Hero MotoCorp Ltd. - "Competition remains a concern":: LKP

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Robust volumes and realization growth result in a 27% yoy growth in revenues

Good monsoons, hike in MSPs of food grains and strong hold in the rural markets led HMCL to report robust 20% growth in volumes to 1.54mn, while realizations have shown a healthy growth of 7% yoy on a per vehicle price hike of ~Rs.750 on 24th June. Festive season in September aided the growth in volumes, while the company did not launch any new model in the quarter. In October, HMCL has launched Impulse, a 150 cc bike priced at ~66,000, a premium of 10-15% to any other bike in that segment. On the back of sustained rural demand, we expect  HMCL to register 14%/12% volume growth during FY12E/13E.

Margins surprise on positive side as RM costs to sales softened by 220 bps qoq

In line with softening of global commodity prices, HMCL‘s profitability reflected the same in Q2 FY12. RM cost to sales has declined by 220 bps to 72.5% v/s 74.7% in Q1 FY12, the highest ever. Also the price hike taken in June helped the cause. Adding back the royalty expense (HMCL has to pay to Honda) to other expenses to make the margins comparable, EBITDA margins came in at 12.2%, v/s 11.2% qoq, an improvement of 100 bps. This also includes a negative Rs.270 mn impact of forex losses as Japanese Yen appreciated v/s Indian Rupee by 10% within a quarter. As HMCL buys most of its RM on short term contracts, the impact of easing commodity prices was immediately seen. Excluding royalty, margins came in at 15.8%. Employee cost to sales declined 20 bps yoy to 3.1%. Going forward, we expect HMCL to improve its margin performance to 12.9%/13.9% in FY 12E/13E on softening RM prices and launch of high margin product - Impulse. Continuation of Yen appreciation may result in a negative currency impact.

Competition from Honda may slowdown HMCL’s volume trajectory

In March 2012, Honda will be doing its solo launches in the executive segment where HMCL is having a strong hold as it earns 80% of revenues from this segment and holds 73% market share. We expect brand Honda to score well and hit the forte of HMCL thus offering a significant market share loss for its ex-partner. Honda is also aggressively increasing their capacities as two new plants in Rajasthan and Bangalore are coming in FY 13 which would take the current capacity of 1.6 mn to 4 mn, while HMCL is functioning at 100% capacity utilization and is facing capacity constraints. With its plans of building 6 new plants over next five years being at a nascent stage, in the medium term, we believe HMCL will face pressures. Hence, we believe HMCL will report a slower volume growth of 12% in FY 13E

Outlook and valuation

In view of improved margin performance and strong volume growth, we believe HMCL will continue reporting good performance in the coming quarters. In line with this, we have revised our estimates and target price upwards to Rs.1,928, however maintaining our underperformer rating on the stock on concerns of competition stiffening in FY 13 from Honda and capacity constraints for HMCL for major part of FY 13. Apart from this, the valuations look a bit stretched to us. (17x FY12E and 14.5x FY13E).