Hero MotoCorp’s stock fell nearly eight per cent on Thursday, deflating most of its strong run last month. This reflected investor sentiment on a slower growth outlook and company guidance for significantly lower dividend. The company is at a crossroads; it is looking to scale up exports, as it faces rising competition in the domestic market. Its concentrated presence (70 per cent of volumes) in the ‘executive’ segment, where it dominates the market (a 78 per cent share in the March quarter), is threatened by rising competition from its erstwhile partner, Honda Motors, and Bajaj Auto, both of which have launches lined up for the segment.
This is even as it has started rebranding its old Hero Honda to a solo Hero tag ahead of the June 2014 deadline. Its management asserts the response to the Splendour series of motorcycles has been encouraging. It is also looking to scale up research and development (R&D) capabilities, which will bear fruit in the medium to long term. In the near term, given relatively rich valuations, rising competition and muted industry growth outlook, there is little upside for the stock.
Q4: Margins hit by currency movements
Hero’s quarterly performance was close to expectations on the top-line front (flattish sequentially and up 12 per cent year-on-year to Rs 6,035 crore), but operating margins took a 30-basis points (bps) hit (sequentially) to 15.3 per cent due to higher raw material costs. This was mainly due to the depreciation of the rupee against the yen in the December 2011 quarter, as vendors were paid with a quarter lag, according to the management. Higher cost of steel in the March quarter accounted for the rest. Higher-than-expected tax cost saw net profit come four per cent below Street expectations to Rs 604 crore. On a full-year basis, revenue growth was healthy, operating margins expanded and net profit grew faster; the latter was helped by a 220-bps fall in the tax rate to 17 per cent.
| FY13: STABLE MARGINS | ||||
| In Rs crore | Q4’ FY12 | FY12 | FY13E | FY14E |
| Revenue | 6,035 | 23,579 | 26,625 | 30,461 |
| Y-o-Y change (%) | 11.9 | 21.5 | 12.9 | 14.4 |
| Ebitda margin (%) | 15.3 | 15.3 | 15.7 | 14.2 |
| Y-o-Y change (bps) | -6 | 180 | 30 | -150 |
| Adjusted PAT | 604 | 2,378 | 2,904 | 3,257 |
| Y-o-Y change (%) | 20.3 | 18.4 | 22.1 | 12.1 |
| Reported EPS (Rs) | 30.2 | 119.1 | 145.4 | 163.1 |
| Y-o-Y change (%) | 20.3 | 23.3 | 22.1 | 12.2 |
| E: Estimates Source: Emkay Global | ||||
The disappointment edged in with a significantly lower dividend announcement of Rs 45 per share (45 per cent payout ratio and yield of about two per cent, according to MF Global Research), against Rs 105 and Rs 110 in the last two years, though the management pointed out that the latter included special dividends (Rs 80 and Rs 70 in 2010 and 2011, respectively), against a historical payout ratio of 40-45 per cent. The management guided to retain a dividend payout of 40-45 per cent. MF Global points out dividends help form a base level for valuations and in this case, are a key source of dissatisfaction with the stock.
The management also highlighted that it would look to conserve cash, as it expected quite a bit of cash outflow for building new capacity over the next two years. Analysts also expect some cash outflow for the company’s ambitious export plans, with the management suggesting it would explore setting up assembly units overseas, given high import duty structures in some countries.
The road ahead
Volumes in the March quarter increased by eight per cent year-on-year (y-o-y), boosted by strong exports on a low base, though growth slowed down domestically to under seven per cent. Volumes in 2011-12 increased by over 15 per cent on strong domestic volume growth of over 14 per cent, mainly in the first half. The management stated it saw the domestic industry’s growth tapering to nine to 10 per cent. Assuring that the dealer level inventory was stable at about three weeks (including three-four days in transit), Ravi Sud, senior vice-president and chief financial officer, said the company expected volumes to grow marginally ahead of this number at over 10 per cent, tracking 6.8 million in 2012-13. The management sees increasing rural penetration as central to its growth strategy, but higher petrol prices could play spoilsport. However, it aims to increase exports to about one million units in three-four years from the current level of 166,000 units.
On May 2, Hero also announced a price rise of Rs 500-1,000 across models to offset higher raw material costs. This was over the price rise taken mid-March to offset the excise duty hike. While the latest rise led analysts to raise their earnings per share (EPS) estimates (by two-three per cent) on higher estimated realisations, they are concerned about its impact against the backdrop of the rising intensity of competition. But the management sounded quite sanguine.
However, longer-term outlook is dependent on product rollout and stronger in-house R&D. Spending on R&D is at about 0.3 per cent of net sales and the ramp-up here is slow, according to Kotak Institutional Research. Hero expects to increase it to about one per cent of net sales and enhance its design and engine capabilities through technical tie-ups in place with AVL and Eric Bull Racing, says Kotak. The products will be key, given that Honda Motors has key launches planned in the 100cc ‘executive’ bike segment, while Bajaj has planned new launches/variants.
In 2013-14, tax exemption for its Haridwar plant is expected to fall from 100 per cent to 30 per cent of profits. Thus, Hero’s effective income tax rate is seen rising to 22-23 per cent (against 16 per cent guidance for 2012-13), say Citi’s analysts in a report. This could curtail profit growth.
Valuations
High valuations after its nine per cent run-up in the past one month were among key concerns. The stock’s correction on Thursday removed some of that froth. A lot depends on competitors’ strategy and pricing outlook in the near term, and valuations in the longer run will reflect Hero’s success in the overseas markets and in ramping up its R&D capabilities. For now, at Rs 2,072, the stock trades at about 15 times one-year forward consensus EPS estimates, and given 2012-13 volume estimates, there is little upside from these levels.
Citi analysts note, “Increasing competitive pressures are evident, as a result of which we think it will be difficult for the stock to re-rate meaningfully from current levels. We forecast earnings CAGR (compounded annual growth rate) of nine per cent over FY12-14 (versus 52 per cent CAGR in FY08-10).”
