Hero Motocorp rating: Neutral — A decent operating performance

HMCL has posted a notable operating performance in these tough times. The narrative around rural demand is positive, but supply chain ramp-up and broad-based demand are important for demand sustainability. We upgrade our EPS estimate by 9% for FY21 to factor in faster volume recovery. But, we maintain our Neutral rating, with TP of Rs 3,045 (~16x Sep’22 S/A EPS + Rs 98/share for Hero FinCorp).

BS6 price hike with no discounts leads to realisation surprise: HMCL’s revenues/Ebitda/PAT declined 63%/ 91% /90% y-o-y. Revenues fell 63% y-o-y to ~Rs 29.7 bn on a ~69% y-o-y decline (-58% q-o-q) in volumes. Realisations were up 21% y-o-y (+12.8% q-o-q) to Rs 52.7k, driven by BS6-related price increases and no discounts. Gross margins fell 80bp y-o-y (-120bp q-o-q) to 29.5%, as it didn’t load contribution margins on BS6 cost pass-through. Lower other expenses supported Ebitda margins to 3.6%. As per mgmt., margins were at 12% after excluding fixed cost of Rs 2.5 bn during lockdown. Ebitda was at ~Rs 1.1 bn and PAT fell ~90% y-o-y to ~Rs 613 m.

Highlights from commentary
Strong demand recovery: Demand does constitute only pent-up demand; recovery seems sustainable. Rural is seeing a V-shaped recovery, while urban is lagging behind due to sporadic lockdowns. 10–12% of demand is owing to purchases being brought forward.

Customer profile: Purchases for commuting to work and additional vehicles have gone up significantly, while replacement demand is down.

Company is quite confident of market share gains in Q1 sustaining, driven by rural buoyancy, response to BS6 products, a refreshed portfolio (Passion, Glamour), and the plugging of product gaps (Scooters and premium). Operations have recovered to 80–90% of pre-COVID-19 levels, and would fully normalise in the coming months. 95% of its dealers are fully operational. It took a price hike of Rs 250 in Jul’20 & Rs 1,000 in Q1FY21. Leap-2 targets cost-cutting by 100bp (2x target), capex phasing, and Project Mileage for overheads.

Valuation and view
Considering the favourable outlook for rural, HMCL should continue to see good demand recovery. However, the sharp price increase in 2Ws over the last two years could lead to adverse mix restricting margins and EPS growth (8% CAGR over FY20–23e). The stock trading at 18.5x/15.9x FY21/FY22e EPS is a fair reflection of the current market condition and expected recovery. Maintain Neutral with TP of Rs 3,045.