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Demand outlook cautious, management expects a 9% growth in FY 13E
Although the company is running at a normal dealer inventory of three weeks, management has given a cautious outlook on the sector growth in FY 13. For them, they have projected to sell 6.8mn units (our estimate of 6.78mn), which translates into a growth of 9%. Hero said that this growth will be higher than the industry growth rate on the new launches that they are planning for this year. They have already launched the scooter Maestro, new Splendor within Hero brand and will come out with a launch of 125cc bike Ignitor, a 110cc bike Passion X Pro and 7-8 new bikes and variants under the Hero brand in FY 13E. Also rural sales as a % of sales stood at 46% at the end of FY 12 and are projected to move up, thus helping volume growth. Additionally the company will shortly announce establishment of a new plant which would take up the capacities above 7mn projected for FY 13. Competition from Honda will cause lesser damage to Hero, as we believe that Honda's capacities are expanding more on the scooters side. Continuation of the overall slowdown on the 2W sector seen since last couple of months will be a real threat to the stock.
Margins get hurt due to yen appreciation and RM costs hike
As said earlier, the company's RM costs moved up to 73.2% from 72.9% sequentially as yen moved up in the first half of the quarter and also in the previous quarter, along with input costs. Localization attempts are also not saving anything considerable for the company. Furthermore royalty outgo when included above EBITDA levels gives us the right picture of margins wherein we see that yen movement has actually led to a fall in EBITDA margins to 11.7%. The impact of falling yen will be seen in Q1 FY 13, however it will always remain an overhang on the margin performance. Management expects a stable margin performance here on. We expect better margins in FY 13 on debottlenecking of capacities, operating leverage coming from new plant, price hikes taken in this quarter, expectations of RM prices to go down and a better product mix. However, the company's foray into export countries like Africa and Latam will put pressure on margins as branding costs and competition related expenses will lead to lower export margins. Management expects to touch 1mn export sales by FY17. Also in domestic markets, branding the existing bikes under the Hero brand will also lead to higher branding expenses.
Lower dividend payout in our view is negative
Dividend payout of 45% is less that the dividends paid in the range of 100% in FY10 and FY11. The dividend yield has been always maintained above 4% which now has come down to less than 2%. This is a good strategy ahead of capex expansion plans, however, investors will not find this move to be investor friendly and will lead to derating.
Outlook and valuation
We believe that Hero is still a better bet within the two wheeler industry considering its market leadership position, scalability, competitive position and exports plans. We are also positive on the new launches to help the company to achieve the required volume target. However, on margins, there are lot many overhangs which would not allow a significant expansion. Also we need clarity on new plant capacities expansion which we may seek in a couple of days. We have introduced FY 14 estimates, which we believe will see a subdued growth at the bottomline as tax rate is expected to move up to 22-23% as Haridwar plant tax benefit will move down from 100% to 30%. In FY 13E it will be at 16% as the company will expand its production from 35% to 40% of volumes from this plant. At CMP of Rs 2,084 the stock trades at 15x times FY 13E EPS of Rs 143, which we believe is slightly stretched. We have maintained our estimates and multiple of 14x and reiterate our Neutral view and Rs 1,996 target price on the stock.
