Contrary to the consensus view, the increase in the govt’s rural spending as outlined in Budget 16-17 is only modestly higher than last year
Our analysis of the Union Budget indicates that total rural spending will likely increase by 14.8% in FY2017e as compared to 13.5% in FY2016e. This implies a modest growth in rural spending as compared to consensus view of a significant impetus by the government in FY2016-17 budget to boost the rural economy. Global food prices remain weak, which does not augur well for farm income. We thus expect two-wheeler industry volumes to increase by ~7% y-o-y in FY2017e. After the recent outperformance, Hero’s stock price factors in recovery in industry growth and is fairly valued at this juncture. We downgrade the stock to ADD from BUY with a revised target price of Rs 3,050 (from R3,000).
Rural spending by government to increase 15% y-o-y in 2017e, largely similar to that last year: We have analysed the government’s budget allocation to rural-focused ministries—the Ministry of Agriculture and the Ministry of Rural Development. We note that, in FY2017e, the budget of Ministry of Agriculture includes an amount of Rs150 bn as interest subsidy for short-term credit to farmers. However, prior to FY2017e, interest subsidy used to be part of the budget of the Ministry of Finance. Therefore, if we add back the interest subsidy to the budget of agriculture ministry for earlier years, then as per our calculations, total rural spending (combined spend of the Ministry of Agriculture and the Ministry of Rural Development) will likely increase by 14.8% in FY2017e as compared to 13.5% in FY2016e.
This indicates that the increase in rural spending is only a few percentage points higher than nominal GDP growth as compared to the general belief of significant impetus to rural economy by the government in the budget.
Good monsoon and recovery in agri commodity prices key for two-wheeler industry growth
Global prices of agricultural commodities such as wheat, cotton, etc. remain weak, which does not augur well for farm income, in our view. Therefore, we believe that even if monsoon rains are normal this year (our base case assumption), two-wheeler industry volumes are unlikely to grow in double digits. We expect two-wheeler industry volumes to grow by 7% y-o-y in FY2017e as compared to ~1% y-o-y growth in FY2016e led by strong growth in the scooter segment and moderate recovery in the bike segment.
Downgrade Hero MotoCorp to ADD with revised target price of R3,050
Our FY2017-18e earnings estimates remain largely unchanged while we increase FY2016e EPS estimates by 2% on higher volume assumptions. We downgrade the stock to ADD (from BUY) with a target price of R3,050 (R3,000 earlier). Our target price is based on 16X December 2017E EPS; the stock has run up by 14% over the past one month and therefore largely prices in potential improvement in industry volumes. A weaker-than-expected monsoon and dip in Ebitda margin due to an increase in commodity prices or increased competitive intensity are key downside risks.