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Robust quarter, better than expectations

Hero reported strong set of numbers in Q4. Volumes grew by 18.5% yoy while fell by 15% qoq to 1.57 mn units, while topline grew by 39.2% yoy to ₹86.86 bn as realizations witnessed a fantastic expansion of 12% yoy mainly on price hikes taken in Q4, model mix tilting towards big ticket models and low base of last year when BS 6 was playing as a dampener. The demand in Q4 remained strong even after the best quarter of Q3. Input costs to sales remained flattish sequentially at 70.4% despite commodity prices moving up by 5%. This was a big surprise for the street as other auto players were unable to arrest this surge. Due to this impact, EBITDA margins surged to 13.9%, while rising from 10.6% yoy and slightly falling qoq. The company managed the balance of market share and margins well as the cost reduction measures paid off well to mitigate the input cost surge. As depreciation expenses de-grew by 6.6% yoy, PBT rose by 73.6% yoy while PAT growth was at 39.4% yoy to ₹8.65 bn with tax rate at 24%.

Demand drivers remain intact in mid to long term

We witnessed that even after festive season ended, there was no demand deceleration. In the year FY21, Hero won 140 bps market share through a very strong demand for Deluxe, Splendor, Passion Pro and its new launches Xtreme 160 and X-Pulse bikes. The retail demand has also reached pre-Covid levels in the second half of the year. Scooters market share has gone up by 270 bps with strong demand for Pleasure. In the premium bikes segment, the company attained market share of 4% on the back of X-treme 150 R and X-Pulse bikes. Additionally, in exports markets the company has gained market share too, as exports grew by 8% in FY21, mainly in markets like Colombia (market share here grew from 4% to 6% in FY21), Bangladesh and Mexico (where Hero has joined hands with a big distribution partner). With strong volume pick up in H2 of FY21, the annual volume fall is arrested to 10.6%. In FY22, Q1 will be a bit subdued considering an unprecedented sharp second wave of the pandemic. Hero shut its plants for some days in April which may impact production and sales in the short term. Going forward, the intrinsic growth drivers are expected to remain intact with the rural story and monsoons expected to pan out well this year as well. We therefore believe FY22E/23E volumes to record a 15%/10% growth respectively.

Cost reduction initiatives prove to be very effective when input costs are rising

Hero’s EBITDA margins in Q4 came robust at 13.9% despite a 5% rise in commodity costs. This was a result of 4% price hike taken by Hero in Q4 and 3% through LEAP program. LEAP cost reduction program yielded 300 bps benefit in Q4 and 200bps in FY21. Model mix tilted in favor of premium segment coupled with lower discounting. The company under the LEAP program is quite aggressive in saving employee costs and other expenses including sales and promotion expenses. These steps shall enable Hero to achieve its margin target of 14-16% in FY22E, despite commodity headwinds. Secondly, premiumisation of bikes with the help of global partner Harley Davidson shall help the product mix to improve further. FY21E margins emerged strong at 13%, while in FY22E/FY23E, we expect them to rise up to 13.8%/14.4% respectively.

Outlook and Valuation

Hero posted robust set of numbers in Q4 FY21. Going forward, we expect a soft Q1, but the growth should come back in Q2 if the second wave comes under control by then. Demand levers post pandemic are intact with rural story remaining strong. Re-migration of construction workers expected to come in to play as well. Also the radical shift to personal mobility from shared mobility is leading the demand. Due to this till now the first time buyers were increasing, but now the replacement demand is also moving up, fuelling the overall demand. Financing has also become easier, which is also a driver for a broad based growth. Also, with a lower level of inventory, ramping up of production, improving demand, new launches and low base, we expect FY22 to post a solid growth after a strong Q4 FY21. HD agreement would provide a fillip to Hero’s ambitions to win a respectable position in the premium range of motorcycles, although in mid to long term. Hero’s recent partnership with Taiwan’s Gogoro to manufacture Electric Scooters and battery swapping platform shall give Hero the first mover advantage in the EV 2W space. Profitability would improve on price hikes, cost saving programs, capex reduction and operating leverage stemming from improving volumes and product mix. We therefore maintain our BUY rating on the stock with a target price of ₹3,289.

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