Low volumes, BS-III discounts pull Hero’s net down by 14%

Analysts had muted expectation for March quarter, given the overhang of change in emission norms

Hit by lower volumes and liquidation of BS-III stocks, Hero MotoCorp, the country’s biggest two-wheeler maker, reported a 14 per cent decline in profit for the March quarter. Profit stood at ~717.8 crore against ~833.3 crore in FY16.

Revenue from sales declined almost eight per centto ~7,488crore. Volumes sold declined almost six per cent to 1.72 million units in the first full quarter after note ban in November last year. The firm said liquidation of BS-III stocks in two days of March at discounts led to a one-time impact on margins. Earnings before interest, taxes, depreciation and amortisation margins was at 12.8 per cent against 14.7 per cent in theyear-ago quarter.

For the full year 2017, revenue saw a marginal growth to ~30,846 crore against ~30,701 crore in FY16. “In the domestic market, we have maintained our leadership in a competitive environment,” said Pawan Munjal, chairman, managing director & CEO while announcing a capital expenditure of ~2,500 crore for FY18 and FY19.

Investors may forgive Hero MotoCorp’s Q4 miss

The end of the March quarter was extremely painful for two-wheeler and commercial vehicle manufacturers.

In an unexpected blow, companies were pushed to clear the inventory of BS-III vehicles. The mad rush at dealerships is still fresh in memory, which is why analysts toned down their expectations from Hero MotoCorp.

However, March quarter (Q4) results of Hero MotoCorp failed to meet even the benign expectations. Revenues at ~6,915 crore and net profit at ~718 crore missed Bloomberg estimates of ~7,010 crore and ~741 crore, respectively. This is the second consecutive quarter of revenue decline (down eight per cent year-onyear), and the fall in net profit (down 14 per cent year-on-year) was steeper than Q3, when the numbers took a beating due to demonetisation.

Consequently, even operating profit margins dipped from 15.84 per cent a year ago, to 13.85 per cent in Q4. While absolute value of raw material and other expenses were down year-on-year, it was in-sync with fall in sales volumes; down 5.8 per cent y-o-y. But, cost of raw material as a ratio of sales shot up by 235 basis points y-o-y on account of increasing costs of steel, rubber and other key components, thereby impacting margins.

Going ahead, analysts believe that the margin pressure should subside for Hero, given it has effected a price hike of ~500-~2,200 on select models. They are also positive that the unsold inventory may find its way to some of Hero MotoCorp’s export markets. If this happens, the need to write off inventory of unsold motorcycles on the BS-III platform should not arise.

Even now, they say the manner in which the inventory BS-III models were sold off was much better than the practice resorted to by its competitors.

Analysts say discounts offered to reduce stock of BS-III inventory was largely at dealer level and did not disturb the wholesale price much.

This is why Ankit Merchant of KRC Research notes that the Street could perhaps not be too unpleased with Hero MotoCorp’s Q4 performance. “Market was prepared for a weak March quarter. So the past was well behind. Going ahead, cues for capital expansion (capex) plans and progress on Bangladesh plant will be closely watched,” he says.

However, even competitors such as Honda Motorcycle and TVS Motor are revving up on launches. Therefore, marketing spends could remain elevated in FY18. This is why analysts feel that even if Hero MotoCorp’s operating profit margins recover to 15 per cent levels by midFY18, it is positive.

For now, Hero MotoCorp has guided for capex of ~2,500 crore and plans for at least six new motorcycle launches in FY18. While this should comfortably help sustain the pole position in the motorcycles segment, it would be interesting to see how the new models are positioned and who makes the best of it. In all, FY18 is expected to be an exciting year for the two-wheelers industry as rural demand is expected to remain strong in anticipation of good monsoon.

Therefore, investors wanting to capture the rural theme could accumulate Hero MotoCorp stock. Benign valuations (18x FY18 earnings) also support the investment rationale.