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Undergoing consolidation

Hero MotoCorp’s (HMCL) Q3FY22 EBITDA margin, at 12.2% (down ~45bps QoQ), was in line with our estimate despite 10% volume decline and adverse raw material environment. Volumes and revenues were down ~30% YoY and ~19% YoY respectively, with ASP up ~15% YoY to a record ~Rs61k/unit. Despite raw material cost per unit being ~16% YoY higher, gross margin shrunk by only ~50bps YoY (vs ~300-500bps for other OEMs), largely driven by cost saving initiatives, better mix, focus on spares and price hikes. Management expects FY23 to witness entry-level demand pickup as farm incomes are likely to improve on higher rabi output, marriage season without covid-driven disruption and improving consumer sentiment. With raw material cost inflation stabilising along with continued price hikes, we expect HMCL to return to ~14% EBITDA margin by FY24E. Its strategic partnerships in EVs (e.g. Ather, Gogoro) are likely to augment its own EV portfolio (launch planned for Mar’22). Maintain HOLD with a target price of Rs2,854.

* Key highlights of the quarter: EBITDA margin of 12.2% was down 228bps YoY as gross margin fell 47bps YoY to 29%. ASP rose 15% YoY to ~Rs61k/vehicle due to higher export/premium segment mix coupled with higher sales of spares (~Rs11.9bn, up 15% YoY). PAT shrunk ~37% YoY to Rs6.9bn (due to 40% decline in other income).

* Key takeaways from earnings call: Management indicated: a) price hikes of Rs1k and Rs0.5k were taken in Oct’21/Jan’22 (Rs0.8k/Rs2.2k were taken in Q1/Q2FY22); b) spares revenue reached an all-time high of Rs11.86bn (up 15% YoY); system inventory stood at 7-8 weeks; c) exports reached an annualised run-rate of 300k units as key markets of Mexico and Bangladesh witnessed economic recovery; d) HMCL is making good inroads into the high-growth 125cc+ scooter segment with XTEC model in Pleasure commanding a 20% share and XTEC model for Destiny to be launched soon; e) on EV plans, HMCL indicated launch of its first EV scooter in Mar’22 followed by a new launch every year; EVs would be launched in both exclusive stores and existing dealership network; f) HMCL would be an exclusive partner with Gogoro for setting up battery swapping stations; however, sharing of infrastructure with other OEMs would be further evaluated when a JV is formed; g) HMCL has invested an additional Rs1.5bn in Ather (cumulative Rs6.5bn) to further strengthen its EV strategy; h) Hero Fincorp raised Rs20bn in its latest funding round with HMCL investing an additional ~Rs7bn; this investment is expected to increase the AUM from Rs260bn to Rs500bn in next three years; finance penetration in Q3 stood at 58% against 37-40% share pre-covid; and i) with 8-10% of sales to students, restart of schools and colleges is expected to further boost sales.

Valuation methodology and key risks

HMCL was impacted by weak demand trends since FY21 as customers’ affordability at the entry level was majorly hit by covid. However, opening up of offices and schools post covid third wave has resulted in a few green shoots of demand and, with marriage season in North India, could aid in recovery of rural markets. HMCL’s multipronged partnership strategy (e.g. Ather/Gogoro) bodes well in terms of collaboration for its future EV product launches. We increase our earnings estimates by 4% / 5.2% for FY23E / FY24E and maintain HOLD with a DCF-based target price of Rs2,854 (earlier: Rs2,681) at an implied multiple of 13x FY24E core EPS. Value unlocking of its ventures in EVs, like Ather, can push valuation up, in our view.

Upside risks: a) Faster-than-expected revival in rural demand in FY23; b) faster-thanexpected reversal in raw material basket costing, pushing up margin higher than estimated; c) exports increasing significantly through success in new markets; and d) launching successful EVs and premium biking models.

Downside risks: a) Rise in competitive intensity in HF Deluxe segment; b) adversity in raw material costing continuing across FY23; c) chip shortage not getting resolved fully; d) e-2W disruption picking up pace faster than anticipated; and e) earningsdilutive M&A in search of growth.

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