Hero Moto: No respite from margin pressure

Hero Motocorp Ltd announced third quarter results of the financial year 2012-2013 (3QFY13). The company has reported a growth of 3% YoY in revenues and a fall of 20% YoY in net profits. Here is our analysis of the results.

Performance summary

• Revenues grow by a mere 3% YoY during the quarter on account of the general slowdown in the auto industry including 2 wheelers.
• Operating margins shrink by 3% to 12.6% in 3QFY13. As a result, operating profits fall by 17% YoY during the quarter.
• Led by the poor performance at the operating level, net profits decline by 20% YoY.

Standalone financial snapshot

(Rs m)	3QFY12	3QFY13	Change	9mFY12	9mFY13	Change
Net sales	60,315	61,876	2.6%	175,393	176,224	0.5%
Expenditure	50,885	54,090	6.3%	148,511	151,877	2.3%
Operating profit (EBDITA)	9,430	7,787	-17.4%	26,882	24,347	-9.4%
EBDITA margin (%)	15.6%	12.6%		15.3%	13.8%
Other income	763	901	18.1%	2,588	2,939	13.5%
Depreciation	2,987	2,832	-5.2%	8,169	8,762	7.3%
Interest	(32)	30		123	88	-28.0%
Profit before tax	7,238	5,826	-19.5%	21,178	18,435	-13.0%
Tax	1,108	947	-14.5%	3,433	2,996	-12.7%
Profit after tax/(loss)	6,130	4,879	-20.4%	17,745	15,439	-13.0%
Net profit margin (%)	10.2%	7.9%		10.1%	8.8%
No. of shares (m)				199.7	199.7
Diluted earnings per share (Rs)*					107.5
Price to earnings ratio (x)*					16.5

* On a trailing 12 months basis

What has driven the performance in 3QFY13?

• Hero Motocorp reported a mere 3% YoY growth in sales during the quarter and this was attributed to the general slowdown prevailing in the market. That said, performance was better than in 2QFY13 on account of decent growth in volumes during the festival period. Further, the company expects volume growth to pick up in the fourth quarter.

• As operating costs grew faster than sales, operating profit margins were adversely impacted as these shrunk by 3% to 12.6% during the quarter. There were two major reasons for this. The first was the rise in raw material costs from 72.9% of sales in 3QFY12 to 74.1% in 3QFY13. This was attributed to the product mix notably focus on the 150cc segment and launch of new models. Other expenditure also increased from 8.2% of sales in 3QFY12 to 10.1% in 3QFY13. This was largely on account of higher marketing and brand building spends for its new launches.
  Cost break-up...

  (Rs m)	3QFY12	3QFY13	Change	9mFY12	9mFY13	Change
  Raw materials	43,948	45,854	4.3%	128,633	129,581	0.7%
  % sales	72.9%	74.1%		73.3%	73.5%
  Staff cost	1,993	1,982	-0.5%	5,432	5,950	9.5%
  % sales	3.3%	3.2%		3.1%	3.4%
  Other expenditure	4,943	6,253	26.5%	14,446	16,345	13.1%
  % sales	8.2%	10.1%		8.2%	9.3%

  
  
• Led by the poor performance at the operating profit level, net profits fell by 20% YoY. Even a drop in tax expenses was not enough to stem the slide in the bottomline. For the nine month period, total sales grew by 1% YoY, while net profits fell by 13% YoY. Tax expenses are expected to increase going forward as the tax benefits accruing to the plant at Haridwar come to an end.

What to expect?

At the current price of Rs 1,773, the stock is trading a multiple of 7.9 times our estimated FY15 cash flow per share. The past several quarters have been tough for Hero Motocorp as a subdued environment in the auto industry including two wheelers has been a drag on performance. Going forward, the management intends to introduce 7 new products every year which will be a combination of completely new products, refreshing existing products and launching new variants. Marketing spend could remain firm as it focuses on bolstering volumes amidst increasing competition including that from its erstwhile partner Honda. Issues with the labour force at its Gurgaon plant could also impact growth depending on how the scenario pans out. Based on the performance in 9mFY13, we will have to revise our estimates downwards for the full year. Consequently, we have a 'Hold' view on the stock.