Hero MotoCorp's Q1FY19 results (Outperformer) - Steady Quarter, Rural Demand the Key

Q1FY19 results

• PAT below estimates: Hero MotoCorp’s Q1FY19 PAT at Rs9bn (-1% yoy) was 9% below our estimates mainly on lower other income and higher tax rate. Operational performance was broadly in-line.
• Revenues in line; Operating performance in-line: Revenues at Rs 88bn (in-line) increased by 11% yoy led by 14% yoy volume growth. Realizations declined by 2% qoq on account of lower other operating income (Rs 1.79bn v/s Rs 2.8 in 4QFY18)  on expiry of Haridwar incentives. EBITDA margins came in at 15.6% (-40 bps qoq;-70 bps yoy) as lower other expenses (-220 bps qoq) was more than offset by higher RM costs (+240 bps qoq). The RM cost increase reflects the stronger commodity cycle; the other expenses decline is on account of operating leverage and lower advertisement/fixed expenses (that maybe bunched up in future quarters). PAT at Rs 9bn (-1% yoy) moderated due to lower other income and higher tax expense.
• Concall highlights: (a) The management indicated price differential in the entry level segment wrt to competition existed in the past. It expects to maintain its market share without compromising on profitability.(b)It sees strong growth in the 125cc scooter segment going forward while 100/110 cc segment stagnating. The company will launch a 125 cc scooter during the festive season.(c)It has guided for a double digit growth for the 2W industry in FY19 driven by increase in MSPs, good monsoon and rural infra spends.(d) Rural growth(+11%) was faster than urban growth by 200 bps and the trend is expected to continue.(e) It has taken a price hike in July to counter commodity cost inflation and is expected to further raise prices in September.

Key positives: Lower other expenses

Key negatives: Lower other income and higher RM costs

Impact on earnings: We cut our FY19 and FY20 EPS by 5%/6%.

Valuations & view

HMCL with over 50% of its revenues from rural areas would be a key beneficiary of an improvement in rural demand on the back of a normal monsoon and support measures from the government. This cyclical uptick could mask the structural challenges before HMCL (high penetration levels, shift towards /premium motorcycles) over the next 1-2 years. While we recognise the risks posed by the detoriating pricing in the industry, we believe HMCL with its strong position in the executive motorcycle segment (an area where Bajaj Auto is weak) would be better placed when compared to its peers to weather the storm. Nonetheless taking into account the concerns we cut our target multiple to 17x FY20 EPS (previously 19X) for a target price of Rs3775.