Hero MotoCorp: Costs dent performance

While volumes have recovered, operating profit margins fall steeply due to rise in raw material & sales promotion costs

The country’s largest two-wheeler maker, Hero MotoCorp, had a disappointing quarter with operating profit and margins below analysts’ expectations. Though higher volumes and price hike undertaken earlier in the December quarter helped improve revenues, higher raw material costs and promotional expenses dented margins. Weaker operating performance pegged back net profit, which fell a steep 20 per cent.

Though industry volumes are expected to be lower in single digits for FY13 and volumes in Q1FY14 are likely to be muted, Hero MotoCorp’s management believes that recent launches and rural demand should help it sustain steady volumes, going ahead. The December quarter notwithstanding, analysts believe that the risk reward is getting favourable for the company and suggest an entry, especially if the stock corrects in response to the poor quarter numbers. “A 15 per cent FY14 P/E discount to Bajaj Auto could narrow as margins are expected to improve on stabilising raw material costs, gains from yen depreciation and volume growth, going ahead,” says an analyst.

Margins muted
Earnings before interest, tax, depreciation and amortisation (Ebitda) margins came in at 12.6 per cent, 305 basis points (bps) lower year-on-year (y-o-y) due to higher raw material costs as well as higher other expenses. The management said higher raw material cost was both due to new launches (Ignitor/Maestro) as well as reintroduction of Hunk. New launches increase metal costs, according to the company. And the product mix thus was adverse, according to the management. While raw materials to sales for the quarter stood at 74 per cent, management expects it to stabilise at 72-73 per cent levels, going ahead. Other expenses were up due to brand building activities as the company spent money on publicity and advertising campaign around the launches / refreshes of Maestro, Ignitor, Extreme and Glamour. Hero expects sales and promotion costs as a percentage of sales to be around the two per cent mark. With raw material costs and volumes stabilising and most of the promotions already done in December quarter, analysts expect Ebitda margins for the company at the end of the year to perk up to 14 per cent for FY13. While Bajaj Auto continues to be ahead of its larger peer by consistently posting 20 per cent Ebitda margins, profitability of Hero would improve once the royalty payments cease post-FY14.

LOWER MARGINS
In Rs crore	Q3FY13	% change y-o-y
Volumes*	15.73	-1.0
Net sales	6,187	2.6
Ebitda	778	-17.4
Ebitda (%)	12.6	-305 bps
Adj net profit	487	-20.4
* in lakh units Source: Religare

Volumes rebound
While volume growth for the quarter was down one per cent y-o-y, it improved 18 per cent sequentially due to the launch of new models, higher festival sales and a weak September quarter. The previous quarter was a poor one for the company with sales of 1.3 million units as against an average run rate of 1.5 million units. This helped push up revenues by 2.6 per cent y-o-y and 19 per cent sequentially. Despite the steady December quarter, motorcycle volumes for the nine-month period ending December dropped five per cent. Scooter sales however, jumped eight per cent as the overall scooter market continues to outpace motorcycles, growing at about 20 per cent y-o-y. While the company’s Maestro scooter is doing well, Pleasure sales are impacted by competitive pressures from Honda, believe analysts. However, given that motorcycles contribute over 90 per cent of its volumes, the focus will continue to be on sustaining volume growth, going ahead. The company expects to launch seven to eight new models, refreshes and variants in FY14. Analysts say the company could achieve six to seven per cent growth in FY14.