of the two companies using DuPont
analysis.
Here are the Income Statement and Balance Sheet of the two companies for
the previous year.
INCOME STATEMENT
How do the Financials of these two companies stack up?
A very interesting tool to compare the business model of two companies in
similar businesses is the DuPont Analysis.

So what does the DuPont Analysis tells us for HERO Motors and HONDA
Motors?
ANALYSIS RESULT
The ROEs of HERO Motors are much higher than HONDA Motors’. So, one
would think that HERO Motors has better financial metrics.
However, a deeper look at the DuPont Analysis reveals a different story.
But the Net Profit Margins for the two companies are similar, HERO Motors
utilises its assets a little better than HONDA Motors as can be seen in the Asset
Turnover Ratio of HERO at 0.13 vs. HONDA at -0.13.
So, in effect, HERO MOTORS has better financial metrics than HONDA
MOTORS. So, client should invest in TVS Motors.