Ideas for Profit | Hero MotoCorp: Raw material prices weigh on Q3 margin; near-term outlook weak

Nitin Agrawal Moneycontrol Research

Highlights: - 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.

Quarterly snapshot

Key highlights 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.

Outlook

Industry 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.