Though we still like Hero on a medium-term basis, we are a lot more circumspect about the company’s near-term progress, given the slowdown in the domestic two-wheeler market. This, coupled with the fact that currency is likely to put the margins under pressure, means that there is an earnings cut of 6-7% in our FY13/FY14 estimates and our numbers are now 5% below consensus.
The key upside risk is a re-rating of the stock on account of the failure of Honda’s recently launched motor-cycle in the executive segment — Dream Yuga.
Retail volumes in the Indian two-wheeler industry have slowed significantly in the past few months and, with a poor monsoon, are unlikely to pick up the near term. For Hero, almost the entire growth in dispatches since January has been a function of the company building inventory and, hence, with little scope for further inventory increase, dispatches will track retail volumes and remain weak.
We continue to believe that Hero will not lose significant market share in motorcycles to Honda over the next 2-3 years as Honda would need time to establish a new brand in the Indian market.
Margins will be impacted in the next few quarters on account of currency depreciation and the fact that given a slow market, Hero will not be able to pass this on. However, we maintain our medium-term margin expansion thesis on account of royalty expiry and possibility of benefits from component sourcing.
Using Credit Suisse Equity Research’s sales and ebitda forecast from FY13 to FY15, Hero’s cash flow return on investment (CFROI) is expected to further increase from 40% in the current year to 45% over this period. At the current share price, Hero's embedded expectations are for sales growth to slow down to 7% per year with ebitda margins of 14.2% in FY16 and FY17.Credit Suisse
