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Upgrading to Hold, with target price of Rs 1,950
Our upgrade is premised on a better-than-forecast performance of Hero since the
dissolution of its JV with Honda, and an effective transition management.
However, Hero’s current price implies a P/E of 17x FY13E and volume growth
(FY11-13E) of 15%, if we were to assume current margins (a more positive
assessment than we make). This multiple is c80% of Hero’s peak valuation, and
we believe it is an optimistic assessment in the light of risks it faces with respect
to branding and technology. Hence, we rate the stock a Hold.
We forecast c13% volume growth and declining margins
We factor FY12E/13E/14E volume growth of 18%/13%/12%. We expect EBIT
margins to decline over the next three years. We note that, over the past 12
months, Hero’s RM costs/sales have increased by 520bps, due, in our view, to a
deterioration in product mix, which is the prime driver of profitability. Its 1QFY12
gross profit per vehicle (Rs 9,106) currently stands at its 11-year average.
Margin gap with Bajaj could persist
Hero’s FY11 EBITDA margin is 540bps lower than Bajaj’s even after adjusting
down the positive impact of export benefits on the latter’s margins. This is due
primarily to higher royalty (280bps) and advertising costs (150bps). We believe that
the difference in these two cost heads is likely to persist in the medium term.
Current valuations (85% of peak) do not factor long-term risks
Hero is trading at 18x FY13E EPS, vs. a 3-year EPS CAGR (FY11-14E) of 11%. Its
P/E trading range has been 6-21x over the last 19 years. Our DCF-based target
price is Rs 1,950 (RFR 6.7%, 8.1% risk premium, 0.65 beta, 4% terminal growth
rate, 12% CoE). Upside risks: lower-than-forecast technology costs. Downside
risks: higher-than-expected competitive activity from HMSI. We think the key
events to watch are a) performance of new product launches under the Hero
brand, and b) launch of new 100cc motorcycle by HMSI (expected in 1QFY13).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Upgrading to Hold, with target price of Rs 1,950
Our upgrade is premised on a better-than-forecast performance of Hero since the
dissolution of its JV with Honda, and an effective transition management.
However, Hero’s current price implies a P/E of 17x FY13E and volume growth
(FY11-13E) of 15%, if we were to assume current margins (a more positive
assessment than we make). This multiple is c80% of Hero’s peak valuation, and
we believe it is an optimistic assessment in the light of risks it faces with respect
to branding and technology. Hence, we rate the stock a Hold.
We forecast c13% volume growth and declining margins
We factor FY12E/13E/14E volume growth of 18%/13%/12%. We expect EBIT
margins to decline over the next three years. We note that, over the past 12
months, Hero’s RM costs/sales have increased by 520bps, due, in our view, to a
deterioration in product mix, which is the prime driver of profitability. Its 1QFY12
gross profit per vehicle (Rs 9,106) currently stands at its 11-year average.
Margin gap with Bajaj could persist
Hero’s FY11 EBITDA margin is 540bps lower than Bajaj’s even after adjusting
down the positive impact of export benefits on the latter’s margins. This is due
primarily to higher royalty (280bps) and advertising costs (150bps). We believe that
the difference in these two cost heads is likely to persist in the medium term.
Current valuations (85% of peak) do not factor long-term risks
Hero is trading at 18x FY13E EPS, vs. a 3-year EPS CAGR (FY11-14E) of 11%. Its
P/E trading range has been 6-21x over the last 19 years. Our DCF-based target
price is Rs 1,950 (RFR 6.7%, 8.1% risk premium, 0.65 beta, 4% terminal growth
rate, 12% CoE). Upside risks: lower-than-forecast technology costs. Downside
risks: higher-than-expected competitive activity from HMSI. We think the key
events to watch are a) performance of new product launches under the Hero
brand, and b) launch of new 100cc motorcycle by HMSI (expected in 1QFY13).
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