Hero MotoCorp's Q3FY19 results (Outperformer) - Inline Quarter; rural demand key

Q3FY19 results

• Inline quarter: Hero MotoCorp’s Q3FY19 PAT of Rs 7.7bn (-5% yoy) was ahead of our expectations but inline with consensus estimates. The operational result was on expected lines.
• Operating performance in-line: Revenues at Rs 78.7bn (+7% yoy) was backed by a 5% yoy volume growth and a ~3% qoq increase in realizations. The higher realisations were a reflection of price hikes taken in October and a better product mix. EBITDA margins at 14.0% (down 190bps yoy) were impacted by higher commodity costs (+140bps yoy). On a sequential basis, negative operating leverage led to an increase in other expenses/employee costs. PAT was aided by a treasury gains on the back of higher other income.
• Concall highlights: (a) While 2W demand in the first half of January was weak, there has been a distinct improvement in the last 2 weeks. (b) It expects pre-buying in H2FY20 on account of a change in emission norms. This could lead to a volume growth in high single digits in FY20 (c) Rural demand has been sluggish partly due to lower rabi crop sowing and stress in the agricultural sector. Going forward, the company expects rural demand to show an uptick. (d) The inventory levels with dealers is high at close to 8 weeks (average 4-6 weeks). To offset stress on the dealers, the company has increased the credit period. This has led to receivables rising by ~10 days. (d)The company expects commodity pressures to ease a bit in the coming quarters.(e) The decline in scooter sales maybe linked to higher fuel prices in Q3 (scooters are less fuel efficient than motorcycles). (f) There has been downtrading in the industry post the increase in motorcycles on regulatory issues.   

Key positives: Higher realisations

Key negatives: Higher other expenses

Impact on earnings: We cut our FY19 and FY20 EPS by 2%/7% on lower volume growth/lower margins.

Valuations & view

There are near term pressures on the 2W segment with regulatory led cost pressures (ABS/Insurance) coming at a time when competitive pressures in the industry are rising. However, we believe HMCL with its strong position in the executive motorcycle segment would be better placed than its peers to weather the storm (it is least affected by ABS implementation). HMCL would be a key beneficiary of an expected improvement in rural demand on the back of government sops. The valuations at ~13.5XFY19 are inexpensive. Maintain an Outperformer rating with a target price of Rs2900 (14XSept2020E EPS).