Hero MotoCorp: Geared for a comeback

Considering that 60-65 per cent of two-wheeler purchases are paid for in cash, the ban on high value currency notes has impacted sales in this segment quite badly. But while the effect of demonetisation is expected to wean away by the end of this fiscal, measures announced in the Budget to boost rural India will lead to a pick-up in demand.

With over half of its entry-level bike sales coming from the rural markets, Hero MotoCorp will be a beneficiary. A growing foothold in the executive segment bikes implies that the company will also benefit as urban consumption returns to normalcy, after the note ban.

Investors with a one- to two-year perspective can buy the Hero MotoCorp stock. It currently trades at about 18 times its trailing 12-month earnings, cheaper than other listed two-wheeler makers such as Bajaj Auto (20 times) and TVS Motors (36 times).

Two-wheeler sales were muted last fiscal, but showed signs of improvement in the first seven months of 2016-17. From a low 3 per cent volume growth in 2015-16 (over the previous fiscal), industry two-wheeler sales volumes picked up to grow at 16 per cent in April-October 2016 (over the same period last year). But the note ban took the wind out of the sails. Sales volumes in this segment contracted by up to 22 per cent year-on-year in each of the last three months. Having lower access to non-cash payment methods, the rural areas felt the heat of this move more than urban India. Hero’s rural focus hence saw the company’s sales volumes drop by up to 33 per cent year-on-year in the last three months.

But things are expected to improve. While sales volumes in the months of November and December bore the brunt of the demonetisation impact, the contraction in sales volumes has been less drastic in January. As withdrawal limits fade away, new currency circulation improves and digital payments gain ground, the note ban impact should be a thing of the past. This apart, generous hike in Minimum Support Prices for the 2016-17 season and increased year-on-year acreage of rabi crops imply good tidings for rural incomes. Secondly, the Budget’s thrust on rural India will also boost rural jobs and hence, rural incomes and consumption.

With strong brands such as Dawn, Deluxe, Splendor, Passion and its variants in the entry segment (110-125 cc bikes), Hero will benefit. The company is the market leader in the entry segment. Despite the headwinds in the last few months, its market share for the April 2016-January 2017 period stands at 73 per cent, higher than the 71.4 per cent in the corresponding period last year. The Splendor iSmart 110 was launched in this category in July 2016.

Besides, Hero has managed to gain ground in the executive bike segment (110-125 cc bikes) which brings in higher realisations. In the last 10 months, it has improved its market share in the 110-125 cc bikes category by about 250 basis points y-o-y to 40.9 per cent. The Super Splendor, Glamour and Ignitor brands belong to these segments. A new Glamour is expected to hit the markets next month.

Despite a 12.8 per cent fall in overall volume growth in the December 2016 quarter, Hero posted only about 2.6 per cent drop in net profit to ₹772 crore. While the 12 per cent dip in net sales to ₹6,246 crore mirrored the lacklustre volume show, lower input prices and cost control efforts helped margins. Operating margin was 17.3 per cent, about 140 basis points higher than a year ago.

The impact of recent rise in prices of steel, aluminium, etc. is expected to hit the company fully in the coming quarters as the company negotiates prices of materials six months in advance. However, it has already taken some price hikes in the quarter and as demand improves, it may be able to pass on more of the cost increases to customers.

Besides, the ongoing ‘Leap’ programme to save costs and improve margins across domains, will cushion the margins to the extent of 50-60 basis points in fiscal 2018.