Priced to perfection; downgrade to Reduce: Hero Motocorp stock has rallied 24% in past three months on the hopes of rural recovery and recent strong monthly numbers. We believe this theme has already played out. We reckon that the downside risks have increased from higher raw material prices and potential increase in competitive intensity.
Further, the recent spurt (which is the basis of Street’s excitement) in volumes is on account of inventory build-up at dealer level. Full valuations, limited room for disappointment and downside risks to profitability result in our downgrade to Reduce from Add with revised target price of Rs 2,850 (Rs 3,050 earlier).
Strong volume growth over past two months was on account of inventory build-up
Industry growth in the past two months was helped by inventory build-up ahead of the marriage season in North India. Hero MotoCorp’s dealer inventory has gone up to eight weeks in March from six weeks earlier while retail volumes have grown in low single-digits. While we assume recovery in two-wheeler industry volume growth to 8% y-o-y in FY2017e (2.8% y-o-y growth in FY2016), we believe double-digit volume growth is unlikely as global agricultural prices are still subdued.
Downside risk due to rise in raw material prices and likely increase in competitive intensity
Domestic steel prices have increased by 7-8% over the third quarter of fiscal 2016 average levels and given our subdued outlook on two-wheeler industry growth, price increase would be difficult to offset the rise in raw material prices. We also note that Honda Motorcycles (HMSI) has lost 70 bps market share in the domestic two-wheeler market in FY2016 due to steep decline in motorcycle volumes. HMSI has recently commissioned 1.2 mn unit plant and we believe it may become more aggressive to increase capacity utilization of the new plant. This does not augur well for the industry’s profitability.
Downgrade to REDUCE with revised target price of R2,850
We cut our FY2017-18e earnings estimates for the company by 2-3% as we lower our Ebitda margin assumptions by 30-40 bps to factor in the impact of recent increase in domestic steel prices. We lower our target PE multiple for Hero MotoCorp to 15X (from 16X earlier) as we believe the potential increase in competitive intensity from Honda could lead to downside risks to the industry’s profitability going ahead. Therefore, we downgrade Hero to REDUCE (from ADD) with a revised target price of R2,850 (R3,050 earlier), which is based on 15X FY2018e EPS.
