Hero MotoCorp - Margin expansion continues, volumes to grow on rural demand:: LKP

Operationally above expectations, high tax rate dampens the PAT

Hero Motocorp (Hero) reported a good set of numbers in Q1 mainly on the improvement in margin performance, which led to a better than expected performance till the PBT level. Hero’s 1Q volumes were down by 5% yoy, while were up by 2%qoq. Net revenues were up by 1% yoy and down 1% qoq. The net realizations improved by 3.7% yoy, while were down 1% qoq as product mix became adverse sequentially as the demand for premium segment bikes reduced, while executive segment and mass segment bike demand was high. The company took an average price hike of Rs 1000 price hike in May, which somewhat offset the qoq decline in realizations. The company benefited from softening of the commodities which brought down the RM/sales ratio to 72.3% from 74.1% yoy, while remaining stable qoq. However, staff costs and other expenses grew by 8% yoy (3.6% of sales, stable sequentially) and 13% yoy (9.2% of sales, down from 10.3% qoq) yoy respectively. Reduction in other expenses was the result of the cost cutting initiatives taken by the company on the admin and marketing side. In line with this, the overall impact on EBITDA margins was positive, which came at 14.9%, above 110 bps qoq and 40 bps yoy . Depreciation and interest costs came in more or less in line with our expectation, while there was a surprise element in tax terms of 10% additional surcharge, thus taking tax rate at 27%. This dampened the PAT below our expectations at Rs 5.49 bn, which was a 11% yoy and 4% qoq drop.

Outlook and valuation

Though demand scenario has not been very encouraging , with good monsoons, demand pick up in rural markets, 7-8 new launches (including variants and refreshes), expansion of dealership network will help the company to post good volume performance from Q2 onwards. High festive demand will enable the company to put up good growth number on a low base of last year when festive demand was not that high. 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. The innovative measures taken by the company like the 5 year warranty scheme is playing a good role in helping Hero to post monthly run-rate of volumes in excess of 5 lakhs consistently. Margin uptrend will continue on the back of commodities softening, cost reduction initiatives, higher pie of scooters sales and price hike taken. In line with this we have increased our FY14as well as FY 15 margin estimates to 14.4% and 14.6% respectively. But at the bottomline, with the surprise coming in the form of 10% surcharge on existing tax rate, our FY 14E EPS stands slightly revised downwards at Rs109 from Rs 113. However, in FY 15, with the royalty outflow going out from Q2 FY15, volume growth expectations becoming higher and margins continuing to outperform, we believe the impact of higher tax rate of c.27% coming from Haridwar benefit going out and surcharge of 10% will not be able to hamper the earnings. Factoring these pros and cons, we have increased the FY 15E earnings estimates and thus target price to Rs2,090, thus continuing with our BUY rating on the stock

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