Hero MotoCorp’s robust margins face challenge of rising input costs

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Hero MotoCorp Ltd cruised along in the September quarter, surprising investors positively with a beat on profitability, driven by strong festive season sales and demand for motorcycles.

To begin with, the results for the quarter are not strictly comparable with the year-ago period, given the different accounting because of the goods and services tax (GST) that subsumes excise duty, service tax and other such taxes, which earlier were shown separately in the profit and loss statement. Even discounts offered are included in the revenue figures.

In any case, the operating margin at 17.4% was 100 basis points higher than what the Street had anticipated. A basis point is 0.01%. Although raw material cost as a percentage of sales rose on the back of soaring commodity prices, there was a sharp reduction in other expenses, which the management said was on account of GST-led changes. For instance, service tax now gets subsumed in GST, which in earlier quarters was provided in other expenses.

Of course, the higher operating leverage helped, given the 11% jump in two-wheeler sales during the quarter at 2,022,805 units. Note that this was the highest-ever quarterly sales posted by Hero MotoCorp. Although the company adjusted prices in line with changes in GST, the net realization per vehicle sold was in line with recent quarters.

Net revenue for the quarter at Rs8,362 crore was 7.3% higher than the year-ago period, although it missed Bloomberg’s 23 analysts’ average forecast by a wide margin, given the GST-led accounting. Adjusted for this (with respect to the Haridwar plant that had excise duty exemption), revenue grew by 11.5%.

However, at this juncture, Hero MotoCorp’s market stature as the largest two-wheeler manufacturer in the country and a strong rural presence gives it an edge among peers. A good monsoon and lower interest rates along with a pipeline of new launches through the year augur well for the firm. The one concern is that the company has not had a great innings so far in the premium motorcycle segment and in scooters. Competition has seen market share erosion in the latter segment.

That said, analysts are confident that Hero MotoCorp would maintain sales traction and better the industry average even in the coming quarters. This is likely to sustain its current valuation of 18 times one-year forward estimated earnings per share. What needs to be watched is the pressure of higher commodity costs and marketing expenses that may eat into profitability in the second half of FY18, which in turn may have a sobering effect on the rising stock.