- Subdued volume growth due to multiple challenges
- Operating margin continues to be under pressure
- Business outlook is weak for the short-term, positive for the long-term
- Accumulate in a staggered manner
Hero MotoCorp (HMCL) posted an operationally disappointing set of numbers in Q3 FY19. Weak demand led the company to post single-digit growth in its net revenue. Factors such as increase in fuel prices, rise in interest rates, higher compulsory long-term insurance premiums, rainfall deficit and weak festive demand have dampened demand. Operating profitability also continued to be under pressure due to rise in raw material (RM) prices.
Amid overall weakness in the market and expectations of a contraction in operating margin, the stock has remained weak, which provides a strong opportunity for investors to enter in a fundamentally strong business at a reasonable valuation.
Factors such as increase in fuel prices, rise in interest rates, higher compulsory long-term insurance premiums, rainfall deficit and weak festive demand have dampened demand for HMCL. This has led to only 5.3 percent YoY growth in volumes. Average realisation, however, witnessed a growth of 2.2 percent on the back of price hike taken by the management and higher spare parts sales, which led to a 7.5 percent growth in net operating revenue.
Negative operating leverage, coupled with a rise in raw material prices, resulted in a 4.6 percent decline in earnings before interest, tax, depreciation and amortisation (EBITDA), which contracted 175.3 bps YoY. Consequently, profit-after-tax (PAT) declined by 4.5 percent.
OutlookIndustry volumes to grow
Going forward, the management expects volumes to grow in high single-digits due to pre-buying expected in H2 FY20, ahead of Bharat Stage VI implementation. They indicated that the sales momentum would pick-up in rural areas due to government’s focus on uplifting rural economy.Leadership position
Despite aggressive pricing actions taken by competitors, HMCL has been able to maintain its leadership in the space. Its domestic motorcycle market share remains strong at 50.9 percent on the back of its strong distribution network and brand recall.Rejig in portfolio to include premium products
HMCL is under represented in high growth premium bike and scooter segments. In order to capture growth in these segments, it has changed its product strategy and unveiled two 200cc motorcycles -- XPulse and Xtreme 200R, marking HMCL’s entry in the premium bike segment. In the 125cc bike segment, the company launched Destini 125 in October 2018, which helped the company gain 10 percent market share in the 125cc segment.
HMCL has forayed into the high growth 125cc scooter market by launching Maestro Edge 125 and Duet 125 as it believes that the next leg of growth in the scooter segment is expected to come from this segment.Focus on exports
In Q3 FY19, YoY volume growth for the company was strong at 25 percent. The management indicated that they plan to double their export presence to 40 countries from 20 over the next few years. It has chalked out plans to grow exports via entry into Mexico, launching new products and building a brand through various marketing activities. However, foray into the export market could be challenging for the company as it is a late entrant and Bajaj Auto has already made a significant presence in those markets.Valuations at attractive levels
Weak demand outlook and market volatility has resulted in the stock falling 31 percent from its 52-week high. HMCL currently trades at 15.0 times FY19 and 13.6 times FY20 projected earnings.
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