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Gross margins slip as input cost pressure rise

Hero MotoCorp’s (HMCL) Q1FY22 operating numbers missed consensus estimates as margins came in at 9.4% (down 449bps QoQ).

Topline declined ~37% QoQ (below consensus) to ~Rs54.9bn as ASP fell ~3.2% to ~Rs54.8k/unit (potentially due to mix). Input cost pressures have finally caught up with gross margins (down 204bps QoQ), as costs continue to rise, gross margin trajectory over H2FY22 would be a key monitorable. HMCL is witnessing demand pressures in entry-level segment due to weak consumer sentiment; rising vehicle prices are likely to further hurt affordability.

The imminent (Aug’21) electric vehicle product launch from the new-age challenger Ola Electric is likely to bring investors more clarity on the right-to-win of new-age companies in a 2W-like matured business. Hero has strategic partnerships in EVs (e.g. Ather, Gogoro (Link)), which could provide it with multiple roads to future success in EVs. Maintain ADD.

* Key highlights of the quarter: HMCL reported EBITDA margin of 9.4%, down 337bps QoQ, as gross margins slumped 204bps QoQ at 27.5%. ASPs also surprisingly declined 3.2% QoQ to ~Rs53.5k/vehicle likely due to adverse product mix. PAT shrunk 58% QoQ to Rs3.6bn (in-line with EBITDA decline of 57%). The key points for the earnings call: a) pricing power and gross margins, b) demand situation, c) electrification strategy

* Retail demand trends remain key as festive season approaches: We have witnessed 2W retail demand trends gradually improving post covid reopening (link), which bodes well for demand trends in upcoming festive season (started) 4th Aug’21 with Onam).

2W industry inventory levels are relatively high, and we believe HMCL inventory is likely to be at the higher end of ~6-8 weeks (our Aug’21 estimate). Industry is grappling with steep increase in input costs and HMCL too needs to find ways to pass on the additional cost inflation to customers. Entry-level has been witnessing demand slack and consumer sentiment revival still remains fragile. Progress on export markets also remains a potential growth driver for HMCL.

* Maintain ADD: HMCL has witnessed weak demand trends since Mar’21 as entrylevel demand has been significantly impacted by marriage season demand in Q1. HMCL’s multi-pronged strategy (e.g. Ather/Gogoro) bodes well for its future product launches. We have cut our earnings estimates by ~-8.7% / -7.0% for FY22E / FY23E and retain our target multiple at 16x FY23E EPS of Rs185.3. Maintain ADD with a revised target price of Rs2,965 (earlier: Rs3,189).

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