Hero MotoCorp Ltd (HMCL) – Q3FY15 Result Update :: HDFC Securities

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HMCL reported lower‐than‐expected Q3FY15 results. Given below are some of the key highlights, which we came across while reviewing the results. Key highlights of Q3FY15 results:  Net sales in Q3FY15 fell marginally to Rs.6,792.5 cr on the back of 2% fall in total volumes. HMCL's EBIDTA margins were lower on account of higher promotional expenses. Increase in tax rate led to PAT margins falling by 250 bps y‐o‐y to 8.6%.

Other Highlights:  HMCL's revenues in Q3FY15 were marginally down at Rs.6,792.5 cr. Sequentially, revenues declined by 1% led by a 3% fall in volumes. The company took a blended price hike of Rs.150 per unit in October 2014.  In Q3FY15, HMCL recorded total volume of 1,648,548 units down 1.9% y‐o‐y and down 2.6% q‐o‐q. Its domestic bike volume fell 6.2% y‐o‐y (down 5.8% q‐o‐q) to 1,381,794 units vs. industry de‐growth of 5.4% y‐o‐y. HMCL’s exports rose 123% y‐o‐y to 70,227 units. HMCL entered into Colombia market with six of its best selling bikes with 120 outlets. Its domestic scooter sales rose 12% y‐o‐y to 196,527 units due to TVS’ Jupiter taking away shares from Pleasure. HMCL lost 44 bps y‐o‐y market share in domestic bike segment to 52.3%, while it lost 121 bps y‐o‐y to 17.2% market share in scooter segment during the quarter.  The overall volume growth has turned negative in the December quarter after recording 9% CAGR growth in the preceding five quarters. In order to offset moderating volume in motorcycle segment, the company is increasing sales volume in the scooter segment. Going forward, scooters could contribute substantially in the incremental volume growth of the company, but having a dominant player like Honda, its scope for scale and size will be limited.  Cost saving initiatives continues to deliver, with ~Rs.60 cr savings, which were off‐set by the cost push on Aluminum. 9MFY15 savings was on account of ‘Leap’ program is Rs.2.4 bn, which was more than off‐set by cost pressures.  EBIDTA per vehicle declined by 6.7% y‐o‐y and 9.7% q‐o‐q. The reasons for the fall as cited by the management were  excise duty anomaly whereby production in Haridwar does not attract excise duty whereas components attract excise duty which is higher than excise duty on the final product;  higher advertisement expenses owing to festive seasons;  lumpy brand building spends in the export market such as appointment of Tiger Woods as global brand ambassador;  sponsorship of The Hockey India League and I‐League – Football;  higher staff costs owing to Diwali bonus and commencement of the Neemrana plant.

 HMCL’s new Neemrana plant went on stream during the quarter, adding to higher depreciation charge.  HMCL’s dependence on Yen has significantly reduced now that royalty has gone out and the company has just 9.5% dependence on Yen through both direct and indirect imports. Weakening on Yen v/s Rupee is expected to assist margins further up to some extent.  HMCL launched various new models over past six months. Most of them are successful including its latest launch of new Splendor i‐smart. It further plans to launch 2 new scooters over next one year to improve falling market shares and grab opportunity out of rising scooter demand. It has been adding ~500 touch points annually since past 7 years. Company’s strong network of ~6500 touch points, strong product pipeline and rising exports could be the key driving force for volumes. Guidance:  Outlook on demand environment remains positive driven by structural drivers like reducing replacement cycles; under penetrated rural market; changing dynamics in urban markets leading to increasing demand for scooters; and low finance penetration and prevailing higher cost of financing which could trend lower.  HMCL has plans to launch 32 new refreshes, variants, facelift and new models over the next four years. In the next quarter they will be launching a refresh of Extreme and couple of new scooters in next 12 months.  HMCL seems to have lost its grip over the scooters business thus losing its market share to the likes of Honda and TVS. This has been due to capacity constraints on the scooter side. The company has already started to expand its capacity which is at 80,000 scooters per month currently and could reach 100,000 by FY15E. This could help them to regain their lost market share. Also the commissioning of the new plant in Gujarat could contribute to addition of scooter capacities by next June.  On the exports side, the management expects to sell 2.5‐3 lakh units in FY15, which is possible given the improved monthly run rate of 25,000‐30,000 and its entry into developing markets like Iran and Colombia.  In light of heavy global expansion and increasing domestic competition, spends on the marketing side would tend to remain high, thus constricting possible expansion of EBITDA margins.  HMCL's current touch points stands at ~6,000 and it plans to add another 500 touch points in FY15.  HMCL aims to scale up exports to 10% of sales volume by FY19/20 from 3.5%.  HMCL passed on an increase in excise duty on motorcycles from January 1, 2015, which is likely to benefit it in Q4FY15 as 30% of production comes from excise‐free plants. Concerns  If commodities prices rise, there could be pressure on EBIDTA margins going ahead.

 Maintaining market share going ahead could be tough for HMCL, given that its former partner Honda has become very aggressive in the entry level and executive motorcycle segment with Dream Yuga and Dream Neo motorcycles and new offerings to come, and Bajaj Auto has launched all new Discover 150cc model to take on Hero's Splendor and Passion range. TVS Motors is also becoming aggressive in capturing market share in motorcycles and scooters.  HMCL could find it difficult to scale up in nascent export business, where it is a late entrant (post separation from Honda).  Since HMCL has started exporting to newer geographies, any adverse movement in currencies will have a negative impact on margins.  Weak portfolio in premium segment means that HMCL may not benefit (as its competitors) from a recovery in urban demand. Conclusion & Recommendation HMCL reported a lower‐than‐expected quarterly profit as promotional costs in new international markets and employee expenses jumped with the start of its fourth plant. The overall volume growth has turned negative in the December quarter after recording 9% CAGR growth in the preceding five quarters. In order to offset moderating volume in motorcycle segment, the company is increasing sales volume in the scooter segment. The management will be continuing cost rationalization initiatives, and is now expecting more savings to the tune of Rs.300‐350 cr from vendor rationalization, logistics, power cost, productivity and labour cost savings along with their localization endeavors in FY15E. However this is yet to get reflected in the trend of EBIDTA margin from quarter to quarter. Going forward, the management remains cautiously optimistic about the business climate. With crude prices hovering below the USD 50 mark, and commodity prices continuing to remain soft, a lot will also depend on the much‐awaited budget to be presented by the central government later this month. While sentiments are already high with the central government expected to revive the economy, the other factors such as interest rates, retail inflation and the likely changes in global economy will also play a role in determining the industry growth in the coming quarters. Factors such as decent volume growth on high base, higher rural penetration and scope of margin expansion supported its premium valuation so far. However, moderating volume growth and shrinking margins are turning investors nervous. We are revising our FY15 estimates downwards following poor Q3 results and also lowering FY16 topline estimates but maintaining margins. At the CMP of Rs.2,728.5, the stock is trading at 20.8x FY15RE EPS of Rs.131 and 16.5x FY16RE EPS of Rs.165.2. In our Q2FY15 result update dated October 20, 2014, we had recommend investors to buy the stock at the then CMP of Rs.2,874 and add on dips to Rs.2,574‐Rs.2,675 price band for a target of Rs.3,014. The stock achieved our target on October 22, 2014 by making a high of Rs.3,120.05. We feel investors could buy the stock at the CMP and add on dips to Rs.2,478-2,560 (15-15.5x FY16RE EPS) for a target of Rs.3,056 (18.5x FY16RE EPS) over the next quarter.

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http://www.hdfcsec.com/Share-Market-Research/Research-Details/StockReports/3011281