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Decent Q2, set for a good performance

Hero reported good set of numbers in Q2, on a sequential volume growth of 2.7% despite high base and a flattish decline of 0.7% yoy to 1.43 mn units. Topline grew by 7% yoy and 8.1% qoq to ?90.75 bn as realizations supported them by growing 8.1% yoy and 5.3% qoq mainly on reasonable price hikes taken in Q2 and product mix tilted towards premium models. The spares business also supported the cause as they grew by 17% qoq and 9% yoy at ?12.44 bn. The retail demand in Q2 witnessed a solid recovery on the back of array of XTech launches, impact of pandemic fading off and general positive sentiments. Input costs to sales ratio in Q2 was at 72%, down from 72.8% qoq and 72.3% yoy. Other expenses to sales as well as employee costs to sales were reported at 10.6% and 6% yoy respectively. EBITDA margins were sequentially up by 20bps at 11.4% as the input cost benefits were somewhat offset by higher currency related costs and marketing costs related with the EV brand ‘Vida’ and expansion of the X-Tech brand. As depreciation expenses remained flattish yoy and qoq, and other income de-grew by 41% (on MTM losses of ?440 mn on Gogoro investments), PBT de-grew by just 8% yoy while PAT de-grew by 10% yoy, while growing at 8% qoq at ?7.16 bn

Demand outlook remains positive

As mentioned by the company, the festive retail demand was up by 20%. This is quite a heartening sign for prospects of wholesale demand hereon as generally wholesale demand follows retail demand. The company is gaining strength through the XTech (Extra Technology) variant expansion across its brands (20% of current retail demand) seen in Q2. In the premium bikes segment, the company attained market share of higher single digits on the back of X-treme 150 R and X-Pulse bikes. Going forward, the intrinsic growth drivers are expected to remain intact with the rural markets bouncing back well during the festivals post slow demand owing to unseasonal heavy rains in the middle of October. However, these rains shall have a positive impact of Rabi crop and reservoir levels. Geographically too, apart from AP Telangana, the company witnessed good festive demand even in eastern states where monsoon was insufficient. Urban demand remained strong throughout the festive season. On the EV side, Hero has launched EV scooter under the Vida brand in the three major cities in the country in the festive season and has forged several partnerships and collaborations on this front including charging infrastructure. 

By March, the company will have its EV presence cross 10 cities. Increased emphasis on premiumization by launching high end variants under the X-Tech brand, partnership with Harley Division soon launching its products should help the company to post a good volume growth in FY 23E and increase its market share further. Recent comeback in the highly competitive 125 cc should once again lead to a good hold in this segment. Diligent management of the chip shortage issue has led Hero to tackle this issue completely. According to management the retail demand is 95% of pre-Covid levels.

Margins should grow as most of the factors are falling in place

Hero’s EBITDA margins in Q2 came 20 bps high at 11.4% qoq as we saw main input costs like those of steel and aluminium declining. There were other cost savings under LEAP-2 program as well. The company took price reasonable price hikes in Q2. Due to fall in input costs, the company saved 30-40 bps which led to RM costs to sales falling qoq. This along with favorable product mix shall lead the company to achieve its margin target of early of 14-16% in the medium term. Regarding product mix, premiumization of bikes with the help of global partner Harley Davidson shall augur well further. The launches of XTech variants which are priced higher by 5-7% than the original models should help the margins further to grow as operating leverage comes into play. Price hikes combined with superior product mix, input cost benefits and better operating leverage should help margin growth. The only negative factor is the currency depreciation which is impacting semi-conductor import. This may pull down margins a bit.

Outlook and Valuation

Hero posted decent set of numbers in Q2, led by good volume performance and ASPs growth. Along with the volumes, increase of margins qoq was the highlight of the quarter given the input cost benefits and product mix. Going forward, we expect decent volume trajectory with the XTech variants launched in Q2 and new launches coming up under the Hero as well as the HD brand. Expansion of the EV scooter in 10 cities by March will further add to the steam. Demand levers post pandemic are intact with rural story remaining strong on good monsoon and expected bumper Rabi crop. Now that the economy has opened up, normalcy has prevailed and demand is coming back on track (95% of pre-Covid levels). Financing has also become easier, which is also a driver for a broad based growth. Also, with inventory getting back to normal levels of 6-7 weeks v/s 4-5 weeks post festive, ramping up of production, improving demand, new launches and low base, we expect FY23 to post a high single digit growth after a weak FY22. Hero’s recent partnership with Taiwan’s Gogoro and 37% stake in Aether Energy to manufacture Electric Scooters and battery swapping platform shall give Hero a good entry in the EV 2W space. Profitability would improve through better product mix on Hero’s premiumisation theme under which the focus of the company is now on the premium bikes and X-Tech variants, price hikes (if required), cost saving programs like LEAP-2, operating leverage stemming from improving volumes and cooling off of the input costs. We therefore maintain our BUY rating on the stock with an increased target price of ?2,970.

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