Stock Call. How Hero MotoCorp is well-placed to ride out the storm

Automobile sales, which have been going downhill since the second half of 2018-19, suffered a double whammy due to the Covid-19 outbreak. Being a discretionary consumption item, new vehicle sales may not recover in a hurry. Nevertheless, there are pockets of opportunity.

Preference to personal mobility with a view to maintaining social distance is one. Expectations of better rural demand vis-à-vis urban is another.

Value segment products may do better, thanks to Covid-19-induced pressures on income.

Hero MotoCorp is in a good position to cashin on these trends.

The company is the market leader in entry/commuter bikes and has a strong foothold in the rural markets.

Perhaps, considering the positives, the stock has gained over 50 per cent from the one-year low of ₹1,475 it had touched in late March. However, when considered in the light of its valuation, the stock trades cheaper than its peers. Hero’s trailing 12-month PE stands at 12.6 times; Bajaj Auto trades at 15.4 times, and TVS Motor at 27.5 times. Investors with a two-year perspective can make use of the broader market volatility to accumulate the stock on dips.

Market leader

After closing operations temporally in April due to Covid-19, Hero has gradually resumed operations across all its plants.

The company was able to sell 1,12,682 units (including exports) in May as against the run rate of about 5 lakh units in January and February (pre-Covid). All the company’s vendors have also recommenced operations, and about 90 per cent of the dealership outlets have also opened up.

Though it is still early days and capacity utilisation remains on the lower side, the company is currently seeing encouraging enquiry and conversion rates.

Given the uncertainty, Hero has refrained itself from giving guidance for FY21.

In 2019-20, the total domestic two-wheeler sales for the industry dropped by 18 per cent over 2018-19 and Hero’s volumes saw a similar fall.

In the months to come, Hero expects demand in the rural and semi-urban markets to be better than in urban. Rural India is relatively less-affected by the pandemic. Good rabi harvest, forecast of normal monsoon, higher minimum support prices for khariff crops and greater allocations to the MGNREGA scheme are expected to translate into more income in the hands of the rural consumer.

Hero’s market leadership position in the commuter segment augurs well in this regard.

Commuter bikes predominantly cater to the rural and semi-urban markets.

With models such as Deluxe and Splendor, Hero MotoCorp has over 70 per cent market share in commuter bikes and entry-level bikes (75-110 cc). In the past two years, the company has been facing stiff competition from peer Bajaj Auto in this space.

Bajaj’s market share in the commuter segment, which stood at 12.8 per cent in 2017-18, moved up to 17.1 per cent in 2019-20.

Amid the slowdown in new vehicle sales, Bajaj Auto shifted it focus to volumes rather than margins to improve its share.

As a result, Hero lost the market share initially, from 74.5 per cent in 2017-18 to 72.4 per cent in 2018-19. However, the company has been able to retain its share at the same levels in 2019-20.

Hero has also improved its position in the executive (110-125 cc) and premium segments (150-200 cc). Its market share in the executive segment (Splendor iSmart, Passion Pro, Super Splendor Glamour) improved by 10.5 basis points last fiscal, over the previous fiscal. It now holds almost 50 per cent share in this space. It will also introduce the Xtreme 160R shortly in the premium space.

Preference for personal mobility over public transport in urban markets may work in favour of these bikes this year.

About 43 per cent of the company’s sales went through the financing route in FY20. While factors such as pay-cuts may result in more consumers resorting to financing this year, Hero does not expect lending institutions to play truant. Considering the lower ticket-size and duration, the company considers two-wheeler loans to be relatively less risky for banks/finance companies.

Financials

Although volumes for Hero MotoCorp dropped by 26 per cent in the quarter ended March 2020 (over January-March 2019), the company managed to contain the fall in revenues to about 21 per cent (₹6,238 crore). Higher realisations from a better product mix as well as price increase of up to ₹2,000, effective January, helped the top line.

Lower expenses and benefits on the tax front due to adoption of the new tax rate of 25.17 per cent helped contain the profit fall to 15 per cent (₹621 crore). However, despite some tailwinds on the cost front, operating margins came in at 10.6 per cent, compared with 13.5 per cent in the three months ended March 2019.

Apart from lower operating leverage due to a fall in volumes, the margin performance was also impacted by one-off items such as discounts for clearing BS IV inventory as well as provisions for loss of incentives receivable for the Neemrana plant as part of the GST transition.

To tide over the tough times, Hero has launched another phase of its ‘Leap’ cost savings programme and is targeting a reduction of 100 basis points compared to 50 basis points last year. It is also focusing on improving productivity on overheads. Capex plans for this fiscal has been pruned to ₹ 600 crore from ₹ 1,000 crore.

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