Hero MotoCorp - “Positives are in the price” LKP Research

1Q FY13 results in line with expectations

Hero Motocorp (Hero)’s 1Q volumes were up by 7% yoy and 4% qoq. Net profits were up by 10.3% yoy and 2% qoq. The company took a price hike of Rs500-1000 in May to compensate for the rise in RM costs, the impact of which was not completely seen in Q1 FY13 as realizations were dampened due to adverse product mix. The company sold less number of scooter Pleasure on competition and promoting new scooter Maestro.   EBITDA grew by 16% to Rs 8.9bn, while margins improved by 20 bps qoq and 80 bps yoy to 14.5% due to softer RM prices and price hike despite Yen appreciation and adverse product mix. RM to sales declined yoy from 75.3% to 74.1%, while other expenses to sales ratio remained flattish. Other income remained flattish, due to which PAT came in slightly below our expectations. Tax rate came in at 16.3% which was down from 19.5% in Q4. Royalty expenses to Honda came in at Rs2.2 bn as Yen appreciated significantly (~7%) in Q1 v/s rupee. This brought the net profits down to Rs6.15bn, which was just 2% up sequentially.

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Despite slowdown, Hero expects to grow higher than the industry growth of 10% in FY 13E

Although the company is running at a normal dealer inventory of 3-4 weeks, management has given a cautious outlook on the sector growth in FY 13. However, Hero said that their growth will be higher than the industry growth rate of 10% on the new launches that they are planning for this year. They have already launched the scooter Maestro, new Splendor within Hero brand and will come out with a launch of 125cc bike Ignitor, a 110cc bike Passion X Pro and 7-8 new bikes and variants under the Hero brand in FY 13E. Although scooter Pleasure’s sales were down in Q1, due to the company’s focus on Maestro launch, they believe that the scooter sales will recover from Q2.  Also they are seeing rural growth higher than urban growth with Eastern markets showing a good traction followed by South. Additionally Hero has announced to set up two new plants in – 1).Neemrana, Rajasthan, a capacity of 0.7mn to come up in August 2013 and a capex of Rs 4bn and 2). Gujarat, capacity of 1.4mn coming in 4Q FY14 for a capex of Rs11bn taking the total capacity beyond 9mn at the end of FY 14. This capex will be entirely funded through internal accruals.  Competition from Honda will cause lesser damage to Hero, as we believe that Honda’s capacities are expanding more on the scooters side. Hero will be the prime beneficiary of any recovery in the demand.

Margins improve despite yen appreciation, to improve hereon

As said earlier, the company’s RM costs remained flattish at 74.1% sequentially despite yen moving up in Q1. However, due to some softening seen in input costs and lower other expenses at 8.1% v/s 8.4% qoq, margins came in 20 bps higher qoq and 80 bps higher yoy at 14.5%. Management expects a stable margin performance here on. We expect better margins in FY 13 on debottlenecking of capacities, price hikes taken in this quarter, expectations of RM prices to go down and a better product mix with the scooter Maestro gaining traction and Pleasure seeing recovery. However, the company’s foray into export countries like Africa and Latam will put some pressure on margins as branding costs and competition related expenses will lead to lower export margins, though it will be not be a significant part of the business in the coming two years. Management expects to touch 1mn export sales by FY17. Also in domestic markets, branding the existing bikes under the Hero brand will also lead to higher branding expenses. However, this will not be able to offset the strong improvement in margins coming from RM cost reduction.

Outlook and valuation

We believe that Hero is definitely the strongest two wheeler player in India considering its market leadership position, scalability, competitive position and exports plans. We are also positive on the new launches to help the company to achieve the required volume target. Although on margins, there are some overhangs we see some expansion in margins hereon. We now value the stock on FY14E estimates, which we believe will see a subdued growth at the bottomline as tax rate is expected to move up to 23-25% as Haridwar plant tax benefit will move down from 100% to 30% from FY 14 onwards. In FY 13E it will be ~16.3% as the company will has expended its production from this plant to 38% of volumes. At CMP of Rs 2,050, the stock trades at 14x times FY 14E EPS of Rs 146, at which we believe  the upside is capped as most of the positives seem to be priced in. We have maintained our FY 13E estimates and now value the stock on FY14E earnings at 15x and reiterate our Neutral view with a target price of Rs 2,187.