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Above est; higher realizations, LEAP-2 savings lead to margin beat

Hopeful of demand recovery, led by wedding season and delayed harvesting

* Hero MotoCorp (HMCL)’s performance was driven by higher realization and efficient cost management, despite high cost of inflation. While cost inflation is being managed reasonably well, demand recovery is the missing link in the story.

* We lower our FY22E/FY23E EPS estimates by 2%/4.5% on lower volumes. We maintain Buy, with TP of INR3,100 (~15x Mar’23E S/A EPS + INR154/share for Hero FinCorp).

Mix-led sharp ASP improvement drives performance

* 2QFY22 revenue/EBITDA/PAT declined 10%/17%/17% YoY (+54%/+107%/+117% QoQ) to INR84.5b/INR10.7b/INR7.9b. 1HFY22 revenues/EBITDA/PAT grew 13%/13%/14% YoY.

* Volumes declined 20% YoY (+40% QoQ). Realizations improved 14% YoY (10% QoQ) to INR58.8k (v/s est INR55.4k), led by price hikes, higher spare sales, and other operating income. Vehicle ASPs improved 2.6% QoQ.

* Gross margins contracted 120bp YoY (+20bp QoQ) to 27.7% (v/s est 28%) on commodity cost inflation during the quarter. The LEAP-2 savings program led to savings of 320bp YoY, largely led by saving on RM as well as some other variable costs restricting the contraction in gross and EBITDA margins.

* The EBITDA margin contracted 110bp YoY (+320bp QoQ) to 12.6% (v/s est 11.7%). EBITDA declined 17% YoY (107% QoQ) to INR10.7b.

* Higher other income restricted the adj. PAT decline to 17% YoY (117% QoQ) at INR7.9b (v/s est INR6.8b).

* FCFF stood at -INR2.75b (v/s +INR31.9b in 1HFY21) on working capital outflow of INR12.9b (v/s inflow of INR23b in 1HFY21).

Highlights from management commentary

Outlook: Festive season sales declined in the early double digits, impacted by delayed monsoons/harvesting. However, it is hopeful of making a recovery in the upcoming wedding season on the back of multiple positive indicators – such as good monsoons, an improving consumer confidence index, the reopening of the Hospitality sector, and the recent cut in fuel prices.

RM cost inflation and price hike: The LEAP-2 savings program led to savings of 320bp YoY, largely on account of saving on RM as well as some other variables. Net RM costs were higher by 110bp QoQ, and this needs to be covered. It took price hikes of INR1,200 in Jul’21 and INR1,000–1,200 in Sep’21 (total of INR3,000 since Apr’21).

The nascent exports business and Premium segment are showing good traction. While the exports run-rate is now over 300k p.a., the Premium Motorcycle segment market share improved to ~4.1% in 2QFY22 (>6% in 3QFY22YTD).

 Retail financing penetration further improved to 55% in 2QFY22 (v/s 51% in 2QFY21), with the share of Hero FinCorp (HFCL) 35–40% in financing for HMCL

Valuation and view

HMCL is a good proxy on the rural market recovery, with a stronghold in the 100cc Motorcycle segment. It has a low vulnerability to EVs as it gets just 8% of volumes from Scooters – the core 100cc Motorcycle biz is less prone to the EV disruption. The stock trades at ~17.1x/13.7x FY22E/FY23E EPS. Maintain Buy, with TP of INR3,100.

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