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

The Economic Times - - Smart -

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%.

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