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LEAP savings aid margins

Hero MotoCorp’s (HMCL) Q2FY22 operating numbers were ahead of consensus estimates with margins coming in at 12.6% (down 112bps YoY). Topline declined ~10% YoY to ~Rs84.5bn (cushioned by higher share of spares: ~13%) as ASP rose ~14% to ~Rs58.8k/unit. Input cost pressures were managed via price hikes (YTD: Rs3k) and through LEAP savings to contain gross margin drop at 119bps. HMCL continues to witness demand pressures in entry level due to delayed monsoon and consumer sentiment recovery amidst weak affordability is likely to be delayed. HMCL’s strategic partnerships in EVs (e.g. Ather, Gogoro) are likely to augment its own EV product portfolio (first launch in Mar’22). Valuations remain attractive (~15x PE FY23E EPS/~4% FCF yield). Maintain ADD.

* Key highlights of the quarter: HMCL reported EBITDA margin of 12.6%, down 112bps YoY, as gross margins slipped 119bps YoY to 27.7%. ASP grew 13.8% YoY to ~Rs58.8k per vehicle likely due to higher export and premium segment share (4.1% of sales) coupled with higher spare sales (Rs11bn.4bn, up 40%). PAT shrunk ~17% YoY to Rs8bn (in line with EBITDA decline of 17%).

* Key takeaways from earnings call: Management indicated: a) price hike of Rs1,200 was taken in Sept’21 (Rs1,000 in Jul’21, ~Rs800 in Apr’21) to offset RM inflation (110bps yet to be recovered); b) LEAP savings in Q2 led to benefit of 320bps; sales from spares and accessories reached an all-time high of Rs11.4bn (up 40% YoY); c) exports reached an annualised run-rate of 300k units as Mexico and Bangladesh witnessed economic recovery while Columbia attained EBITDA breakeven; d) premium category witnessed strong growth at 4.1% of sales (target: 10%) against 2.2% in Q1 (6% in Oct’21); e) on EV plans, HMCL indicated launch of its first EV scooter at FY22-end followed by a new launch each year; f) inventory levels at the end of festive season stood at 5-6 weeks; and g) entry level has been witnessing demand slack as rural consumer sentiment remains fragile.

* Maintain ADD: HMCL was impacted by weak demand trends since Mar’21 as affordability of customers at the entry level was majorly hit by Covid. However, end of festive has witnessed few green shoots of demand and upcoming marriage season in North India could aid recovery of the rural markets. HMCL’s multi-pronged partnership strategy (e.g. Ather/Gogoro) bodes well in terms of collaboration for its future EV product launches. We introduce FY24E estimates and cut earnings by -12.7% / -8.7% for FY22E / FY23E. We roll over to Sep’23E and prune our target multiple to 15x (earlier: 16x) Sep’23E EPS of Rs198 (earlier: Rs185). Maintain ADD with a revised target price of Rs2,964 (earlier: Rs2,965).

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