Stock Review: Hero MotoCorp

HERO MotoCorp continues to lead the two-wheeler pack on sales. In August, the company reported 18.6 per cent year-on-year growth in volumes to 503,654 units, led by strong momentum across all product segments. Going by the strong demand for two-wheelers, the company is targeting sales of six million units this financial year. The first quarter also saw several product launches and refreshed product ranges, which helped drive the volume performance.

Despite this strong volume growth, analysts are sceptical about the company's ability to deliver on profitability. The last few quarters have been challenging for the company as far as profit margins are concerned. In the first quarter, input cost pressure continued to pinch, with raw material costs as a percentage of sales rising 190 basis points sequentially to 74.7 per cent (highest ever increase). Other expenses were also high at 11.5 per cent of net sales, on account of IPL spend. As a result, operating profit margin declined 80 basis points sequentially to 11.3 per cent. While many analysts argue that commodity cost pressure is softening, the company may be hit by an additional one-time cost of rebranding and research and development expense at 1-1.2 per cent of sales. According to Standard Chartered Equities Research, the Hero group will continue to be in investment phase over the next couple of years, to develop products on its own, establish its brand without Honda, spend on capacity addition and establish its presence in export markets, which are likely to hurt return ratios.

However, the management believes margins bottomed out in the June quarter and should expand, driven by the price increases undertaken in June, softening of commodity prices and higher operating leverage. While the company will spend on brand transition, the management has conveyed its plans to replace some of its existing advertisement, and therefore, the impact on margins would be limited. The company also plans to focus on reducing input cost pressures by restructuring its supply chain. Motilal Oswal believes margins can expand by 200-300 basis points over the next two-three years, driven by price increases and input cost savings. Additionally, what some analysts are excited about is the opening of export markets after Honda's exit. Hero MotoCorp has plans to target new markets like Africa, Southeast Asia and Latin America for exports, and expects to start exporting to some countries in Africa by December.