A spurt in Hero MotoCorp Ltd’s share price in Thursday morning’s trading session is not surprising after the company’s performance for the December quarter breezed past the Street’s forecast. But the question investors need to consider is whether the huge outperformance on operating margin will sustain in the coming quarters in the face of steadily rising costs.
Sure, net revenue of Rs6,364.2 crore, although lower by 12% year-on-year, topped Bloomberg’s average estimate. The quarter’s estimates had been watered down after the two-wheeler maker’s sales plummeted by 13% as it bore the brunt of the note ban. But in spite of lower sales, Hero MotoCorp’s operating profit of Rs1,079.8 crore was commendable and a huge beat on forecast.
The operating margin of 17% was the sweet spot of the quarter’s performance—130 basis points higher than a year back and a huge 200 basis points higher than Bloomberg’s estimate. A basis point is 0.01%.
The margin benefit came from higher gross margins, notwithstanding higher raw material prices. This offset an increase in the company’s staff costs and other expenses during the quarter.
Analysts reiterated the management’s explanation that the cost saving drive taken over the last several quarters is beginning to play out.
That said, note that Hero MotoCorp’s margin gains could have come from the higher finished goods inventory, as sales were suddenly hit in the December quarter. As this normalizes in the current quarter, margin growth may not sustain.
Meanwhile, with new emission norms coming into force, costs may increase. Some analysts feel that Hero MotoCorp’s new launches in the pipeline will entail higher advertising and marketing spends. All these could temper profit margins in the near term, unless demand is robust and the firm can pass on the cost increases to customers.
Meanwhile, the December quarter’s net profit of Rs772.1 crore was a tad lower than the year-ago period, but again topped Street forecasts.
Hero MotoCorp’s stock trades at Rs3,264, a fair 16 times the estimated earnings for fiscal year 2018. What’s important and could drive valuations higher is a sales ramp-up in the coming months, as the demonetization effect wears off.
A report from Emkay Global Financial Services Ltd while highlighting some positives says that higher rural spending by the government, and increase in disposable income with pay commission recommendation and tax savings in the recent budget can drive demand. This, along with the company’s ability to pass on any cost pressures through price hikes, will perhaps be the formula for margins to keep pace with growth.