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Largely in-line EBITDA; time for margin to pick up

Hero MotoCorp’s (HMCL) Q2FY23 EBITDA margin, at 11.4% (up 23bps QoQ), missed consensus estimate of 12.3% though revenue at ~Rs91bn, up 8% QoQ, was higher than consensus estimate of Rs88bn. Gross margin was up 82bps QoQ on 30-40bps benefit from lower commodity costs and ~40bps from better mix. ASP at Rs63.5k was up 5% QoQ with premiumisation led better mix QoQ other than the impact of price hikes. HMCL is likely to improve margin gradually in coming quarters as benefit of lower input commodity costs would get partly offset by adverse currency moves. Though we believe festive season demand levels (95% of pre-covid levels) would be tough to sustain despite the upcoming marriage season, higher MSPs, after effect of decent rainfall, low rural demand base and stable TCO should help rural retails recover in coming quarters in a gradual manner. We maintain our ADD rating on the stock with a revised DCFbased TP of Rs2,955 (earlier: Rs3,101), implying 13.5x FY24E core EPS with FY22- FY25E earnings CAGR at 20%.

Key takeaways from earnings call:

* Despite ~20% YoY growth in festive season retails, October wholesales were down 17% YoY. This huge divergence was on the back of a couple of factors: a) Destocking inventory levels from 6 weeks to 4 weeks, b) spreading the post festive season wholesale weakness across a couple of months instead of absorbing in a single month. Retail demand during the festive season was 95% of pre-covid levels, though we believe it is too early to assume the sustainability of such a huge volume. Though urban 2W demand recovered earlier, rural weakness has been persisting till September, though suddenly October retails across majority of target rural markets were encouraging and are remaining strong even in November. HMCL is looking forward to launch a premium model involving Harley-Davidson in coming quarters in order to tap the rising opportunity of premiumisation in 2Ws.

* Gross margin improved 80bps QoQ, with decline in raw material basket (RMB) contributing half of it and with balance coming from favourable mix and spares. Though there is scope for further benefit from RMB in coming quarters, the weakening of local currency may be a hurdle for that trickling down fully at margin level. Management is open to further price hikes if needed to reach the target EBITDA margin level of ~14%, though rising mix of EVs in coming quarters can be a potential hurdle.

* Financing mix moved up to as high as 60% from 50% a year back and Hero Fincorp continued to take care of ~35% of total HMCL vehicles funded. Ather continues to do well by scaling-up volume every quarter, and now post the recent round of equity funding to the tune of Rs60bn, HMCL’s stake in it got diluted by 200bps to 37%. Vida plans are as per schedule with test drives planned in December followed by launch in three cities in January.

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