Hero MotoCorp’s (HMCL) Q1FY18 Ebitda of Rs 12.9 bn (up 5.4% y-o-y) surpassed our estimate by 2.7% due to the gross margin beat, as price hikes helped offset higher commodity and BS-IV transition costs. Key con-call highlights: (i) 2W industry to grow in high single digits in FY18; scooters to outperform with double digit growth; (ii) HMCL aims to gain market share led by recovery in rural demand and ramp up of scooter refreshes (Maestro Edge and Duet); (iii) commodity costs to remain largely stable going forward; and (iv) reiterated capex of Rs 25 bn over next 2 years towards capacity addition, R&D, digitisation and maintenance. Maintain Hold with target price of Rs 3,960.
Price hikes help offset headwinds
Revenue, at Rs 79.7 bn (up 7.7% y-o-y), was 1% below our estimate on muted spares revenue (5% y-o-y). Ebitda margin surprised positively at 16.3% (our estimate of 15.7%), led by gross margin beat (32.3% versus our estimate of 31.5%) and lower overhead expenses. Provision of Rs 450-500m was made to compensate dealers for GST impact. Reported PAT of `9.14 bn (up 3.5% y-o-y) exceeded our estimate by 1%.
Rural demand revival, but structural concerns persist
While HMCL should benefit from recovery in rural demand in FY18, over longer term scope for market share gains remains challenging given weak franchise across fast-growing scooter and premium bike segments. In our view, margin benefit from LEAP programme and volume recovery would be neutralised by HMCL’s efforts to gain market share in the highly competitive scooter and premium bike segments. Also, FY19 will see impact of expiry of excise benefits at its Haridwar plant (80 bps margin impact), though it would be partially offset by the ramp up in Halol plant.
Outlook and valuations: Fairly valued; maintain ‘HOLD’
We continue to have concerns on HMCL due to the shift in demand from its bread-and-butter executive 100cc motorcycle segment to scooters and rising demand for >250cc motorcycles, where its presence is limited. However, a healthy business franchise with RoE of 36% and robust free cash flow generation will limit downside. We maintain ‘HOLD/SU’ with a target price of Rs 3,960 (19x FY19e core EPS plus Rs 361 cash per share). At CMP, the stock trades at 17x FY19e PER.
Key conference call highlights
Demand outlook: Management expects industry to grow in high single digits for FY18, and scooters to extend outperformance with double digit growth. For Q1FY18, retail volume growth at industry level was lower than wholesale growth of 8% y-o-y. However, for HMCL retail volumes were in line with dispatches. Both urban and rural markets witnessed growth. Following good monsoons and upcoming festive season, the company expects rural momentum to pick up further.
Inventory levels for HMCL are broadly unchanged, only spares saw some destocking in Q1FY18. GST transition has been smooth. Though volumes during first few days of July were soft, the company expects volume momentum to pick up going forward.
Scooters: Wholesale volume growth of scooter industry stood at 20% y-o-y. Refreshed Maestro Edge scooter has met with good response. Company expects Duet volumes to pick up as well going forward. Targets to gain market share in scooters led by product improvements (Maestro Edge and Duet) and upcoming new launches.