Slowing entry segment volumes may derail Hero MotoCorp's sales trajectory

Shares of India’s largest two-wheeler maker, Hero MotoCorp have fallen nearly 15 per cent from the closing highs of March 2, far more than the 6.7 per cent decline in the S&P BSE Auto index during this period. Investors are concerned that slowing demand in Hero MotoCorp’s bread-and-butter segments, large inventory and rising commodity prices will dent its near term operating performance.

Demand pressures have increased due to a sharp increase in the cost of ownership led by successive price hikes taken by two-wheeler makers and the increase in prices of petrol. Customers are either postponing purchases due to this or opting for public transportation, say analysts. Vehicles registered till March 29 indicate that overall vehicle registration is down 30 per cent and two-wheeler registrations are down by a steeper 36 per cent.

While overall two-wheelers sales are down, what is hurting Hero MotoCorp is that the slowdown is impacting the entry and executive segments the most. Hitesh Goel and Rishi Vora of Kotak Institutional Equities say, “The slowdown is more evident in the price-sensitive domestic economy bike segment where wholesale volumes have declined by 6 per cent y-o-y in the past six months versus 14 per cent y-o-y increase in domestic motorcycle segment volumes during the same period.” Hero MotoCorp has around 65 per cent market share in this segment.

The weakness on the ground is perhaps also reflected in the higher inventories of two-wheeler makers. Hero MotoCorp's dealers say that inventories have been rising month-on-month with stock equivalent to 2-3 months of sales as compared to 3-5 weeks for Bajaj Auto/TVS Motor. Royal Enfield has negligible inventory and in some cases a waiting list, says Antique Stock Broking. While the company has raised prices, it is not enough to overcome the sharp rise in commodity costs. Further, any increase in discounts to clear the inventory could lead to increased pressure on margins.

In addition to the registrations, the Street will also keep an eye out for wholesale numbers for March for the two-wheeler industry. Given the lower base last year and the lockdown restrictions, wholesale two-wheeler numbers are optically higher.

This is also visible in Hero's numbers. For the month of March 2021, Hero reported sales of 576,957 units. While it is up 72 per cent y-o-y from 334,647 units sold in March 2020, it is still 0.7 per cent lower than 581,279 units it sold in the month of March 2019.

Lockdown restrictions after the surge in Covid-19 cases would be detrimental to near term volumes, both due to dealerships being open for limited hours and social distancing norms. The company, however, would be banking on a recovery in April led by the cash flows from the rabi season as well as demand due to the marriage season.

Given the headwinds, investor preference may switch to Royal Enfield (Eicher) and Bajaj Auto. Mitul Shah, head of research at Reliance Securities, says, “Eicher Motors and Bajaj Auto are at an advantage compared to domestic players such as Hero MotoCorp in this situation due to a stronger presence in the premium category of products and a sizeable presence in the high margin export business with favourable exchange rates.”

At the current price of Rs 2,958.10, the Hero MotoCorp stock is trading at 18.6 times its FY22 earnings estimates. Given the volume and margin pressures, investors should await better entry points.