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Business News/ Companies / Hero MotoCorp’s margins to remain under pressure
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Hero MotoCorp’s margins to remain under pressure

High spending on marketing initiatives to shore up flagging sales in rural India hurts cost-saving efforts

Photo: BloombergPremium
Photo: Bloomberg

Mumbai: Hero MotoCorp Ltd, India’s largest maker of motorbikes, is unlikely to meet the cost-saving targets it set for itself in the year ending 31 March because of high spending on promotions to prop up flagging sales in rural India and increased expenditure on brand and marketing initiatives, say analysts, although the company is confident of doing so.

The company is investing money to strengthen its brand after ending a joint venture with its Japanese partner Honda Motor Co. in December 2010.

In May 2013, Hero MotoCorp, the maker of Splendor and Passion bikes, started a four-year initiative called Leap that envisaged cost savings of 75 crore in each quarter till the end of the programme.

“Increasing competition in the domestic market, weak rural sales and high marketing and promotional expenses aimed at protecting the market share will eat into the savings and the actual realization for the firm may be lower," said Bharat Gianani, an analyst at Angel Broking Pvt. Ltd.

Hero MotoCorp had to boost expenditure on marketing and promotions because of weak sales in India and on setting up infrastructure in the newer markets that it is tapping into, for exports. Over the past couple of years, the company has entered several countries in Africa and Latin America, and is in the process of setting up local assembly plants in Colombia and Bangladesh.

In an emailed response to queries from Mint, a Hero MotoCorp spokesperson attributed slowing rural sales to factors including the curtailment of spending on the rural job scheme, poor crop realization and moderating wages.

The industry, the spokesperson said, has felt the impact of such factors on retail sales in Bihar and Madhya Pradesh, and sugarcane-growing areas of Uttar Pradesh and Maharashtra.

To be sure, the downturn is not a nationwide phenomenon.

“We are clocking double-digit growth in some other rural markets including West Bengal, Odisha, Karnataka, Uttarakhand and also parts of Uttar Pradesh. With the onset of the marriage season in April, the industry expects the market sentiments to improve," said the spokesperson.

Reflecting a slowing trend in the broader motorcycle market, Hero MotoCorp’s sales dropped 4% to 484,769 units in February for the second consecutive month. In the 11 months from April to February, sales advanced 6.6% to 5.7 million units from the same period last year, according to company statements.

The Leap programme contributed more than 150 crore in savings in fiscal 2013-14 and the company expected to more than double it in fiscal 2014-15.

This, the spokesperson said, will add 100-110 basis points (bps) to the company’s operating margin on a stand-alone basis. A basis point is 0.01%.

Hero MotoCorp’s quarterly run-rate of savings currently is to the tune of 75-80 crore, he said. “These savings are enabling us to invest judiciously in our global foray, brand-building initiatives and new product development," the spokesperson added.

Hero MotoCorp’s other expenses, which also include sales and marketing expenses, have been rising steadily since the December quarter of fiscal year 2012-13. Such expenditure went up to 798 crore in the three months to December on a one-time expense the firm incurred after engaging golfer Tiger Woods as a brand ambassador.

This dragged down margins—both sequentially as well year-on-year. Margins fell to 11.41% in the December quarter of 2014-15 from 12.67% in the corresponding quarter last year and from 12.86% in the September quarter.

To be sure, increasing expenses on sales promotions, which includes dealer incentives and indirect discounts to buyers in the form of cheap finance schemes—largely a function of tepid demand—is an area of concern for analysts tracking the company.

“While the company has succeeded in saving costs, it’s being consumed by increase in expenditure in sales promotions and marketing, yielding negatives for the shareholders," said an analyst at a domestic brokerage firm, who declined to be identified. This, he pointed out, can be seen from the margin drop.

Typically, two-wheeler firms offer attractive finance schemes instead of giving cash discounts through their dedicated finance arms.

Hero FinCorp Ltd, the captive arm of the company, for instance launched a special scheme in February offering credit at 6.99%, which is lower by as much as 400 bps compared with commercial bank rates, according to the company’s dealers who declined to be identified.

So far this calendar year, Hero MotoCorp’s shares have lost 14.53% on BSE, underperforming both the auto index and the benchmark Sensex, which rose 5.52% and 4.5%, respectively.

Analysts said the stock will continue to remain under pressure for at least two-three months more. Normal monsoon rainfall, which will help boost rural demand, is a key factor.

Gianani of Angel Broking has pared the target price for the stock from 3,260 to 3,118. So have others.

“We reduce our earnings per share estimates by 2%, 9% and 11% (for fiscal 2014-15, 2015-16 and 2016-17) to 130.9/ 157/ 185.3, factoring weak rural demand," wrote Raghunandhan N.L., an analyst at Quant Capital, a securities and brokerage firm, in a 17 March report.

He, however, expects robust earnings at a compounded annual growth rate of 19% over FY15-17E and has a “buy" rating on the stock with a target price of 3,150.

Analysts say Hero will benefit from the tax incentives that it gets at its Haridwar plant.

“Although, the company expects saving of more than 100 bps from Q4FY15 on higher benefits from the tax-free plant as higher excise rates have been reinstated, we believe margins may remain low for next few quarters on higher expenses on entry into newer export markets and commissioning of new plants," Ashish Poddar, an analyst at IDBI Capital Market Services Ltd, wrote in a 4 March report.

Poddar said healthy volume growth driven by success of new launches (two new scooters are planned in fiscal year 2015-16) and cost-reduction measures will help Hero MotoCorp to expand margins meaningfully in the long term.

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Published: 24 Mar 2015, 12:28 AM IST
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