Hero Motocorp: Several triggers for FY15 earnings

Cost-cutting steps to see 300-bp margin expansion by FY17, robust scooter demand to boost volumes

The market may have lost interest in expensive consumer staples, but the outlook on consumer discretionary stocks remains positive. Even though auto companies may have exited FY14 on a weak note, latent demand is expected to push up volume growth to seven to eight per cent in the current financial year. And two-wheelers are expected to ride out of the slowdown faster than the passenger vehicle segment as consumer appetite for scooters remains robust. Hero Motocorp has visibly gained both on the volume and profitability front, thanks to its strong presence in the scooter segment. The company's revenues grew six per cent to Rs 6,513 crore, driven by 4.1 per cent volume growth and 2.2 per cent growth in net average realisations. The volume uptick was primarily driven by the 15.5 per cent year-on-year growth in scooter volumes.

The scooter portfolio is a big factor that differentiates Hero from its competitor Bajaj Auto. Strong scooter sales have also helped lift the company's operating margins. While the Street was expecting the company to report a decline in margins on dealer compensation for the excise duty cuts, Hero surprised the Street. Its margins expanded by 67 basis points year-on-year to 13.7 per cent against expectations of a 60 basis points decline.  This was driven by the higher realisations and a right control on costs.  The company exited the financial year with operating margins of 14 per cent. The company has conveyed that it intends to improve margins by 250-300 basis points by FY17. While the market believes it is too ambitious a target, analysts are expecting current margin levels to sustain.

Higher margin guidance and increase in scooter capacity are two big triggers for the stock claim analysts. In FY15, the company's planning to launch a electric hybrid scooter (Leap) and a 110  cc scooter (Dash), apart from two motorcycles in the higher than 150 cc segment. The management has conveyed that it expects the two-wheeler industry to clock volumes by 10-11 per cent in FY15. Centrum Equity Research says: "While the company continues to hold strong franchise in the rural market, we believe improved consumer sentiments on the urban side should help it register better than expected growth. Also, unlike Bajaj Auto, it has a strong presence in the scooter segment and continues to hold on to its market share in this fast growing segment."  Another big trigger that could lead to earnings upgrades later this year is Hero's cost-cutting spree and its impact on margins. The company’s cost-cutting measures are yielding benefits. The company has indicated that it will cap adspends at 2-2.5 per cent of sales. The company has consolidated its raw material purchases through vendor rationalisation and is better managing its logistics. IIFL expects the company to end FY15 at monthly savings Rs 50-60 crore. The stock is trading at a relatively attractive valuation of 14.2x its FY16 earnings, which is not considered expensive.