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Strong quarter; demand outlook remains positive

* Q3FY21 OPM contracted 30bps yoy to 14.5%, above the estimate of 13%, owing to higher spare sales, inventory gains and cost savings. Spares grew 29% yoy to Rs10.3bn, led by better penetration with retailers/mechanics, and is likely to sustain growth at high levels.

* Management emphasized positive demand outlook, driven by improving macros and expectations of recovery in replacement demand. In addition, demand recovery in categories such as students and migrant workers is likely to aid volumes.

* We marginally increase FY21-23 earnings estimates by 1-2%, led by higher spares revenue and other income. We expect revenue/earnings CAGR of 15%/22% over FY21- 23E, with strong post-tax ROICs (~50%) and healthy FCF generation (~Rs35bn/year).

* The stock trades at a P/E of 16x on FY23E vs. historical average of 18x. Retain Buy with a TP of Rs4,000 (Rs3,839 earlier), based on 18x FY23E P/E and value of investments at Rs95/share. The target multiple implies a core P/E of 19x and net cash/share of Rs496.

* Strong revenue/EBITDA performance: Revenue grew 40% yoy to Rs97.8bn, slightly above the estimate of Rs95.6bn, owing to higher spare-parts revenues. Spares grew 29% yoy to Rs10.3bn, led by better penetration with retailers/mechanics. Volume rose 20% to 1.85mn units and realization increased 17% to Rs52,977/unit. EBITDA margin contracted by 40bps yoy to 14.5%, beating the estimate of 13% due to higher spare sales, cost reduction efforts and inventory change. Cost savings (Leap programme) benefits were at over 100bps vs. 50bps last year. Overall, adjusted PAT grew 23% yoy to Rs10.8bn (est.:Rs9.1bn) above estimates, owing to higher operating margin and other income. Other income grew 11% yoy to Rs2bn. Share of loss from associates (Ather Energy and Hero FinCorp) stood at Rs987mn vs. a profit of Rs250mn last year.

* Retain Buy: We expect a robust cyclical upturn in domestic 2Ws in FY22, thanks to recovery in economic activity, continuation of positive rural sentiments, resurgence in urban demand, improving finance availability and favorable base effect, among others. HMCL remains a key beneficiary of this uptrend, and we expect revenue/earnings CAGR of 15%/22% for FY21- 23E. Valuations are reasonable at P/E of 16x on FY23E vs. historical average of 18x. Reaffirm Buy with a TP of Rs4,000 (Rs3,839 earlier), based on 18x FY23E P/E as well as value of investments for Hero FinCorp and Ather Energy at Rs95/share. The target multiple implies core P/E of 19x and net cash/share of Rs496. Key downside risks include delayed recovery in economic activity, heightened competition, lack of pricing discipline in the industry, higher commodity prices, etc. 

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