Hero MotoCorp - "Robust margin expansion” :LKP

Better than expected results

Hero Motocorp (Hero) reported a good set of numbers in Q4 mainly on the improvement in margin performance, which led to a better than expected show. Hero’s 4Q volumes were down by 3% yoy as well as qoq. Net revenues were up by 2% yoy and 1% qoq. The net realizations improved by 2% yoy and 1.5% qoq on improved product mix coming from a good performance from the scooters segment and a slight price hike of Rs300 taken in the previous quarter. The company benefited from softening of the commodities which brought down the RM/sales ratio to 72.2% from 74.1% qoq as well as yoy. However, staff costs and other expenses grew by 17% (3.7% of sales) and 26% (10.3% of sales) yoy respectively. Staff costs increased due to slight wage hike taken in the quarter and higher number of recruits during the same period, while other expenses were due to higher power and transportation costs and launch of new products. However, the overall impact on EBITDA margins was positive as margins expanded meaningfully to 13.8%, 120 bps qoq. This was due to the benefit of Yen depreciation, RM costs decline and effective cost control initiatives taken by the management.  Depreciation and interest costs came in more or less in line with our expectation, while tax rate came in at 16.3% in line with the last quarter’s tax rate thus indicating higher number of production from the tax haven Haridwar plant.

Outlook and valuation

Revival seen in demand off late though in a small way is expected to continue, mainly in the scooters and entry level bikes. Reduction in inventory levels is a good sign and expansion of scooters as well as overall capacities will take care of Honda’s growing capacities. Expansion of dealer network mainly in the northern region, the stronghold of Hero will benefit the company well to pull back the lost market share. The innovative measures taken by the company like the 5 year warranty scheme is playing a good role in volume revival. Margin uptrend will continue on the back of yen depreciation, commodities softening, cost reduction initiatives, higher pie of scooters sales and price hike taken. We have maintained our FY 14 earnings estimate at Rs113, while we have introduced FY 15E estimates which will be free from royalty payment from Honda from the second quarter of FY 15 as the royalty term ends then. This will provide a solid boost to the bottomline thus adding approximately Rs25 to the EPS in FY 15. We are rolling over our estimates from FY 14E to FY 15E thus upgrading the stock from Underperformer to Outperformer (post achieving our previous target of Rs 1579) with a target price of Rs 1,855.

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