As volume challenges persist, Hero MotoCorp eyes recovery across segments

Margins should improve on lower raw material costs, operating leverage

Except for a slight slip in profitability, the October-December quarter performance of the country’s largest two-wheeler maker — Hero MotoCorp — was broadly in line with Street estimates.

Even as volumes declined 4 per cent year-on-year (YoY), overall revenues saw an increase of 2 per cent, given higher revenue from spares and an uptick in realisations.

A sharp fall in exports, a lower share of the 125cc and higher segment, and muted rural sentiment dented volumes in the quarter.

Its gross profit margins saw a sequential improvement of 250 basis points (bps), given price hikes over the past few quarters. The company also highlighted that there has been an 80 bps in the cost savings programme LEAP over the past nine months. A better product mix and a 70-100-bps gain from softening raw material prices, too, helped lift profitability.

The gains on the gross profit front, however, did not percolate through to the operating level as margin gains were limited to 7 per cent on a sequential basis, while they were down 67 bps YoY. The company indicated that a 70-bps impact on margins was on account of the new mobility business (the company launched its maiden electric two-wheeler Vida V1) which, coupled with higher festival-related spending, weighed on margins.

Even as raw material to sales as a percentage of revenue was down 150-250 bps on a sequential and YoY basis, the proportion of other expenses was up 170-200 bps, as was employee costs (22-74 bps), offsetting the input cost advantage.

The company indicated that margin improvement would continue as raw material costs have softened and gains from price hikes taken earlier will sustain. While spending on the electric vehicle (EV) segment will continue, the gains on the much larger internal combustion engine-based business should help maintain the margin expansion trend. A lot will depend on volumes as the company is banking on operating leverage to boost profitability.

The company is struggling in the entry-level segment, given affordability issues in rural areas, and has been losing share in the 125cc and above category. It has lined up a slew of launches in the premium category to recoup market share and benefit from higher growth rates in the segment.

Hero MotoCorp indicated that there are some green shoots in the rural segment and the wedding season should boost sales in key markets.

Say analysts Mitul Shah and Sheryl Fernandes of Reliance Securities, “Although we expect the domestic two-wheeler industry to face near-term demand weakness, we expect revival in the rural market after rabi harvesting amid better reservoir level. Sentiment will improve going forward on decent agriculture output at higher pricing.”

The brokerage has a ‘buy’ rating on the stock, given expectations of demand recovery, premium segment focus, and attractive valuations.

With exports facing multiple headwinds, the near-term growth drivers will depend on continued traction for the scooter segment (Xoom launched recently), premiumisation trends, lower-priced EVs, and more importantly, a revival in the rural segment.