Hero Motocorp - Volume Recovery Ahead; Upgrade to Accumulate - Prabhudas Lilladher

Management commentary positive; Rural economy to drive volumes: In the recent Annual Report, the management was cautiously optimistic and expects a recovery in two-wheeler volumes driven by good monsoon and pre-election spending. In the country's main cropping regions, monsoon has been timely and 20-30% above average so far, prompting farmers to expand cultivated area by 9% to 930 lakh hectares, with the biggest gains in pulses, oilseeds and coarse cereals. Low penetration level, lack of adequate mode public transport and rising per capita income in rural India would lead to long-term healthy volume of two-wheelers. The company has benefited from stronger rural demand - rural forms 45% of Hero's sales versus 40% for the industry and beneficial impact of the warranty scheme (first to offer a 5-year warranty on two-wheelers).

Competitive intensity receding; Hero Motocorp to maintain its turf: Hero has made a strong come back in the recent months on the strength of its strong brands and distribution. Given the strong distribution reach and wider product portfolio, including scooters, we believe volumes could grow by ~4% in FY14E and 11% in FY15E, thereby, maintaining its turf in motorcycles with a market share of 53.6%. Going forward, in our view, Hero would gain 180bps in market share in the scooter segment thanks to 'Maestro' and 'Pleasure' at 21.6%. HMSI is likely to further gain market share to the tune of 260bps to 14.7% by FY15E at the cost of Bajaj Auto. Our channel checks suggest good traction for its products, both in scooters as well as motorcycle segments, whereas, Honda's Dream series has fizzled out and no longer a threat.

Advanced R&D by tie-ups with various international companies: During 2012-13, Hero Motocorp tied up with the Italian design firm Engines Engineering. The Bologna-based firm has been developing and designing scooters and motorcycles for various manufacturers over the years and is now sharing its expertise with Hero MotoCorp to help develop next generation two-wheelers. At the same time, R&D tie-up with AVL of Austria will help in developing new engines. It also tied up with EBR of the US to launch high-performance platform bikes for meeting domestic and international needs.

Entered high growth markets of Africa, LatAm and Asia: HMCL entered into a partnership with the reputed ABANS Group of Sri Lanka. Under the alliance, ABANS has been appointed as the sole distributor of Hero MotoCorp range of two-wheelers in Sri Lanka. HMCL has launched its range of two-wheelers in Guatemala City, El Salvador and Honduras, marking the iconic Indian brand's first foray into new international markets. A partnership has been forged with Indy Motos Group of Guatemala to bring its two-wheelers to these markets. Under the alliance, Indy Motos has been appointed as the authorized distributor of Hero MotoCorp range of two-wheelers in Guatemala, Honduras and El Salvador. We expect exports to account for ~10% of volumes (0.9m) by FY18E end. We expect exports to grow by 40% in FY15E albeit at a lower base.

Earnings to grow at a CAGR of 18.0% for FY13-FY15E period: We expect Hero to gain market share in scooters segment and maintain its market share in the motorcycle segment. We expect a 10.7% CAGR in revenues with margins likely to expand by 130bps (given the lower competitive intensity and cost cutting initiatives). At the same time, we expect savings of Rs4.5bn on account of royalty payments to Honda ending by March 2014. As a result, earnings are expected to grow at 18.0% CAGR for FY13-FY15E period. At the CMP, the stock trades at 17.6x FY14E EPS and 13.3x FY15E EPS. Hence, we upgrade the stock from 'Reduce' to 'Accumulate' with a TP of Rs2,176 based on 15x FY15E earnings, in line with its past 5 year average. The stock is likely to get re-rated given the strong rural economy and higher interest rates leading to a shift from four-wheeler stocks to two-wheelers.

Source : Equity Bulls

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