Overall weakness in the market and expectations of a contraction in operating margin have led to significant weakness in the stock. This provides a great opportunity for investors to enter into a fundamentally strong business run by a quality management at a reasonable valuation.
Despite multiple challenges that the automobile sector is facing on the back of an increase in fuel prices, rise in interest rates, higher compulsory long term insurance prices, rainfall deficit and delayed festive season, Hero MotoCorp (HMCL) posted a decent set of earnings for Q2 FY19. While revenue grew in high single-digits, operating margin continues to remain under pressure due to significant rise in raw material (RM) prices.
Overall weakness in the market and expectations of a contraction in operating margin have led to significant weakness in the stock. This provides a great opportunity for investors to enter into a fundamentally strong business run by a quality management at a reasonable valuation. We believe HMCL should be a part of investors’ long term portfolio.Quarterly snapshot
Volumes continue to grow at a steady pace
Factors such as increase in motor fuel prices, rise in interest rates, higher compulsory long term insurance prices, rainfall deficit and delayed festive season have dampened demand for the entire auto sector and HMCL is no exception. The company registered a year-on-year (YoY) volume growth of 5.5 percent.
Realisation improved 3.3 percent YoY on the back of price hikes undertaken in the quarter gone by. This led to 8.7 percent growth in net revenue from operations.
Operating margin continues to remain under pressure
Earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted 223.3 bps YoY and 46.7 bps quarter-on-quarter (QoQ) in Q2. The YoY contraction was due to a significant rise in RM prices and increase in other expenses. In the quarter gone by, the contraction was primarily due to partial price hikes undertaken by the management to pass on the rise in input prices.What makes HMCL a long-term bet?
Industry volumes to grow
The management expects 8-10 percent volume growth in the 2W segment going forward. They expect sales momentum to pick-up on the back of upcoming festive season, new launches, increase in minimum support price (MSP) lifting rural sentiments and government’s rural focus ahead of crucial assembly and general elections.Dominant position; strong brand
HMCL is a formidable player in the 100/110cc segment and continues to maintain its market leadership. Its domestic motorcycle market share remains strong at 51.2 percent on the back of its strong distribution network and brand recall.Continued focus on brand building
In light of the price action undertaken by the competitor in entry-level bike segment to capture market share, the management said it will not buy market share and rather focus on brand building and products to gain market share incrementally.Rejig in portfolio to include premium products
In order to capture the strong growth accruing in the premium bike and scooter segments, the company has started reworking its product strategy.
Recently, it unveiled two 200cc motorcycles – XPulse and Xtreme 200R – in Auto Expo 2018. Sales of Xtreme 200R has begun pan India, marking HMCL’s entry into the premium bike segment. In terms of price point, it the most affordable bike in this engine displacement segment and is receiving positive traction from customers.
In 125cc bike segment, the company has launched the new Passion PRO, Passion XPRO and Super Splendor to strengthen its leadership in the 100-125cc motorcycle segments.
The company has forayed into high growth 125cc scooter market by launching Maestro Edge 125 and Duet 125 at Auto Expo 2018 as it believes the next leg of growth in scooter segment is expected to accrue from this segment.Focus on exports
In Q2 FY19, export growth has been strong at 25-26 percent YoY. The management said it continues to focus on exports and plans to expand presence in the fast growing markets of Sri Lanka, Bangladesh and Nepal. It commenced production at its second global manufacturing facility in Bangladesh in May last year and was able to garner retail level market share of around 30 percent. The company has chalked out plans to grow exports by entering new market such as Mexico, launching new products, building the brand through various marketing activities.Focus on electric vehicles
The management has been focusing on electric vehicles and invested Rs 201 crore to acquire 30 percent equity in Ather Energy, a start-up to build EV scooters. It said Ather will start retailing its smart electric scooter S340 soon.Expansion plans are on track
The management has earmarked Rs 2,500 crore to be spent over two years for capacity expansion, technology upgradation and digitisation. It has commenced construction of its eighth manufacturing facility in Chittoor, Andhra Pradesh and has started commercial production at its second manufacturing facility outside India, in Bangladesh.Valuations at attractive levelsThe stock currently trades at 15.6 times FY19 and 13.8 times FY20 projected earnings. With an efficient execution and transformation strategy in place, the emerging macro opportunity makes HMCL an ideal candidate for accumulation by long term investors.
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