BackCost pressures puncture net profit at Hero MotoCorp even as sales cruise
Raw material costs rose by 140 basis points as a percentage of sales. Other expenses were higher too
PremiumIn challenging times, sales growth alone is inadequate to sustain profits. December quarter (Q3 FY19) results of India’s largest two-wheeler maker Hero MotoCorp Ltd reflected the same. In spite of clocking decent sales growth with better volumes and realizations, profits dropped from the year-ago and sequentially preceding quarters.
Ebitda (earnings before interest, tax, depreciation and amortization) slipped by 4.6% year-on-year to ₹1,104.8 crore. This was notwithstanding the 7.5% net sales growth. In case of arch-rival Bajaj Auto Ltd, whose Ebitda too fell in the quarter, it was a steep drop in realizations that dragged profits down. But for Hero, average realizations grew 2.2% even as it sold 5.3% more bikes and scooters during the quarter.
Clearly, costs took a toll on the company’s profits. Foremost was raw material costs that rose by 140 basis points as a percentage of sales when compared to the year-ago period. Other expenses were higher too, while employee costs rose a bit. In its media release, the management said, “There have been temporary setbacks in the third quarter of the current fiscal on account of multiple factors, leading to higher than normal inventory levels at dealerships."
Normally discounts and marketing costs are mirrored in “other expenses". Obviously, promotional expenses may have been warranted due to low demand and stiff competition with Bajaj Auto, which has been offering price cuts in some segments. In this context, Hero’s ability to hold out with market share in motorcycles at around 51.5% (December quarter), with only a marginal dip from the FY18 level, is commendable.
Without doubt, higher costs weighed on profit margins. Hero’s Q3 Ebitda margin was 180 basis points lower than a year ago.
The key question for investors is whether rural demand will gain traction in the coming quarters. After all, Hero’s sales are skewed in favour of rural markets. Much depends on the fate of the monsoon and the rural benefits doled out by the government.
Meanwhile, there is good news for Hero and all other auto firms on input costs, since commodity prices have softened in the last few months. Hopefully, this should support Ebitda margins ahead.
This is not to say that investor confidence would return soon. Hero MotoCorp’s stock, although an outperformer in the two-wheeler pack over a longer time frame, has met with the same fate as its peers in the recent past. Weak demand along with stiff competition could entail higher marketing costs to sustain its leadership position in the industry. At ₹2,612, it trades at 15 times one-year forward earnings, which is reasonable compared to peers. However, whether investors have a cushy ride would hinge on strong Q4 sales accompanied with margin expansion.
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