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Healthy Q2, new launches to drive performance hereon

Hero (HMCL) reported strong set of numbers in Q2 sequentially on low base, while the yoy drop in numbers was lower than expectations. Volumes grew by 40.4% qoq on a small base while fell by 20.7% yoy to 1.44 mn units. Topline grew by 10% yoy to ₹84.5 bn as realizations grew by 13.8% yoy mainly on price hikes taken. The demand in Q2 started improving as Wave#2 of Covid softened and rural markets started opening up. Input costs to sales ratio in Q2 was at 72.3%, slightly down from 72.5% qoq and up from 71.1% yoy. EBITDA margins jumped to 12.6%, up sequentially from 9.4% on better mix and higher realizations while falling from 13.7% yoy. Depreciation expenses de-grew by 5% yoy, PBT fell by 16% yoy while PAT decline was at 16.7% yoy to ₹7.94 bn with tax rate at 24.5%.

Demand drivers remain intact in mid to long term, EVs to drive the scooters business

Retail demand in rural markets has started picking up now after Wave#2. The company is gaining strength in the scooters segment as well with increasing market share yoy. In the executive bikes segment as well, their bikes are performing well. However, still the overall demand is below precovid levels. In the premium bikes segment, the company attained market share of 6% (target 10%) on the back of X-treme 150 R and X-Pulse bikes.

HMCL will increase its focus on EVs through its own products (first launch by Mar’22), a joint development with Gogoro (Taiwan) for a swappable battery model (launch in CY22) and investments in Ather Energy. It plans to launch more products every year. The company is setting up an E-2W and battery manufacturing facility at its Andhra Pradesh plant. In the next 5-7 years, HMCL plans to invest ₹100bn (50% for EVs). HMCL plans to invest ₹100 bn (50% in EVs).

Additionally, in export markets the company is anchoring well mainly in markets like Nigeria (new product launched), Colombia (gaining market share rapidly here), Bangladesh and Mexico (where Hero has joined hands with a big distribution partner). Among overseas markets, 7-8 countries have started to witness market share gains. Export EBITDA margin is lower than domestic because of launches in Nigeria and other countries. However, as premium products are launched, the export margins are expected to be similar or higher than domestic margins.

The Khariff season this year has been good and Rabi is also expected to be good, which would drive rural sales and Hero’s performance too. Their partnership with Harley Davidson is also gathering steam with expansion in network and product development. We therefore believe FY22E/23E volumes to record a 3%/8% growth respectively

LEAP-2 and price hikes to arrest decline in margins

EBITDA declined 17% to ₹10.7bn, higher than our estimates, owing to higher spare-part revenues and cost savings. HMCL registered cost savings of 320bps (in comparison to last year) under LEAP2 program, mainly led by material cost reduction and some reduction in other variable costs. The company took price hikes to the tune of ₹3000 per vehicle in FY22 (₹800 in April, ₹1200 in July and ₹1000 in Sep). The company under the LEAP program is quite aggressive in saving employee costs and other expenses including sales and promotion expenses. These steps shall lead the company to achieve its margin target of early to mid-teens in FY 23E, despite commodity headwinds. Secondly, premiumisation of bikes with the help of global partner Harley Davidson shall help the product mix to improve further. FY 21E margins emerged strong at 13%, while in FY22E/FY23E, we expect them to rise up to 11.9%/12.9% respectively.

Outlook and valuation

The HMCL stock has underperformed the Indices during the last one year due to lack of exports unlike Bajaj Auto and lack of the Scooter opportunity unlike TVSM. With its EV strategy firmly in place now, we believe HMCL is now well positioned to return to growth trajectory next fiscal. Hero posted robust set of numbers in Q2, which were better than expectations as Wave #2 of the pandemic subsided. Going forward, we expect better performance in H2 and thereafter as the covid situation seems to be under control. Demand levers post pandemic are intact with rural story remaining strong. Financing has also become easier as it increased to 55% in Q2 v/s 51% in Q1 (Hero holds 35-40% market share), which is also a driver for a broad based growth. Also, with a normal level of inventory, ramping up of production, improving demand, new launches and low base, we expect H2 FY22 and FY23 to post a solid growth. 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 partnership with Taiwan’s Gogoro to manufacture Electric Scooters and establishing a manufacturing facility shall give Hero the first mover advantage in the EV 2W space. New launch of EV by the end of FY22 shall provide fillip to the EV strategy of Hero. Profitability would improve on price hikes, cost saving programs like LEAP-2, capex reduction and operating leverage stemming from improving volumes and product mix despite input cost pressures. We maintain our BUY rating on HMCL with a target price of ₹3,265.

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