Stock Fundamentals

Why the stock of Hero MotoCorp is a good ‘Buy’

Parvatha Vardhini C BL Research Bureau | Updated on April 17, 2021

Price correction is a good opportunity for long-term investors to take the plunge

Investors with a one to two year perspective can buy the Hero MotoCorp stock. Market volatility since the benchmark Sensex index first touched the 50,000-mark has seen many bluechips correct and Hero is one of them. The stock has lost about 20 per cent from its one-year high of ₹3,628 clocked in mid- February.

A rise in fuel prices as well as price hikes to pass on escalation in commodity costs have also impacted the stock, as the company caters to the price-sensitive commuter segment, predominantly.. With the second wave of Covid rearing its head, production and sales volumes could take a hit in the next 2-3 months.

However, over the medium term, prospects remain intact. For one, after two-years of a cyclical downturn, a low base promises to support volume growth for the auto industry this fiscal.

Secondly, the forecast of normal monsoons bodes well for rural sales, wherein the company has a strong foothold. Three, the focus on and increase in market share in the premium segment indicates that Hero will benefit from better realisations and margins over the next few years. Hence, the correction in the price is a good opportunity for long-term investors to take the plunge.

At the current price of ₹2,893, the Hero MotoCorp stock trades at a valuation of 15.5 times its estimated earnings for FY22 (Bloomberg consensus). This is at a discount to peers Bajaj Auto (18.7 times FY22) and TVS Motors (30 times FY22).

Pulling back from the lockdown early last fiscal and backed by a good festival quarter in the October-December period, Hero did well to end FY21 with a 10 per cent year-on-year (y-o-y) fall in sales volumes (wholesale) vs the industry average fall of 13 per cent. In a tough year, Hero managed to grow its market share in the commuter segment, after being beaten down by Bajaj Auto in the last three years.

Sanguine outlook

With models such as Deluxe and Splendor, Hero MotoCorp is the market leader in commuter bikes and entry-level bikes (75-110 cc). Bajaj’s market share in the commuter segment, which stood at 12.8 per cent in FY18, moved up to 17.1 per cent in FY20. Amid the slowdown in new vehicle sales in those years, Bajaj Auto shifted focus to volumes rather than margins to improve its share. As a result, Hero lost market share, from 74.5 per cent in FY18 to 72.4 per cent in FY20. In FY21, though, Hero’s share improved to 76.2 per cent while Bajaj’s came down to 13.65 per cent.

Hero’s strong foothold in the rural markets, which did better than urban for a good part of last fiscal, as well as preference for personal mobility by users of public transport due to the need for social distancing, augured well for Hero.

Besides, Hero also strengthened its presence in scooters with launches. After almost halving from 13.1 per cent in FY18 to 7.2 per cent in FY20, Hero’s market share moved up to 9.8 per cent in the scooters segment last fiscal.

Into FY22, there are two concerns. One, retail sales continue to lag wholesale, going by data from FADA (Federation of Automobile Dealers Association). However, there is no inventory build-up with two-wheeler dealers, indicating that the end customer offtakes are indeed steady. Post the festival season — which usually sees two-wheeler dealers having an inventory of 6-8 weeks — inventory levels have been steady at 30-35 days in the last four months. The retail numbers can be taken with a pinch of salt as not all RTOs are covered here and there could be lead and lag impacts.

A second concern is on further production and/or dealership shutdowns. This is, however, not expected to happen on a large scale like last year and hence the dent may not be deep. The low base of FY20 and FY21, where two-wheeler volumes dropped y-o-y by 18 per cent and 13.6 per cent respectively, provides good support for volume growth this year.

Hero will also benefit from its premiumisation efforts, a trend that has caught on due to increasing affordability and urbanisation. Hero’s market share in the 150-200 cc segment bike — a space it entered only two years ago — stands at 6.8 per cent in FY21, thanks to successful launches such as the Xtreme 160R, Xtreme 200S, XPulse 200 and XPulse 200T. Over the next three to five years, the company plans to strengthen its presence in this middle-weight segment through consistent launches/refreshes. The tie-up with Harley Davidson also brings a ready presence in the super premium segment for Hero.

Financials

For the nine months ended December 2020, net sales was down 2 per cent year-on-year at ₹22,114 crore and adjusted profits, down 16 per cent to ₹2,099 crore. Operating margin came in at 12.7 per cent vs 14.3 per cent a year ago. With input prices increasing, the company has been taking periodic price hikes to partially pass it on, since October last year. While the company maintains its medium-term margin target of 14-16 per cent, the fourth quarter is likely to see some margin pressure. A volume growth of 18 per cent (helped by a low base in March 2020) , a superior product mix from premium bikes as well as the company’s ongoing cost savings programme‘Leap’ might help mitigate it to an extent.

Published on April 17, 2021

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