Margin cushion insufficient for decline in volumes! - Hero MotoCorp Q3 Review

What’s Buzzing 

Hero MotoCorp (HMCL) reported a mixed performance in Q3FY23. EBITDA margins for the quarter came in at 11.5%, up 10 bps QoQ. The company witnessed a 250 bps gross margins expansion on a QoQ basis. The benefits, however, were negated by higher other expenses, which were up 173 bps QoQ at 12.3% of sales as well as higher employee costs, which were at 6.8% of sales, up 70 bps QoQ. 

Context 

In Q3FY23, for HMCL, total operating income was at Rs 8,031 crore, down 11.5% QoQ with average selling price (ASP) coming in at Rs 64,782/unit, up 1.9% QoQ – the real surprise for the quarter amid adverse product mix. Sales volumes in Q3FY23 were at 12.4 lakh units, down 12.3% QoQ. EBITDA in Q3FY23 was at Rs 924 crore with consequent PAT at Rs 711 crore, flat QoQ (supported by higher other income). The company also declared an interim dividend of Rs 65/share with record date for the same set as February 17, 2023. 

Our Perspective 

Hero MotoCorp is the market leader in the domestic 2-W space with 34.5% market share as of FY22. The segment, however, is witnessing faster than anticipated shift towards electrification. HMCL is approaching EV space through both organic as well as inorganic routes. Organic route includes its captive electric-2-W i.e. VIDA V1 Plus & VIDA V1 Pro under VIDA brand, which were launched recently at ex showroom price of Rs 1.45 lakh and 1.59 lakh, respectively, which we believe to be an expensive proposition in terms of initial cost of acquisition from a customer standpoint. On the inorganic front, it is approaching electrification though its investments in Ather Energy (manufacturer of EV scooters) with targets of achieving revenue of ~US$1 billion in CY23 and turn profitable in next few years along with investment in Gogoro for battery swapping offerings/technology. Overall, we await more lucrative offering from the company in EV space along with meaningful recovery in volumes before turning decisively positive on the stock. At the current market price, it trades at reasonable valuations of ~19-20x PE on trailing basis and ~14-15x PE on forward basis with healthy ~20% return ratios and ~75% dividend payouts (dividend yield at ~4%).