Hero reported strong numbers in the fourth quarter boosted by strong volumes and low raw material cost. Share gains in scooter segment and recovery in rural markets will likely help Hero’s volume growth accelerate from FY17e, after 4 years of anaemic growth. Operating leverage, higher tax incentives, lower royalty costs will likely offset commodity headwinds. We forecast c16.4% growth in earnings in FY16-18e and find the stock cheap at 15.7x Fy17e. Maintain Buy
Q4 numbers strong: Hero’s volumes grew 9.2% in Q4, driven largely by the new scooter launches. Strong growth in spare parts sales and higher recurring tax incentives helped sales grow 10.6%, in line with forecasts. Gross margins expanded 425bps boosted by low commodity prices. However, higher other expenses, resulted in Ebitda growing 40% y-o-y.
Volume outlook getting stronger: Hero guided to mid to high single digit volume growth in 1H & stronger 2H. We forecast c9.6% growth in FY17e driven by (i) market share gains in scooters, (ii) marginal recovery in rural markets resulting in growth in lower end motorcycles, and (iii) full year impact of higher share in 125cc motorcycles segment. We forecast Hero’s share in motorcycle market to fall c30bps and in scooters to rise 200bps in FY17e.
Profitability likely to remain strong: Hero will likely face commodity headwinds. However, we forecast margins in FY17e to increase 30bps y-o-y driven by (i) tax incentives from the new plants, (ii) lower royalty payment to Honda on phasing out of some models, and (iii) operating leverage on higher volumes. Hero would benefit from tax
incentives in three plants in FY17 and FY18, likely boosting margins sharply but will lose some incentives in FY19e. We tweak our FY17-18e marginally.
Hero has an extremely strong franchise with consumers but is under-appreciated by investors. The two major growth headwinds—low rural growth and lack of scooter portfolio—are both likely tailwinds from FY17e. Competitive environment is tough but no tougher than in other consumer businesses. Hero has invested heavily in both tangible and intangible capacities but is only now starting to benefit from those investments. We find the stock inexpensive at 15.7x FY17e. Maintain Buy with marginally higher DCF TP of R3,660. Key risk: weak monsoons