Hero MotoCorp's Q2FY18 results (Outperformer) - Steady Quarter, Rural Demand the Key

Q2FY18 results

• PAT in-line: Hero MotoCorp’s Q2FY18 PAT at Rs10.1bn (+1% yoy) was in-line with our estimates. Lower other income (-23% yoy) restricted  PAT growth in spite of  strong operating performance.
• EBITDA margins surprise led by strong operational performance: Revenues at Rs 83.6b (below est) increased by 7% yoy – revenues were negatively impacted to the extent of Rs3.3bn as a consequence of difference in accounting policies due to GST. Consequently, while reported EBITDA of Rs14.5bn (up 6% yoy) met expectations, the EBITDA margins at 17.4% (+110 bps qoq) were 100 bps higher than estimates. EBITDA margins was driven by lower other expenses (-150 bps) on complete discontinuance of royalty payment to Honda in 2QFY18 and lower CSR expenses. The company indicated that EBITDA had been higher by ~Rs500mn (+60 bps) as state incentives for the Haridwar plant (due to a shift to GST) are yet to be notified. Overall, PAT at Rs 10.1bn (up 1% yoy) was inline with expectations.
• Concall highlights: (a)The company accounted for Rs 706 mn in revenues (58% of GST incentive) at Haradwar plant pertaining to Central government share of CGST Central governmente EBITDA margins by 100 bps which will be partially offset by state tax benefits xpects zation . It expects ~Rs500mn GST incentive refund from the state government in the coming quarters b)The management expects RM costs to increase in 2HFY18 as commodity costs have started firming up. c) Rural market showed signs of improvement in 2QFY18, the company expects momentum to improve in 2HFY18. d) Inventory levels stood at 4-6 weeks. e) Phasing out of Hardwar plant to impact EBITDA margins by 100 bps which will be partially offset by state tax benefits at Gujarat plant going forward.

Key positives: Lower other expenses

Key negatives: Lower other income.

Impact on earnings: We maintain our EPS estimates for FY18/19.

Valuations & view

With overall monsoons being normal (although spatial distribution is a concern), there is a reasonable possibility of a revival in rural demand on a low base. HMCL with over 50% of its revenues from rural areas would be a key beneficiary of the revival. With the effect of demonetisation waning and the low base in H2, there could be a boost to motorcycle growth rate, particularly as dealer inventory is now at reasonable levels. This cyclical uptick could mask the structural challenges before HMCL (high penetration levels, shift towards scooters/premium motorcycles) over the next 1-2 years. Maintain an Outperformer with a target price of Rs4,300 (19x Sep-19 EPS).