Hero’s Q2 EBITDA was in line as slight beat in revenue was offset by a miss in margin. Management indicated a tepid start to festive season so far but remains hopeful of an acceleration during the rest of season as confusion on higher personal accident insurance abates and demand picks up. Despite the recent correction, we remain cautious on the stock due to near-term cost headwinds for 2Ws and structural growth concerns on Hero.
Better revenue but weaker margin
Hero’s Q2 revenue was slightly ahead of our estimate partly helped by strong 24% growth in sale in spares to Rs 7.1 bn; however Ebitda was in line as margin of 15.2% missed our estimate by 20bps mainly on account of higher other expenses. Net profit beat our estimate by 9% helped by high other income, partly due to higher interest income on tax deposits.
Tepid start to festive season so far
Management indicated tepid/flattish sales in the festive season for the first few days which started from 9th October post end of Shradh period, but remained hopeful of a pick-up going forward. It maintained its guidance of double-digit growth going forward helped by rural demand.
3 launches but we remain sceptical
Hero launched Xtreme 200R in September. It plans to launch 125cc variants of 2 scooters (Maestro and Duet) with the first planned to be launched in one market soon and pan-India a few weeks later and the second likely some time after. However, we remain sceptical of their success, given (i) historic low success rate of new launches in 2W; (ii) Hero’s weakness in premium motorcycles; and (iii) difficulty of extending its already weak scooter brands to a new segment.
Key takeaways from earnings call
(i) Management maintained long-term margin target of 14-16%; (ii) Hero has invested an additional Rs 2.5 bn into Hero FinCorp during Q2 through rights issue maintaining its stake at 41%; (iii) it does not expect much impact of issues in NBFC sector on 2-W financing, given low duration and higher margins.
Near-term cost headwinds for 2-W, structural growth concerns for Hero
We cut FY19-20e estimates mainly to factor in weaker margin. We also introduce FY21e estimates which reflect likely adverse impact of BS-VI on volume growth and margin, due to sharp increase in price/costs. We cut price target for Hero to Rs 3,070 (prev. Rs 3,480) as we also factor in higher risk-free rate. As a result, upside remains limited despite recent correction. Maintain Hold.