Hero MotoCorp’s (HMCL) Q4FY17 EBITDA at Rs 9.6 billion (down 20% y-o-y) came 9% below estimate due to gross margin miss (higher-than-expected commodity pressure).
Key conference call highlights: 2-wheeler industry to grow in high single digits in FY18; uptrend in share of scooters to sustain; HMCL aims to gain market share riding rural demand recovery and higher scooters pie; current inventory level at ~4-5 weeks versus normal ~5-6 weeks as retail sales in April-May have been strong; and Rs 25 billion capex over FY18-19 towards capacity addition, R&D, digitisation and maintenance. Maintain ‘hold’ with a TP of Rs 3,585.
Revenue, at Rs 69.1 billion (down 8% y-o-y), came 1.3% below estimate. Discounts of Rs 1.93 billion (our estimate: Rs 2.0 billion) were offered to clear BS-III inventory. Gross margin surprised negatively at 31.5% (estimate 32.8%) due to higher-than-expected commodity cost pressure (raw material per unit up 4% q-o-q).
Though cost pressure is likely in Q1FY18 as well, we expect it to be largely offset by price hikes in May (~Rs 500-2,200) and softening of commodity prices. Reported PAT of ~`7.2 billion, down 14% y-o-y, surpassed our estimate 8% due to lower effective tax rate.
We expect HMCL to benefit from a recovery in rural demand in FY18. However, over the long term, market share gain scope remains challenging given weak franchise across fast-growing scooter and premium bike segments. In our view, margin benefit from LEAP programme and volume recovery will be neutralised by the company’s efforts to gain share in highly competitive scooter and premium bike segments.
Also, FY19 will see impact of expiry of excise benefits at its Haridwar plant (~80bps margin impact). Our concerns on HMCL emanate from: shift in demand from its bread-and-butter executive 100cc motorcycle segment to scooters; and rising demand for >250cc motorcycles, where HMCL’s presence is limited. However, a healthy business franchise with RoE of ~36% and robust free cash flow generation limit downside.
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We maintain ‘hold/SU’ with target price of Rs 3,585 (17x FY19E core EPS plus `387 cash per share). At CMP, the stock trades at 16x FY19E PER. Management expects 2W industry to grow in high single digits in FY18, driven by normal monsoons, govt spend on infrastructure and demand recovery post demonetisation.