Hero MotoCorp's Q1FY20 results (Outperformer) - Inline quarter; outlookuncertain

Q1FY20 results

• Inline quarter: Hero MotoCorp’s Q1FY20 reported PAT of Rs 12.6bn (38%yoy) was ahead of estimates on account of exceptional items (one-time reversal of provisions). The performance on an operating level was largely inline with expectations.
• Operating performance in-line: Revenues at Rs 80.3bn (-9% yoy) was a tad below estimates on lower realisations (down ~2% qoq). Realisations were impacted lower revenues from spare parts (7.7% of sales in Q1 versus 10% in Q4FY19). EBITDA margins at 14.4% (down 121bps yoy; up 90bps qoq) were a bit ahead of expectations (est: 14.0%). The sequential improvement in margins was on lower promotional expenses (decline in launch costs) that offset lower gross margins (down 70bps). Gross margins were impacted by high margin lower parts revenue/rollover to CBS that negated benefits from lower commodity prices.  We do note that the lower expenses could reverse in the coming quarters. The depreciation rose sharply by 57% qoq on accelerated depreciation policy (impact Rs650mn) while other income had a benefit of Rs500mn on exceptional interest income. Consequently, adjusted PAT at Rs 7.8bn (-13% yoy) met expectations.
• Concall highlights: (a) While the company expects H2 to be better than H1, it would wait till the festival season to recalibrate its outlook.  (b) It expects pre-buying in H2FY20 on account of a change in emission norms. (c) Rural demand has seen more decline vs urban demand. However, if monsoon are normal then company expect some revival in rural segment. (d) The inventory levels with dealers close to 40-45 days. Notably, the company indicated that this excludes inventory only at the network of the dealer (i.e sub dealers). To offset stress on the dealers, the company has increased the credit period. (e) Commodity costs could be stable going forward.

Key positives: Lower other expense 

Key negatives: Higher employee cost

Impact on earnings: We cut our FY20/21 EPS by ~10% each on lower volume growth/lower margins.

Valuations & view

The 2W segment is facing challenges with regulatory led cost push (ABS/Insurance) coming at a time when competitive pressures in the industry are rising. Further, the risk of an increase in registration charges coupled with BSVI cost hikes increases the volume risk for H1 FY21. However, we believe that HMCL’s current valuations at ~13x 12 month trailing EPS seems to reflect these concerns. Maintain an Outperformer on inexpensive valuations. Target price of Rs2500 (~14XFY21E EPS).