Hero MotoCorp Ltd. 26 July 2013

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CMP: Rs.1828

Target Price: Rs.1953

Upside: 6.8%

Key Data

Size Segment Large Cap Market Cap (Rs, Cr.) 35,035 Market Cap (US$ mn) 5,938 O/S Shares, Cr. 19.97 Free Float Factor 0.48 Face Value, Rs 2 2 Wk Avg. Vol., NSE 332 52 Wk High/Low 2279/1662 Rs/US$ 59.0 Bloomberg HMCL IN Reuters HROM.BO NSE HEROMOTOCO BSE 500182 Source: Shah Investor’s Research

Shareholding Pattern

Q1 FY14 Q1 FY13

Promoter 52.2% 52.2% FII 29.9% 33.2% DII 9.3% 5.9% Public 8.7% 8.7% Source: BSE, Shah Investor’s Research

Institutional Holding Institutions Q1 FY14 Q1 FY13

Europacific Growth Fund 5.0% 5.0% LIC 4.1% 2.5% Aberdeen Global Emerging Market 2.4% 1.6% Source: BSE, Shah Investor’s Research

Source: Ace Equity, Shah Investor’s Research Harsh Mehta (Research Analyst) harsh.mehta@sihl.in

Positive surprise on margin front and stock fairly valued; Recommend Hold Hero MotoCorp (HMCL) Q1 FY14 result was in line with our estimates. Revenue for HMCL was at Rs.6,160 Cr. led largely by higher realization YoY of Rs.39,293/unit. EBITDA for HMCL is in line with our estimate at Rs.915 Cr. (est. Rs.925 Cr.) and EBIDTA margin is around 14.9%. Other expenditure is higher at Rs.567 Cr. despite volumes down 4.9% YoY due higher Ad spends in wake of intense competition and increase in power and logistics cost. PAT for the HMCL is Rs.549 Cr.

Key result highlights

Sales volumes: HMCL’s volume in Q1 FY14 was down 4.9% YoY but up 2.1% QoQ

to 1,559,282 units due slowdown in domestic motorcycle market. Motor-cycle industry was down 11.5% YoY but up 2.6% QoQ; sub-125 cc segment was down 10.4% YoY but up 4.8% QoQ while 125+ cc segment was down by 16.6% YoY and 6.5% QoQ. Contribution from 75-125 cc segment for HMCL has increased by 267 bps YoY but down 53 bps QoQ. Major contribution in 75-125 cc segment have been 125 cc segment (Ignitor, Super Splendor and Glamour) which has led to growth in realization. Exports for HMCL are down by 29.8% YoY and 20.1% QoQ in Q1 FY14. Management expects industry and HMCL to grow at mid to high single digit number in FY14. We estimate a volume growth of 3.7% (earlier estimate was 8.7%) in FY14 to 62,99,696 and FY15 sales volume growth at 4.8% (earlier estimate was 6.1%) to 66,00,000 units.

Improvement in realization: Net realization for HMCL is down 1.2% QoQ to

Rs.39,293/unit mainly due to lower contribution of 125cc bikes. Realization was also higher due to lower contribution from scooter segment and weaker export sales nos. HMCL has increased prices of all the products by Rs.500-1,500 from April 2013.

EBITDA margin: EBITDA for HMCL in Q1 FY14 was down 2.3% YoY but up 7.7%

QoQ to Rs.915 Cr. EBITDA margin is down 14 bps YoY but up 103 bps QoQ to 14.9%. RMC as % of net sales were down 142 bps YoY and 39 bps QoQ to 72.7% due to weak Yen (Yen depreciated more than 20%), softness in commodity prices and some internal cost management projects. HMCL management expects stable commodity prices going forward. Other expenditure was down 113 bps QoQ but up 115 bps YoY to 9.3% due lower marketing spends. Other expenditure was higher YoY due to increase in dealer margin and higher transportation and logistics cost. Marketing spend remains in the range of 2% of net sales and will continue to remain on higher side in FY14 due to slew of new launches and exploration of new markets.

Key conference call highlights

HMCL have witnessed 7% YoY growth in retail sales while channel sales have witnessed inventory correction of 50,000 units in Q1 FY14

Management expects volume growth in FY14 to be around high single digit (7-8%) vs. double digit growth in FY11 and FY12

Royalty amortization for quarter stood at Rs.202 Cr. vs. Rs.192 Cr. in QoQ More than 7-8 product actions planned for FY14 starting in festival seasons to

boost sales volumes. Product actions would include new launches, re-launches, refreshes and variants.

To boost the sales of its 2-W sales, HMCL has decided to offer retail financing solutions to customers. HMCL which holds 40% stake in Hero FinCorp, is expected to infuse additional equity of about Rs.200 Cr. by 2014-15.

HMCL has entered in Central American and African markets in Q1 FY14. Due to low brand awareness, HMCL plans to have big product launch and state of the art infrastructure facilities

Export volume guidance for HMCL at 350,000 units for FY14 and 1.0m units by FY17.

HMCL has initiated cost reduction programme to improve efficiencies and improve profitability of the company. This projected is expected to yield benefit gradually from 3QFY14 onwards.

Tax rate to remain high at ~24-27% levels on partially expiry of Haridwar tax benefits.

HMCL invested USD25m for 49.2% stake in Erik Buell Racing (EBR). EBR would be an extended R&D arm of HMCL. HMCL may consider taking further majority stake in EBR.

Management expects overall marketing spends to remain in the range of 2% of net sales.

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Hero MotoCorp Ltd. 26 July 2013

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Assumption and Valuation

DCF based Valuation

Rs. Cr. FY14E FY15E FY16E FY17E FY18E FY19E FY20E Terminal Value

Discounted Cash Flow 1,001 2,276 3,669 4,171 4,744 5,337 6,080 45,115

NPV of Cash Flow 903 1,853 2,696 2,765 2,837 2,880 2,961

NPV Enterprise Value 38,866

Source: Shah Investor’s Research

Terminal Growth Rate 4% Total Enterprise Value (Rs. Cr.) 38,866

Beta 0.5 Net Debt (Rs. Cr.) (1,40)

Risk Free Rate 8% No of Shares (Cr.) 19.97

Market Premium 7% Value per Share 1,953

Post Tax Cost of Debt 6.6%

Cost of Equity 10.8%

WACC 10.8%

Debt 0.3%

Equity 99.7%

Outlook and Valuation

Going by flat sales volumes growth in last quarter (Q1 FY13), we estimate domestic Motor-cycle industry to clock mid to high single digit volume growth in FY14. We estimate FY14 and FY15 sales volume target to 62,99,696 (earlier 66,00,000) units and 66,00,000 (earlier 70,00,000) units. We estimate major concern for HMCL is weakness in domestic demand rather than competitor’s aggressiveness as overall domestic industry flat in FY13. We estimate a minor uptick in EBITDA margin due to stable raw material prices and weak Yen. However Other expenses will continue to remain on higher side due to increased in Ad expenses and logistics which could offset any gains of lower raw material cost. We estimate that the benefit on account of reduction in royalty Q1 FY15 onwards would compensate the incremental cost pressure for HMCL. We have downgraded our FY14E EPS target to Rs.121.9 (earlier Rs.131.2) and FY15E EPS target to Rs.143.6.

The stock is currently trading at PE of 15x FY14E EPS of Rs.121.9 and 12.7x FY15E EPS of Rs.143.6. We estimate increasing competition and slowness in domestic market could remain near term overhang for the stock.

We have revised downwards our target price to Rs.1,953 (earlier Rs.2,016) on DCF basis and recommend Hold , with an investment horizon of 12 months and upside potential of 6.8%.

PE Band EV-EBITDA Band

Source: SIAM, Shah Investor’s Research Source: SIAM, Shah Investor’s Research

-

500

1,000

1,500

2,000

2,500

3,000

3,500

10x 15x 20x 25x HMCL

-

10,000

20,000

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40,000

50,000

60,000

70,000

80,000

6x 10x 14x 18x EV

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Exhibit 1: Trend in sales volume mix

Product Mix Q1 FY14 Q1 FY13 YoY Q4 FY13 QoQ

Motorcycle 1,393,686 1,520,864 -8.4% 1,364,020 2.2%

Domestic 1,364,546 1,486,654 -8.2% 1,331,283 2.5%

75-125 cc 1,326,883 1,425,821 -6.9% 1,275,032 4.1%

125 cc+ 37,663 60,833 -38.1% 56,251 -33.0%

Export 29,140 34,210 -14.8% 32,737 -11.0%

75-125 cc 26,973 31,920 -15.5% 28,162 -4.2%

125 cc+ 2,167 2,290 -5.4% 4,575 -52.6%

Scooters 165,596 119,336 38.8% 163,331 1.4%

Domestic 163,434 108,971 50.0% 156,884 4.2%

Export 2,162 10,365 -79.1% 6,447 -66.5%

Total 1,559,282 1,640,200 -4.9% 1,527,351 2.1%

Source: SIAM, Shah Investor’s Research

Exhibit 2: Trend in segment contribution

Product Mix Q1 FY14 Q1 FY13 YoY Q4 FY13 QoQ

Motorcycle 89.4% 92.7% (334) 89.3% 7

Domestic 97.9% 97.8% 16 97.6% 31

75-125 cc 97.2% 95.9% 133 95.8% 147

125 cc+ 2.8% 4.1% (133) 4.2% (147)

Export 2.1% 2.2% (16) 2.4% (31)

75-125 cc 92.6% 93.3% (74) 86.0% 654

125 cc+ 7.4% 6.7% 74 14.0% (654)

Scooters 10.6% 7.3% 334 10.7% (7)

Domestic 98.7% 91.3% 738 96.1% 264

Export 1.3% 8.7% (738) 3.9% (264)

Source: SIAM, Shah Investor’s Research

Exhibit 3: Trend in net realization and EBITDA margin

Source: Company, Shah Investor’s Research

Exhibit 4: Trend in annual sales volume

Product Mix FY10 FY11 FY12 FY13 FY14E FY15E

2-W Sales

Motorcycle 4,444,918 5,040,971 5,779,611 5,499,155 5,669,688 5,940,000

Domestic 4,293,991 4,926,390 5,651,056 5,362,730 5,527,937 5,702,400

75-125 cc 4,055,304 4,589,003 5,320,330 5,165,222 5,362,091 5,474,304

125 cc+ 238,687 337,387 330,726 197,508 165,847 228,096

Export 150,927 114,581 128,555 136,425 141,750 237,600

75-125 cc 82,824 102,524 114,308 122,015 128,993 213,840

125 cc+ 68,103 12,057 14,247 14,410 12,757 23,760

Scooters 214,272 361,473 455,584 574,336 630,008 660,000

Domestic 208,440 342,991 418,224 549,808 617,408 646,800

Exports 5,832 18,482 37,360 24,528 12,600 13,200

Total 2-W Sales 4,659,190 5,402,444 6,235,195 6,073,491 6,299,696 6,600,000

Source: Company, Shah Investor’s Research

37,4

56

37,6

50

37,9

29

37,8

48

38,6

49

39,1

02

39,7

58

39,8

12

15.8% 15.6% 15.3% 15.0%

13.9% 12.6% 13.8% 14.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

33,000

34,000

35,000

36,000

37,000

38,000

39,000

40,000

41,000

Net Realization EBITDA Margin

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Exhibit 5: Domestic 2-W break-up

Source: SIAM, Shah Investor’s Research

Exhibit 6: Market Share in Scooter Segment

Source: SIAM, Shah Investor’s Research

Exhibit 7: Market share in sub-125 cc Motor-cycle segment

Source: SIAM, Shah Investor’s Research

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Scooter Volumes Motorcycle Volumes

0%

20%

40%

60%

80%

100%

HMCL TVS Suzuki HMSI M&M 2-W Piaggio

0%

20%

40%

60%

80%

100%

Yamaha BAL HMSI TVS HMCL Suzuki

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Exhibit 8: Market share in 125+ cc Motor-cycle segment

Source: SIAM, Shah Investor’s Research

Exhibit 9: Quarterly income statement

Particulars, Rs. Cr. Q1 FY14 Q1 FY13 YoY Q4 FY13 QoQ

Gross Sales 6,127 6,208 -1.3% 6,072 0.9%

Less: Excise Duty - - NA - NA

Net Sales 6,127 6,208 -1.3% 6,072 0.9%

Other Operating Income 33 40 -17.3% 73 -55.4%

Total Revenue 6,160 6,247 -1.4% 6,146 0.2%

Expenditure

Total Expenditure 5,244 5,310 -1.2% 5,296 -1.0%

EBITDA 915 937 -2.3% 850 7.7%

EBITDA Margin % 14.9% 15.0% (14) 13.8% 103

Depreciation 274 303 -9.6% 266 3.3%

EBIT 641 633 1.2% 584 9.7%

EBIT Margin % 10.4% 10.1% 27 9.5% 90

Other Income 112 104 7.5% 105 7.4%

Interest 3 3 NA 3 -3.9%

PBT 750 735 2.1% 686 9.4%

PBT Margin % 12.2% 11.8% 42 11.2% 102

Tax 202 119 68.8% 111 80.8%

Effective Tax Rate % 26.9% 16.3% 1,062 16.3% 1,062

PAT 549 615 -10.9% 574 -4.5%

PAT Margin % 8.9% 9.9% (95) 9.3% (44)

EPS 27.5 30.8 -10.9% 28.8 -4.5%

Source: Company Data, Shah Investor’s Research

Exhibit 10: Quarterly expenditure analysis

Particulars, Rs. Cr. Q1 FY14 Q1 FY13 YoY Q4 FY13 QoQ

Total No Units 1,559,282 1,640,200 -4.9% 1,527,351 2.1%

Net Realization 39,293 37,848 3.8% 39,758 -1.2%

RMC as % of Net Sales 72.7% 74.1% (142) 73.1% (39)

EC as % of Net Sales 3.6% 3.3% 32 3.7% (10)

OE as % of Net Sales 9.3% 8.1% 115 10.4% (113)

RMC per Unit 28,575 28,061 1.8% 29,067 -1.7%

EC per Unit 1,421 1,248 13.9% 1,479 -4.0%

OE per Unit 3,638 3,068 18.6% 4,128 -11.9%

Source: Company Data, Shah Investor’s Research

0%

20%

40%

60%

80%

100%

HMCL TVS BAL Suzuki HMSI Yamaha Royal Enfield

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Exhibit 11: Standalone annual income statement Exhibit 12: Standalone balance sheet statement

Particulars, Rs. Cr. FY11 FY12 FY13E FY14E FY15E Particulars, Rs. Cr. FY11 FY12 FY13E FY14E FY15E

Gross Sales 20,662 25,024 25,333 6,127 6,644 Sources of Funds

Less: Excise Duty 1,417 1,656 1,821 - 474 Shareholder's Funds 2,956 4,290 5,006 5,932 7,175

Net Sales 19,245 23,368 23,583 6,127 6,171 Share Capital 40 40 40 40 40

Other Operating Income 153 211 185 33 67 Reserves & Surplus 2,916 4,250 4,966 5,892 7,136

Total Revenue 19,398 23,579 23,768 6,160 6,237 Total Loans 13 17 17 17 17

Deferred Payment Credits 1,458 995 287 - -

Expenditure Total Liabilities 4,427 5,301 5,310 5,949 7,192

Total Expenditure 16,785 19,960 20,484 5,244 5,290

Appliation of Funds -

EBITDA 2,613 3,619 3,284 915 948 Gross Block 5,538 6,308 7,808 10,108 11,470

EBITDA M argin % 13.5% 15.3% 13.8% 14.9% 15.2% Less: Depreciation 1,458 2,523 3,665 4,769 5,787

Depreciation 402 1,097 1,142 274 276 Net Block 4,080 3,786 4,144 5,339 5,683

EBIT 2,210 2,521 2,143 641 672 Capital WIP 50 39 39 39 39

EBIT M argin % 11.4% 10.7% 9.0% 10.4% 10.8% Investments 5,129 3,964 3,741 3,541 3,751

Other Income 290 365 398 112 109 Other Non Current Assets 16 26 26 26 26

Interest 15 21 21 3 6 Current Assets, Loans & Advances -

Exceptional Items (80) - - - - Inventory 525 676 666 708 763

PBT 2,405 2,865 2,520 750 775 Sundry Debtors 131 272 238 253 272

PBT M argin % 12.4% 12.1% 10.6% 12.2% 12.4% Cash & Bank 72 77 314 157 1,070

Tax 477 487 411 202 178 Other Current Asset 37 40 48 51 54

Effective Tax Rate % 19.8% 17.0% 16.3% 26.9% 23.0% Loans & Advances 687 1,009 1,070 1,138 1,226

PAT 1,928 2,378 2,109 549 597 Total Current Assets 1,451 2,074 2,334 2,306 3,385

PAT M argin % 9.9% 10.1% 8.9% 8.9% 9.6% Current Liabilities & Provision -

EPS 96.5 119.1 105.6 27.5 29.9 Current Liabilities 4,971 3,289 3,328 3,539 3,813

Source: Ace Equity, Shah Investor's Research Provision 1,081 1,090 1,438 1,554 1,670

Total Current Liabilities 6,052 4,379 4,766 5,094 5,484

Exhibit 13: Standalone cash flow statement Net Current Assets (4,602) (2,305) (2,431) (2,788) (2,098)

Particulars, Rs. Cr. FY11 FY12 FY13E FY14E FY15E Deferred Tax Assets (247) (208) (208) (208) (208)

PBT 2,405 2,865 2,520 3,203 3,725 Total Assets 4,427 5,301 5,310 5,949 7,192

Adjustments for: Source: Ace Equity, Shah Investor's Research

Depreciation 402 1,097 1,142 1,104 1,018

Interest - others and f inancial charges 15 21 21 22 27 Exhibit 14: Key ratios

Provision for doubtful debts/w ritten back 2 0 - - - Y/E March FY11 FY12 FY13E FY14E FY15E

Interest received on long term (58) (58) (38) (40) (40) Profitability %

Interest received on loans, deposits etc (18) (22) (60) (60) (60) EBITDA Margin 13.5% 15.3% 13.8% 15.4% 15.7%

Dividend income (6) (3) (3) (4) (4) PAT Margin 9.9% 10.1% 8.9% 9.6% 10.5%

Profit on sale of non-trade investments (211) (282) - - - RoCE 74.4% 58.6% 42.7% 46.7% 45.4%

CFO before change in WC 2,550 3,633 3,581 4,226 4,666 RoE 65.2% 55.4% 42.1% 41.0% 40.0%

Adjustments for: 146 768 1,062 1,022 941 Per Share Data (Rs.) 0 0 0 0 0

Increase in inventories (89) (151) 10 (42) (55) Adj. EPS 96.5 119.1 105.6 121.9 143.6

Increase / (decrease) in trade payables 465 (313) 38 212 274 Adj. CEPS 112.9 118.2 159.5 177.3 196.1

(Increase)/decrease in receivables (192) (226) (33) (86) (112) BVPS 148.0 214.8 250.7 297.1 359.3

Cash generated from operations 2,735 2,942 3,597 4,309 4,773 Adj. DPS 105.0 45.0 60.0 65.0 70.0

Less:Direct taxes paid 481 583 411 769 857 Valuation, x 0 0 0 0 0

Net cash from operating activities 2,254 2,360 3,186 3,540 3,917 P/E 18.9 15.4 17.3 15.0 12.7

Cash Flow from Investing Activities 0 P/CEPS 16.2 15.5 11.5 10.3 9.3

Net Sale/(Purchase) of f ixed assets (361) (503) (1,500) (2,300) (1,362) P/BV 12.3 8.5 7.3 6.2 5.1

Net Sale/(Purchase) of investments (999) 1,443 224 200 (210) EV/Sales 1.63 1.74 1.52 1.44 1.30

Interest received on long term 34 45 38 40 40 EV/EBITDA 12.13 11.32 11.02 9.36 8.28

Interest received on loans, deposits etc. 18 22 60 60 60 Dividend Yield (%) 6.6% 2.2% 3.3% 3.6% 3.8%

Dividend income (6) (3) (3) (4) (4) Gearing Ratios 0 0 0 0 0

Payment of deferred credits - (817) (708) (287) - Net Debt/Equity (0.0) (0.0) (0.1) (0.0) (0.1)

Net Cash (used) in Investing Activities (1,322) 93 (1,883) (2,283) (1,468) Net Debt/EBITDA (0.0) (0.0) (0.1) (0.0) (0.2)

Interest paid - others and f inancial charges (15) (21) (21) (22) (27) Working Capital Cycle (Days) (68) (20) (20) (20) (20)

Dividend paid (599) (2,097) (899) (1,198) (1,298) Performance Ratios, x 0 0 0 0 0

Tax on dividend (341) (340) (146) (194) (211) Cash Flow -to-Revenue 1.2 1.0 1.5 1.5 1.4

Repayment of long term borrow ings - - - - - Cash Return-on-Assets 3.4 3.4 2.8 2.5 2.5

Net cash (used) in financing activities (955) (2,458) (1,066) (1,414) (1,536) Cash Return-on-Equity 0.25 0.21 0.24 0.23 0.23

Change in Cash & Cash Equivalent (24) (6) 237 (157) 913 Cash-to-Income 0.12 0.10 0.13 0.14 0.14

Opening Balance 63 39 77 314 157 DUPONT Analysis 0 0 0 0 0

Cash & Cash Balance 39 34 314 157 1,070 PAT/PBT 0.8 0.8 0.8 0.8 0.8

Source: Ace Equity, Shah Investor's Research PBT/EBIT 1.1 1.1 1.2 1.2 1.1

EBIT/Total Income 0.1 0.1 0.1 0.1 0.1

Total Income/Total Assets 4.7 4.0 3.4 2.8 2.5

Total Assets/Total Equity 1.3 1.6 1.5 1.6 1.6

Source: Ace Equity, Shah Investor's Research

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