Hero MotoCorp’s Q2 show stellar, Q3 volumes crucial: Analysts

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Prakash Diwan of Altamount Capital termed the performance as great but said that the company’s profit and margins story needs to be seen with a headroom of it diminishing towards the last quarter of the fiscal year 2016-17. He said the company will have to roll out new models and have a healthy product mix to tackle competition. This, he added, will rev up profits for Hero MotoCorp, he said. A good product mix will help the company perform better in FY18, Diwan said. Echoing the Diwan’s opinion, Mayuresh Joshi of Angel Broking said the market will now want to see how the third quarter pans out for the company in terms of volumes. The company will benefit from the ongoing festive season, but the December-quarter performance will be crucial, Joshi said. Below is the verbatim transcript of Prakash Diwan and Mayuresh Joshi’s interview to Sonia Shenoy on CNBC-TV18. Q: There seems to be no flaw in these numbers at all looking very robust with a 15 percent revenue growth and almost a 30 percent profit growth. How do you read into the numbers? Diwan: Numbers are definitely wow there is no doubt and especially such a large P&L you keep on making this kind of strides is commendable, but a couple of things I just wanted to add the profitability and the margin story needs to be seen with some sort of headroom in terms of going forward, it would start kind of diminishing a bit towards the last quarter of this fiscal, because most the Leap programme which they initiated earlier now they are looking at cost related issues and not scale and efficiency because that already come in and where they will start benefiting is if they line up couple of new launches, which is missing as compare to let say a Bajaj and even TVS they have kind of fallen a bit on that. I think if that comes up then you will probably see the story get revved up again, but otherwise had the numbers come out during the market hours I am sure the stock would have still made a march towards a 52 week high or probably cross that as well at some stage, but I am quite optimistic about how things are looking up given the festive season around the corner and general build up that happening around the two-wheeler sales. Q: So the earnings before interest, taxes, depreciation, and amortisation (EBITDA) margins of the company has posted at 16.2 percent are the highest that the company has ever reported. Do you think that things can get better from here, because most of your cost control programme benefits have already flown through over the last couple of quarters? Diwan: That exactly what I am saying, so they should be close to the peaking out of stocks, at best you would see the benefits come only till the last quarter of this financial year. Beyond that they will have to reinvent themselves and I think the area to work on is going to be newer models because various price points if you see if they are competing against the likes of Honda and Bajaj at various price points not just one big player and that’s where they will need to kind of give some of strength on the portfolio. The product mix is something which I still feel can do much better with a pedigree like this. Q: I was just calculating the realisations as well, this time realisations per unit have fallen, but that because they have higher share of their low margin scooters that they are selling so realisations have fallen to Rs 42,750 a unit versus Rs 43,250 a unit earlier, but I wanted your thoughts also on how to approach this stock from here, because it hit their 52 week high or fresh highs of Rs 3,700 in September. It came off a bit from there, do you think there is valuation headroom or do you expect a rerating in the stock purely because the numbers are so good and you expect higher levels? Diwan: Not necessarily either the rerating would not be led by these numbers, these numbers only reinforce the high valuation that the stock trades at whatever it probably 18 times now, but my sense the next big trigger is going to be how they tackle the price point as I was saying. See scooter is a relatively new entry for them because they had to compete with Honda with their erstwhile partners. The same way the higher end bikes they have the Eichers and the Bajaj is eating into that growing market very rapidly. My sense is that is what going to be the next trigger and I definitely feel on dips this stock is definitely a buy because it will get rerated and had enough headroom to even get PE expansion at some stage after a dip, so I won’t be surprised if it is in that Rs 4,500 kind of zone let say early calendar 2017. Q: Solid set of numbers coming in from Hero MotoCorp, much better than what many analysts were forecasting. How did you read into the numbers? Joshi: It is a solid set of numbers as I see it. The net profit is much higher than what we had estimated. Similarly for the income figures. The volume growth is more or less in line with what we had said so, 16 percent growth. So, largely it is going to be a story in terms of how are they going to maintain their volumes going forward. You might have seen a push through happening on the volume front because of the festive season was around the corner. But Q3 hence how the volume growth pans out is going to be extremely important. So, if they point out to a double digit growth in the coming few quarters plus maintaining that market leadership share both in the economy in the executive segment where they are gaining market share my own sense is that the numbers then the street will probably rerate Hero MotoCorp. So, we need to watch out for management commentary in terms of how the volume growth is expected to go ahead. Q: The management commentary is quite good, at least in the press release says and I quote “the second quarter of this fiscal has been a defining phase in the journey of our young brand. The highest ever volume sales during the quarter is a reiteration of the overwhelming customer preference of our products and the launch of the Splendor iSmart and a couple of other launches is what has really boosted sentiments in this particular segment as well. The domestic market has seen a revival in the past two quartersdue to above average monsoons and positive consumer sentiment and the trend will continue likely to result in double-digit growth for the industry this year”. So, Pawan Munjal is talking about double-digit growth for the two-wheeler industry by the end of the year and reiterating that sort of guidance. On the stock how are you positioned because it is already up about 25-26 percent this year. Do you see more upside post these numbers? Joshi: The numbers were good. Again in terms of valuations if you look at the mean and median valuations almost 17.5 times forward earnings. So, largely how are they going to maintain their earnings before interest, taxes, depreciation and amortisation (EBITDA) margins the management has indicated a band of somewhere between 14-16 percent and as you are pointing out if they are pointing out a double digit volume growth my own sense is that it would be a mix through the executive segment and so that the new scooter launches which have come through and which got accepted pretty well. Secondly, one should also understand that the input costs are going up slowly. So, they need to also have demand realisations pick up in terms of volumes. That leverage picks up the average selling price across the categories picks up. And though I think the benefit from the lead program is expected to get on to Rs 18 crore odd even for FY17 the ad spends are expected to go up and the R&D expenditure is expected to go up. So the EBITDA margins might stay in that range but the leverage will get cleared on the balance sheet. So, yes, I remain positive on the stock. So, it is a hold rating from our side. Q: Between Hero MotoCorp and Bajaj Auto , Bajaj Auto hasn’t reported numbers yet, but do you see Hero continue to have a leg up purely because of its domestic focus? Diwan: Basically the leg up continues and not just the domestic focus. But the other advantage that Hero MotoCorp has is a fuel prices go up, let us say, from the bottom that we are at at any stage. Hero MotoCorp is always a preferred brand when it comes to two choices, when you have a Bajaj standing and a Hero MotoCorp product standing, people know that there is a strong perception that goes with the brand in terms of fuel efficiency. And today the spend is going to come from rural India which is still fuel conscious if not completely insulated from that. So, my sense is Hero MotoCorp does has that advantage. You will see a marked improvement in market share post this festive season. So, I will definitely go in for Hero MotoCorp.