Hero Motocorp Ltd is the country’s largest two-wheeler maker, enjoying about half the market share with a dominance in motorcycles. Yet, its stock has been the worst performer among peers in the past year.

Hero Motocorp’s stock trades at 14 times its one-year forward estimated earnings, while peers Bajaj Auto Ltd and TVS Motor Company Ltd trade at 18 and 25 times, respectively.

Graphic by Naveen Kumar Saini/Mint
Graphic by Naveen Kumar Saini/Mint

What gives?

Analysts say Hero’s profitability may be hit the hardest in FY20 and FY21 among two-wheeler firms due to the transition to BS-VI compliant vehicles, starting April. This is because nearly 70% of the company’s two-wheelers are in the entry-level segment, where the cost of transition is reportedly the highest. “Entry-level motorcycles cost increase is likely to be 12-13% double that for premium motorcycles," says Bharat Gianani, analyst, Sharekhan. TVS and Bajaj have 13% and 29% entry-level two-wheelers respectively in their overall volumes.

Furthermore, unlike its peers, Hero cannot find relief in exports where the BS-VI emission rules are not applicable. Only 3% of its total sales accrues from exports. In this respect, Bajaj and TVS export 46% and 20% respectively of their two-wheeler sales. Thus, they can hedge the downturn in domestic demand and impact on profit margins during the transition with exports that have been robust in the last few quarters.

That’s not all. Hero has already underperformed the industry in the last two months as it resorted to inventory correction to transition into new norms.

The pertinent question from an investor standpoint is: Will Hero pass on cost increase to customers? “Given the weak demand, Hero may not do so. This, along with poor operating leverage would impact profit margins," says Gianani.

On top of this, the discounts to liquidate the 30-40 days inventory of BS-IV vehicles will impinge profitability in the near term. As such Ebitda margin fell from 16% levels in FY18 to about 14% in recent quarters. This is unlikely to turn favourable in the near term. Besides, marketing costs for all auto firms in the run up to BS-VI new launches is expected to be high.

“BS-VI would not just impact overall demand but also pose a risk of value migration and change in competitive positioning,“ says a report by Motilal Oswal Financial Services Ltd.

Indeed, the pressure of BS-VI transition is likely to pose risks to all two-wheeler players, albeit in varying degrees. Still, for now it looks like the odds are against Hero due to some inherent weakness in its product mix. The street has also been discerning. Hence, while Hero shares tumbled 30% in the past year, Bajaj gained 12% and TVS lost about 12%. “We have reduced our FY20 and FY21 estimates by 7% and 10% respectively for Hero," says Gianani.

While Hero shares tumbled 29%, TVS fell 22% while Bajaj Auto gained 12%

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