Volumes expected to recover in FY20; HMCL can rerate due to medium-term volume uptick; ‘Buy’ maintained
We hosted the Hero Motocorp (HMCL) management for investors in Hong Kong. Investor queries were mainly around the sudden demand slump, the perceived price war in India 2Ws, and the outlook going into high regulatory costs. Management highlighted that festive season began with sharp de-growth (mainly due to higher insurance cost), but volumes picked up subsequently leading to overall festive volumes being flat y-o-y (lower than budgeted but better than market fears).
Outlook for the next couple of months remains subdued due to (i) high inventory (5-5.5 weeks vs. typically 4 weeks post festive) and (ii) shift in marriage season (Jan/Feb this fiscal vs. Dec last fiscal). Urban growth has weakened, but rural growth remains strong. Company will continue to fill product gaps (125cc scooters and premium bikes).
With demand normalising, we expect volumes to recover in FY20 (reckon ~13% vs. 6/14% in FY19e/FY18), but weaken in FY21 (to flattish) post the emission costs. We remain cautious on 2W OEM margin (going into multiple regulatory cost pressures), but HMCL can still rerate going into a healthy medium-term volume uptick (after 6 years of flattish CAGR). We maintain estimates and Buy rating with TP of `3,433 (10x FY20e EV/Ebitda).
Key takeaways from roadshow
Sluggish festive: Early festive season (Navratri/Dussehra) saw steep volume decline because it was immediately after the 5-7% increase in insurance cost (3rd party insurance increasing from 1 year to 5 years). However, the impact was softened with financing coupled with dealers educating buyers that it was just an upfront payment and not a cost increase. As volumes picked up going into Diwali (almost 70% of festive sales), overall festive volumes were flat.
Volume outlook: Inventory was at 9-10 weeks at peak during the festive season, but ended at 5-5.5 weeks after the season. This is higher than HMCL’s typical post festive inventory of 4 weeks. This coupled with a mismatch in marriage season dates (in Jan/Feb vs. Dec last year) can lead to some de-stocking next month. However, volumes are expected to stabilise from Q4FY19 and pick up sharply in FY20 on pre-buy before the change in emission norms. Needless to say, the pre-buy could lead to softness in FY21 volumes.
2W financing: HMCL’s share of volume financed is lower than industry’s due to former’s higher rural exposure, but it is increasing. 37% of HMCL’s overall volumes are financed (vs. 33% before demonetisation). Of this, Hero Fincorp (in which HMCL owns 41%) finances 1/3rd. HMCL recently invested `2.5 bn in Hero Fincorp as part of its rights issue. This has aided Hero Fincorp’s liquidity. Management does not expect NBFCs to slow down 2W lending (visible in our channel checks as well).