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Spark Capital: Hero MotoCorp 3QFY13 Results Review: Concerns on margins reinforced; Maintain reduce




Spark Capital Advisors(India) Private Limited


18 Jan 2013





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Concerns on margins reinforced; Maintain reduce. EBITDA margin performance in the quarter (down 130bps qoq) was disappointing due to absence of operating leverage on the back of sequential volume growth. Management attribute this to adverse product mix driven by new launches (gross margin down 140bps qoq) and higher advertising expenses (other expenses up 40bps qoq). We continue to factor in margin pressure (remain at ~13.8% through FY15) on the back of increased competition in the entry/executive space from HMSI and Bajaj Auto and advertising spend on rebranding to maintain market share of Splendor and Passion Management believes material costs would reduce in the forthcoming quarters given cost optimization and increase in volumes of new launches. Moreover, indirect yen imports (total forex exposure on material imports stand at ~9% of sales) could lead to gross margin improvement given the outlook of a weakening yen. We however remain skeptical on improvement in gross margin given the history of limited success in the premium and higher end executive segment. Management also expect ad spend to be >2% of sales in 2HFY13, higher than the spend in 1HFY13. We believe that ad spend for the company could continue to be higher than historical averages on the back of rebranding, increased competition in the company’s stronghold segments and new product launches in executive and premium segment. Long term (last 8 year) historical average EBITDA margin for the company has been ~15%; we believe in the near term (through FY15), EBITDA margins would be ~150bps lower than long term average due to higher other expenses. With expected completion in amortization of license fee in 1QFY15, we see a steep drop in D&A in FY15, translating into a steep growth in FY15 PAT (~30% yoy), partially offset by an increase in tax rate due to expiry of benefits at Haridwar plant. We factor in 8% volume CAGR in domestic MC space, while scooters are expected to grow at ~14% CAGR. Exports however are expected to grow at ~23% CAGR albeit at a lower base. We expect topline CAGR of 11% from FY13-15 to Rs. 290bn with EBITDA margin at 13.8%. We value the stock at 13.5x (10% discount to Bajaj) FY15 EPS of 139.8 to arrive at a TP of Rs. 1,888 and maintain our Reduce rating. Key highlights from conference call Capacity expansion to 7.7mn units in 2HFY14 (Rajasthan) and a further 8.4mn units by 2QFY15 (Gujarat). Haridwar facility is currently at 8,400 units/day and is expected to be at 9,500 units/day in FY14. Company maintains export volume guidance of 1mn units by FY17. Dealer inventory stands at ~1 month, inline with industry average.

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