Hero MotoCorp. - Decent quarter, but valuations fair; Sell - Anand Rathi

Demand scenario was decent. Hero MotoCorp.'s 3QFY14 numbers were decent, and on a lower base the company reported yoy growth for a second successive quarter (after a yoy decline for the preceding four quarters). Twowheeler sales were up 6.9% yoy and 18.7% qoq. Consequent on the weak demand environment in the auto industry and keener competition, we expect this challenging industry scenario to continue into 4QFY14.

3Q likely to be good. We expect 11.1% yoy income growth, to Rs. 68.7bn, and 29.7% yoy EBITDA growth, to Rs. 10.1bn. Our expected EBITDA margin is 14.7% (21bps higher yoy, and 20bps higher qoq). We expect the 2Q tax rate to have come at 26%. We expect 22.7% yoy profit growth, to Rs. 6bn.

Laying groundwork for future. The company has started work on building a new R&D centre at Kukas, Rajasthan. This would be a Rs. 4.5bn project, slated to commence operations in 1QCY15. The existing R&D centres at Gurgaon and Dharuhera would also be shifted to Kukas once it is complete. Kukas would be the hub for developing models for domestic and export markets. Besides, the company is setting up a manufacturing plant and a global parts centre at Neemrana, both of which would start operations in 2014. Overall investment in the three projects in Rajasthan would be to the tune of Rs. 13bn.

Our take. In FY13 and 1QFY14, the company reported yoy decline in profitability. A lower base and yoy margin improvement from 2QFY14 could arrest this movement for now. However, the prevailing weak demand environment is likely to continue. The new R&D centre could, though, be a long-term positive. We maintain a Sell with a target of Rs. 1,897 (based on the value of core earnings at 13.5x Mar'15 to Rs. 1,693 and the value of cash and investments at Rs. 204. Risks. Above expected volumes and recovery in rural growth, lower royalty expense.

Source : Equity Bulls

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