Hero MotoCorp to ride high on volumes and low valuation, say analysts

Company's margins could expand on operating leverage and price hikes, say analysts

The stock of the country’s largest two-wheeler maker, Hero MotoCorp, gained over 4 per cent on expectations that strong demand trends, price hikes and operating leverage benefits will lift the company’s performance going ahead. This, coupled with undemanding valuations, added to the gains. As a result, the Hero MotoCorp was the second highest gainer on the Nifty 50 on Thursday, closing the day at Rs 2,509 apiece.

Aided by strong rural sentiment (higher crop prices, robust cashflows and normal monsoon expectations) and ongoing marriage season sales, two-wheeler retail offtake is expected to be strong in the near term. On a lower base, retail sales for two wheelers have risen by 38 per cent year-on-year (YoY) in April.

The company highlighted that inventory levels have come down to 6-7 weeks now as compared to 7-8 weeks at the end of March due to strong retail sales. With recovery in the entry level segment, the market leader, which has a 68.5 per cent share of this segment, is expected to improve on the number.

Analysts, led by Jinesh Gandhi of Motilal Oswal Research, believe that the company is poised for a faster recovery over other two-wheeler peers due to its rural-focused portfolio and market leadership in the entry and executive segments. The brokerage expects more traction in its core executive segment (Splendor and Passion) due to a decrease in percentage-wise price differential between its entry and executive models.

What could act as rerating triggers are an improvement in its competitive positioning in the scooters and the fast-growing premium motorcycle segment. Brokerages believe that the company, which has reported a volume decline in the 10-18 per cent range over the financial year 2019-20 to financial year 2021-22 (FY20-22) period, could improve its volume by 10-14 per cent over the FY22-24 period.

On the electric vehicle (EV) front, while it is less vulnerable, given single-digit contribution of scooters to overall volumes and lower impact on entry level motorcycles, the company has a three-pronged approach. It will launch its own, in-house developed, product in July this year, it also has investments in EV company Ather and is also in a partnership with Gogoro (battery swapping platform).

Though volume growth is positive, the Street will keep an eye on margin trajectory given the challenges on the commodity front. 

The company’s operating profit margins were down 280 basis points (YoY) and 100 basis points, sequentially, to 11.2 basis points in the March quarter and was below analysts’ estimates.

Hero MotoCorp is looking to counter commodity inflation by a combination of judicious price hikes and cost control initiatives. It took a price hike of Rs 500 per unit in the March quarter and Rs 1,000 per unit in April. The ongoing cost-reduction programme helped realise a 300 basis point gain in the March quarter. 

“The expectation of a strong demand recovery in two-wheelers (Q4FY22 retail sales exceeding company’s wholesale numbers) should result in operating leverage benefits for the company against near term raw material headwinds. This, coupled with the company's effective cost cutting efforts through the LEAP savings programme, should result in a 260 basis points margin expansion over FY22‐24E,” Deep Shah and Amber Shukla of YES Securities, said.  

While the company ended FY22 with margins of 11.5 per cent, this is expected to expand to 14.1 per cent by FY24. At just over 12 times its FY24 earnings estimate, the stock is attractively valued according to IIFL Research. Investors should await volume growth and margin improvement trends before considering the stock.