- Volume hit by multiple macroeconomic and regulatory headwinds
- Operating margin under pressure
- Business outlook weak for short term, positive for long term
- Accumulate in a staggered manner
Tough macroeconomic conditions and multiple headwinds are making it hard for Hero MotoCorp Ltd (HMCL) (CMP: Rs 2,712, Mcap: Rs 54,170 crore) as it posted a weak set of quarterly numbers. A big drop in volume took a toll.
The depressed volume pulled down top line for the three months to September and led to a contraction in operating profitability. The only saving grace, however, was improvement in realisation.
Demand is expected to remain muted in the near to medium term. However, we believe that long-term demand outlook in India is very promising. We advise investors to accumulate this fundamentally strong business at a reasonable valuation (14.4 times FY21 earnings).
On a year-on-year (YoY) basis, Q2 FY20 net operating revenue fell 16.7 percent, weighed down by volume decline of 20.8 percent. Average realisation, however, rose 5.1 percent on the back of a price increase and higher sales of spare parts.
Earnings before interest, tax, depreciation and amortisation (EBITDA) took a hit of 20.1 percent due to negative operating leverage. EBITDA margin too contracted 62.1 bps YoY.
One percentage is 100 basis points (bps).
The demand worrylines
Demand outlook continues to be sluggish for the two-wheeler industry. A lot of factors are at work, namely the liquidity crunch, non-availability of retail finance, increase in total cost of ownership after implementation of long-term mandatory insurance and safety regulations, and the slowdown in economic activity.
The management sees subdued demand conditions for the near term as well. It, however, is of the view that the momentum is building up in the festive season. It also indicated that the real signs of recovery would be visible in November when Rabi sowing starts. Additionally, pre-buying ahead of BS VI implementation is also a trigger for the industry.
In the long term, however, we believe that India offers a huge potential for the two-wheeler industry, which is expected to ride well on a likely strong demand from both rural and urban areas. This is a possibility because of low penetration and rising disposable income. Rural market is also expected to get a boost from the government’s focus on rural areas and increase in minimum support price (MSP).
Margins bottom out
According to the management, the margins have bottomed out, primarily because commodity prices are seen to have started coming off from their earlier high levels and the gains were visible in Q2 FY20. Inclusion of high value premium products in the portfolio and the company’s cost rationalisation programme have also helped.
Exports take focus
The management has signalled doubling its exports market presence to 40 countries over the next few years. It has chalked out plans to grow exports by entering new markets such as Mexico, launching new products and building the brand through various marketing activities. However, it could be challenging for the company in the exports market as it's a late entrant and Bajaj Auto has already had a significant presence in those markets.
Subdued demand outlook has seen the stock price correct 20 percent from its 52-week high level, making the valuations very reasonable. HMCL trades at 14.4 times FY21 projected earnings, much lower than its 10-year average forward multiple of 15.4 times.
The prolonged weakness in demand could pressure the financials of the company. Additionally, any adverse commodity price movement would jack up raw material cost, potentially impacting operating profitability.
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