Hero MotoCorp - "Disappointing results, competition intensifies" LKP

Dismal show in the current quarter

Hero Motocorp (Hero)’s 3Q volumes were down by 1.1% yoy and up by18% qoq. Net revenues were up by 3% yoy and 20% qoq. The company increased the dealer margins by Rs100/bike in the wake of rising competition thus increasing the ad spend as well, which led to a sharp increase in other expenses (10.1% of sales v/s 9.8% qoq). Rising competition from Honda led to a decline in margins of Hero for straight fifth quarter. Less profitable shift in product mix and new launches led to higher RMC to sales (at 74.1% v/s 73.2% qoq) despite commodities softening a bit. EBITDA margins skid down to 12.6% v/s 15% yoy and 13.3% qoq. EBITDA de-grew by 13% yoy to Rs 7.7bn. The company mentioned that the depreciation of Japanese Yen will benefit them in the fourth quarter, however, we believe the rising competition will negate the impact of favorable yen movement. Lower other income coupled with operational underperformance led to a 20% yoy fall in PAT at Rs4.87bn. Tax rate came in at 16.3% as this is the second last quarter of full benefit from Haridwar plant.

Outlook and valuation

Disappointing Q3 FY13 results, with bleak expectation in the ensuing quarters has led us to turn negative on the stock. Concerns surrounding competition from Honda are becoming sharper and stronger. Honda’s new launches in the sub 125 cc segment and commissioning of capacities well ahead of Hero’s new capacities get lined up is the biggest concern from market share erosion point of view. We believe both Hero and Bajaj will feel the heat, though Hero will feel it more with its focus on the executive segment. Although Bajaj with its focus on 3 wheelers and exports is still slightly better placed than Hero, we believe that margins of Bajaj will also start weakening in due course of time. We are turning negative on the entire two wheeler sector by downgrading Hero to Underperformer (Bajaj already has an Underperformer rating and TVS a SELL) with structural shift favoring Honda alone. We have cut Hero’s estimates for FY 13E-FY14E by 15-20%, while have brought down the target price to Rs 1,579, which is a downside of 15% from current levels.

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