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Resilient margins; inexpensive valuations, retain BUY

Hero MotoCorp (HMCL) reported a robust Q4FY21 performance. Total 2-W sales volume was at 15.68 lakh units, up 18% YoY, down 15% QoQ. Consequent net sales in Q4FY21 came in at | 8,686 crore, up 39.2% YoY but down 11.1% QoQ with blended ASPs at ~| 55,395/unit (up 4.6% QoQ). EBITDA margins were down 50 bps QoQ at 13.9%, with gross margins expanding 10 bps QoQ despite a spike in input costs over the past few months. PAT came in at | 865 crore, up 39.3% YoY. HMCL declared a final dividend of | 25/share for FY21 along with a special dividend of | 10/share. Hence, total dividend was at | 105/share for FY21.

Stable demand outlook; EV strategy taking shape

With the pandemic pinching the lower income group more, the 2-W segment had been underperforming the industry in recent months. Fresh resurgence in Covid-19 on pan India basis and localised restrictions put in place to combat it have thrown a spanner in the works for the overall automotive industry, which was recovering well over the past few months.

However, with medium-term demand drivers for 2-W in the form of shift towards personal mobility and favourable demographics remaining intact, we expect healthy double-digit volume growth at industry level over FY21- 23E. HMCL, as the market leader with its vast distribution network and expansive product suite, should benefit. The company’s ~50% exposure to the rural economy is set to be an additional tailwind on account of expectation of normal monsoon in 2021.

We build ~12% volume CAGR in FY21-23E, helped in part by low base. In terms of upcoming EV disruption, HMCL has announced a three-pronged strategy. While on-ground presence currently is limited to the company’s ~35% stake in leading electric scooter maker Ather Energy, it is now working on introducing its own offering (fixed charging) during FY22E. The recent tie up with Taiwan’s Gogoro Network using swappable battery technology will represent an added EV foray.

Limited margin pressures up ahead

Q4FY21 margins surprised us positively, with gross margins expanding 10 bps QoQ against our expectation of 210 bps decline. HMCL has displayed admirable resilience on the blended margins front in the past two quarters despite steep commodity cost inflation (~6-7% YoY in FY21) via a mix of price hikes and sizeable cost savings under LEAP-2 programme. Structural margin tailwinds in the form of higher share of spare parts and improved mix (exports, premium motorcycles) along with further price hikes are seen imparting further protection against higher costs in FY22E and FY23E.

Valuation & Outlook

For HMCL we build 16.4%, 15.1% sales, PAT CAGR, respectively, in FY21- 23E. With relative stability in demand and margin outlook, we believe the company offers a sizeable margin of safety at CMP (~7% CFO yield, ~5% FCF yield, ~4% dividend yield over FY21-23E). We maintain BUY, valuing it at | 3,440 i.e. 17.5x P/E on FY23E EPS (earlier target price | 4,000).

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