Switch to Maruti and M&M from Hero Moto: Brokerages
After 25% jump in past 3 months, valuations look stretched as co might not be able to sustain volume growth
ET Intelligence Group: Hero MotoCorp’s stock has gained 25% in the past three months following robust monthly sales volumes, and hopes of recovery in rural demand based on the forecast of good monsoon. Several brokerages have reduced their ratings on the stock citing rich valuations. They recommend a switch to Maruti Suzuki and Mahindra & Mahindra if one wants to take exposure to rural demand.
Hero derives nearly half of its motorcycle sales volumes from the rural market. Due to which it was one of the few stocks which remained above 200-daily moving average — an indicator that shows strong buying interest — when the market was in doldrums between January and March. In addition, robust sales growth in the past two months after a long hiatus has instilled more confidence to increase exposure to rural markets.
After the recent jump, the valuation looks stretched. The company’s enterprise value is 12.2 times operating profit before depreciation (EV/ EBITDA), a record high when compared with 9.9 times of its ten-year average. Analysts expect 7-8% vol- ume growth in FY17 compared with 2.8% in the previous fiscal. They believe that impressive volume growth over the past two months may have incurred as dealers pile up inventories to cater to the demand often fuelled by the marriage season.
If global agricultural prices continue to stay subdued, it may impact domestic crop prices, which in turn would affect rural income in India. Rising competition is another factor of concern. In the motorbike segment, which accounts for two-thirds of Hero’s volumes, new product launchesbypeerswouldputpressure on prices. In the scooter segment, market leader Honda Motorcycle has added new capacity. It may turn more aggressive in pricing to improve capacity utilisation. This could affect the industry profitability.
These factors make it difficult for Hero to sustain volume growth. Also, the company’s ability to expand margins over and above the 260-bps improvementinthefirstninemonthsof FY16isfadingonaccountof theimpositionof minimumsupportpricesfor steel. During the period, volume growth fell 3%, but net profit grew 22% helped by higher margin at 15%.