For the past few quarters, the valuation of the Hero MotoCorp Ltd stock has been tailing that of peers such as Bajaj Auto Ltd, Eicher Motors Ltd and TVS Motor Co. Ltd. Hero shares trade at 14 times estimated FY21 earnings, paling in comparison to Bajaj, Eicher and TVS, which trade at about 17, 23 and 26 times, respectively. The Street has factored in a higher impact of the domestic market slowdown and BS-VI transition on Hero.
Against this backdrop, Hero’s performance beat across all parameters in the December quarter (Q3 FY20) is a pleasant surprise. Sure, revenue declined by 11% year-on-year, but at ₹6,997 crore, it is nearly 5% higher than Bloomberg’s average forecasts. Even as sales volumes declined, its sales mix was better, comprising higher spare parts sales. Further, price hikes improved realizations.
Improved sales mix and the cost-cutting drive that dovetailed lower raw material costs helped profitability. Earnings before interest, tax, depreciation and amortization (Ebitda) margin jumped 80 basis points year-on-year to 14.8%, better than Street expectations. A basis point is one-hundredth of a percentage point.
But the moot point now is whether Hero would continue with the trajectory of margin improvement seen in the last three consecutive quarters.
Unlike its peers, exports that are expected to offset the pain in BS-VI transition and the domestic market slowdown, are insignificant in the company’s revenue.
The good news, however, is that the extent of drop in sales is lower for Hero, across auto segments. In its analyst call, the management said that inventory is now at five weeks, down from six in December. Meanwhile the company is unlikely to increase discounts on BS-IV variants, even as it has been able to pass on the costs of its new BS-VI vehicles. Of course, a clearer picture will emerge by March, as most firms completely stop BS-IV production and start filling inventory channels with BS-VI models.
“While the company anticipates 1HFY21 to be muted, improving rural sentiment is likely to support sales during 2HFY21. Although near-term demand environment remains uncertain, HMCL is one of the best plays for rural recovery," said analysts at JM Financial Institutional Securities Ltd in a report on 6 February.
Meanwhile, the competition among two-wheeler firms to garner a larger pie in the new tech era (BS-VI) is bound to be severe. Analysts say high marketing and advertising spends could be a drag on auto firms’ profitability. Hero is already the undisputed leader in motorcycles, lapping up nearly half the share in the domestic market. However, it needs to gain ground in scooters too.
“Over long term, market share gains in scooters and/or premium motorcycles are imperative for re-rating. Our positive thesis is premised on Hero’s resilient motorcycle market share (51.3% YTD) as well as its valuation cushion vis-à-vis peers," said Yes Securities Ltd analysts in a report.