Hero Motocorp - Restored, ready for more - ElaraCapital

Gross margins restored to healthy levels; earnings beat estimates

Post a scary margin slip in Q3FY13, Hero managed to restore its gross margins back to Q2FY13 levels, through better product-mix, input cost savings via Yen depreciation, and improving contribution from new launches. A sharp QoQ gain of 190bps led to earnings beating estimates by 11%, in an otherwise weak quarter (volumes down 3% YoY). Still Hero continues to struggle from sticky staff costs (up 18%) and other opex (up 26%), deterring EBITDA margin expansion. The management noted multiple initiatives in store to lower down the burden from these heads, which along with expected recovery in volume growth from Q2FY14E, is likely to expand margins further.

Work on EBITDA margin expansion underway

The management sounded quite confident (as it did last quarter too) of taking the margins higher from current levels in coming quarters, driven by Yen depreciation on input costs (we estimate 30bps more gains), price hikes of INR500-1500 per 2W to counter stick overheads, which will bring the opex levels back to normal in Q1FY14E, and falling Yen levels that have accrued cost savings from amortization costs (royalty payment to Honda) to the tune of INR3bn, to materialize over next five quarters. All of these, point towards a healthy EBITDA margin recovery back to 14.2%-14-5% in FY14E, from 13.8% in FY13, which along with expected rise in volume growth, is likely to lead to a healthy earnings CAGR of 20% during FY13-FY15E.

Valuations – volume growth concerns to be over this year; maintain top pick in 2W space

Pricing Hero at ~10.3x FY15E earnings, market seems overly fixated on current demand slowdown in 2-wheeler space, largely ignoring the addition of ~INR22 in FY15E EPS on royalty expiry. Further, a strong revival in domestic demand, success of new products and sharp scale-up in exports operations, though highly likely in next two years, are missing from current valuations, providing attractive entry point for medium term investors. Maintain top pick in 2W space and reiterate Buy.

Source : Equity Bulls

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