Hero MotoCorp - Bucking the trend - LKP Research

Q2 numbers very much in-line with our expectations

Hero Motocorp (Hero) reported a good set of numbers in Q2 mainly on the improvement in profitability and a 6% volume growth. Profitability was much more driven by the cost cutting initiatives taken by the company and the price hike taken in the previous quarter. Hero's 2Q volumes saw an upmove despite the industry rappling to stay in the positive territory. Net revenues were up by 11% yoy and down 7% qoq as in general Q2 is softer than Q1 driven by seasonality. The net realizations improved by 3% yoy as well as qoq as product mix improved. The price hike taken in May along with the softening of the commodities seen in Q1 came with a quarter's lag effect and brought down the RM/sales ratio to 71.5% from 73.2% yoy and 72.3% qoq. However, staff costs and other expenses grew by 19% yoy (4% of sales) and 12% yoy (9.9% of sales) respectively. Several marketing initiatives taken by the company like the 5 year warranty scheme resulted in higher ad spend, thus resulting in the other expenses to move up. However, net-net, the overall impact on EBITDA margins was positive, which came at 14.5%, above 120 bps yoy and slightly down by 40 bps qoq. Depreciation and interest costs also came in line with our expectation, while tax rate continued to remain at 26.9% qoq post the partial exit of Haridwar tax sops last quarter. PAT came in at Rs4.81 bn inline with our expectations of Rs 4.83 bn (but above market expectations of ~Rs4.6 bn), which was a growth of 9.3% yoy and 12% qoq drop.

Outlook and valuation

Though demand scenario has not been very encouraging this year , with good monsoons, demand pick up in rural markets, 15 odd new launches (including variants and refreshes), along with expansion of dealership network and the 5 year warranty scheme above all will help the company to post good volume performance from Q3 onwards. A good festive demand mainly in the rural markets will enable the company to put up good growth number despite high base of last year. Reduction in inventory levels is a good sign and expansion of scooters as well as overall capacities will take care of competition. Margins may see a dip next quarter on rupee depreciation and some firmness seen in commodities off late. However, cost reduction initiatives, higher pie of scooters sales and price hike taken will result into good savings going forward. In line with this we have maintained our FY14 while increased FY15 margin estimates to 14.3% and 14.7% respectively. In FY15, with the royalty outflow to Honda going out from Q2 FY15, volume growth expectations becoming higher and margins continuing to outperform, we believe the impact of higher tax rate of c.27% coming from Haridwar benefit going out and surcharge of 10% will not be able to hamper the earnings. Factoring these pros and cons, we have increased the FY 15E earnings estimates along with the target price to Rs2,354, thus continuing with our BUY rating on the stock.

Source : Equity Bulls

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