Hero MotoCorp - Rising Competition & Higher Expenses to Continue Taking Toll on Margins - Karvy

In Q3FY13, the performance of Hero MotoCorp (HMCL) came way below our as well as street expectation, as the Company's net profit declined 20.4% YoY to Rs 4.88 bn vs. our estimate of Rs 5.9 bn, notwithstanding 2.5% YoY growth in revenue to Rs. 61.8 bn & decent volumes during festive season.

Volume Down 1.5% YoY; Reports Decade Low EBIT Margin: HMCL's volume declined 1.5% YoY to 1.573 mn units in the quarter, as poor productmix - in terms of higher contribution of low margin new products - caused financial deterioration during the quarter. Its EBITDTA margin declined 304 bps YoY (128 bps QoQ) to 12.6% vs. our estimate of 15.1% on the back of higher input cost and advertising expenses. HMCL's NPM declined 227 bps YoY (61 bps QoQ) to 7.9% in Q3FY13, as the depreciation and amortization expenses declined 5.2% YoY to Rs. 2.8 bn in Q3FY13. Its EBIT margin fell 267 bps YoY and 28 bps QoQ to 8% and reported an EPS of Rs. 24.4 in Q3FY13.

Higher Promotional Cost amid Decline in Market Share to Drag Margin: As HMCL's focus on entry-level bikes and capacity expansion will further intensify competition, we expect further fall HMCL's market share in bike segment, going forward. Meanwhile, during the post-results Conference Call, HMCL's Management indicated that higher spending for brand building exercise would continue, which we see as inveterate expenses for next two years in addition to higher marketing expenses for export business. We believe that the benefit on account of reduction in royalty Q1FY15 onwards won't be enough for HMCL to compensate the incremental cost pressure. Dismal quarterly performance indicates HMCL's inability to pass on the incremental cost, despite of decent festive season volume.

Outlook & Valuation

We lower FY13, FY14 & FY15 EPS estimates by 7.4%, 7.2% and 9.4% to Rs. 102.8, Rs. 103 and Rs. 131.4, respectively. We expect contraction in stock's multiples to 14x 1 year forward EPS vs. historical average of 15.7x due to lower margin profile and deteriorating return ratios. However, its valuation comforts us to reiterate our rating of "HOLD" on Hero MotoCorp. We lower our target price by 9.4% to Rs 1,840 per share, valuing the stock at 14xFY15E EPS.

Source : Equity Bulls

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