Hero MotoCorp-IT raid plunge may be a wonderful opportunity to buy a good business model in adversity

Hero Motor was already under pressure even before the IT raid incident due to a weak Q3FY22 report card. Looking ahead, Hero Motor is quite confident of demand revival, easing of higher raw material costs, and supply chain disruptions along with a robust export market.

Hero Motors (HM) plunged over -12% from around 2450 to 2150 in a few trading days after Income Tax (IT) raid/search operations in late March at 25 premises of the company including the personal office and residence of its CEO Munjal.

Unconfirmed report claim that the IT department alleged:

·         HM claimed more than Rs.1B bogus expenses and not paid income tax thereon

·         Cash transaction worth Rs.0.1B (100 cr) for buying a farmhouse in Delhi; use of black money in paying cash

·         HM made unaccounted cash expenditure

·         CEO Munjal purchased the farmhouse at manipulated market price to save tax

·         IT department may impose a huge penalty if such a cash transaction proved

In response to clarification sought by stock exchanges NSE and BSE over news reports that stated ‘IT department finds (Rs) 1,000 crore false expenses claims by Hero MotoCorp’, HM denied all the allegations, terming the same as pure speculative as IT department didn’t intimate the company about such allegation or there was no such evidence.

On 29^th March, HM issued an official statement:

Statement from Hero MotoCorp Ltd

“This is with reference to the Clarification sought from the Company by NSE and BSE on the news item appearing in “Media/Publication” on 29th March 2022.

The allegations made in the press report are not borne out of any document that have been served on us or our internal documents. Therefore, we categorically deny the speculative press reports.

We wish to clarify that officials from the Income Tax department visited our offices in the previous week. The Company has provided all support and cooperation, necessary documents, and data to the authorities and will continue to do so if required. As and when the tax department concludes its findings and communicates to us, we will inform the exchanges suitably.

Hero MotoCorp is a law-abiding corporate, with robust internal financial controls and its financial statements are duly audited. We are conscious of our obligation under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015; we have been discharging the same on a regular basis and shall continue to do the same. As a matter of fact, we do not comment/respond on speculative news.”

HM claimed that the IT search & seizure was a routine inquiry, common ahead of any FY ending:

"Officials from the income tax department visited two of our offices in Delhi and Gurugram and the residence of our Chairman and CEO Dr. Pawan Munjal on Wednesday. We have been informed that this is a routine inquiry, which is not uncommon before the end of the financial year. We reassure all our stakeholders that it continues to be business as usual”.

Further HM also announced a price hike up to Rs.2000 per 2W (Motorcycle and Scooter) wef 5^th April to offset higher raw material (commodity) and logistic costs. Hero Motor also unveiled a new brand identity ‘Vida’ for upcoming EVs and planned a $100 million (Rs.0.76B) sustainability global fund to nurture over 10K entrepreneurs on ESG (environmental, social, and governance) and emerging mobility solutions.

Hero MotoCorp Chairman and CEO Munjal said in a statement:

"Vida means life, and the brand's sole purpose is to create a positive impact on the world and move us all forward in meaningful ways. We believe the name is perfect for what we are building for our children and the next generation. This is truly the dawn of something special. In only 17 weeks from today, we will unveil our Vida platform, products, and services to make the world a better place. With the creation of 'Vida', the company would offer everyone the opportunity to thrive, grow and live better while continuing to move the way they want. I will lead this initiative from the front”.

HM will introduce emerging mobility solutions under the ‘Vida’ brand including its EV that will be officially unveiled on 1^st July’22 IN Dubai (UAE) to coincide with the birth anniversary of HM Chairman Emeritus Brijmohan Lall. The production of the new Vida model will be undertaken at the company's Chittoor-based manufacturing facility in Andhra Pradesh. Dispatches to customers will begin later this year. Dispatches to customers will begin later this year.

HM was already under pressure even before the IT raid incident due to a weak Q3FY22 report card:

In Q3FY22, almost every operating metric of HM was down sequentially as-well-as yearly. Operating revenue was down along with EBITDA/EBTDA and EBITDA margin amid lower sales and higher raw material costs.

Highlights of HM’s Q3FY22 analyst’s concall:

·         Rural demand /sales were affected severely in the past few quarters due to 2^nd  wave of COVID (Delta)

·         Delayed and then extended monsoon also affected rural sentiment

·         Overall demand also affected due to BS-VI transition issues

·         Demand was also impacted due to higher inflation and elevated cost of transportation fuel

·         PAM (parts, accessories, and merchandise) business done well along with global operations

·         Overall FY22 business was impacted due to two major COVID waves and a lockdown

·         Sees improved Q4FY22 and subsequent quarters amid pent/catch-up demand as the pandemic has almost turned into endemic

·         With significant progress in COVID vaccinations, reopening of the economy/society including physical offices, shopping malls, cinema halls, schools & colleges, leisure including big marriage ceremonies, state elections, and travel & tourism (consumer-facing contact-sensitive service industry), demand for 2W is expected to surge amid preference for personal mobility and lower fuel cost (compared to 4Ws)

·         Rural centric Federal budget and 35% increment in capex should also support employment and demand

·         Sees peak of the commodity supercycle, which should support stable raw material costs going forward

·         Special emphasis on EV (inorganic expansion) and thus HM is collaborating with Ather in fund infusion

·         Supported Hero FinCorp (HFC) through large fund infusion; being the NBFC/consumer financing arm of the company, it has a rough time during COVID lockdowns; but now HFC can raise funds of its own

·         HM hiked the price by around Rs.1000 from Oct’21 and again Rs.500 in Jan’22 to cope with rising raw material/production cost

·         Looking ahead, HM will gradually/prudently hike product prices as per evolving situation and commodity prices

·         HM has been losing market share in the ICE/EV scooter segment; It plans to launch a few models and upgrade existing scooters by doing premiumization; Planning to launch the Destini XTEC 125cc EV scooter in April (which is launched on 5^th April)

·         58% of sales are now being done through finance against 40-45% a few years back

·         The current inventory with dealers and sub-dealers is slightly higher at 7-8 weeks against the usual 6 weeks amid weak festive and marriage season

·         Hero FinCorp will be listed at some stage after a couple of years

·         HM will guide about FY23 capex in Q4FY22 earnings concall

·         HM expects around 20% of demand from the replacement market, which was far higher in pre-COVID times

·         Q3FY22 EBITDA margin was affected due to higher raw material costs despite the effort of savings under the LEAP program

·         COVID was an exceptional phenomenon and as the pandemic has now turned into an endemic, consumer confidence is coming back and HM is confident of demand recovery in the coming days

·         Core rural marriage market demand for 2Ws is gaining traction amid cash purchases rather than through finance

·         Huge market scope in the EV scooter segment in the coming days and HM is now well-positioned to gain the market share

Hero MotoCorp Limited is an Indian multinational (MNC) motorcycle and scooter (2W) manufacturer headquartered in New Delhi. The company is the largest 2W manufacturer in the world and also in India. Hero MotoCorp is the dominant market leader in India – the world's largest two-wheeler market – with around 37% share in the domestic motorcycle market. The company has taken rapid strides to expand its presence to 40 countries across Asia, Africa, and South & Central America, with over 100 million satisfied customers across the globe. With innovation at the core of its philosophy, Hero MotoCorp has been at the forefront of designing and developing technologically advanced motorcycles and scooters for customers around the world. India accounts for almost 96% of HM’s revenue, while the rest comes from other global markets. Almost 90% of HM’s revenue comes from 2W sales and the rest from sales of spare parts and other primary services.

HM, like other 2W/4W and contact-sensitive/consumer-facing businesses, is a victim of COVID lockdowns, especially during Q1FY21/22 (1^st and 2^nd wave) coupled with supply chain disruptions, uneven monsoon, price hike, elevated fuel cost, higher regulatory costs and muted rural demand. Also, the lingering geopolitical conflict between Russia and Ukraine/NATO may prolong supply chain disruptions, and higher raw material and fuel costs. Like 4W, the 2W market is also affected due to higher regulatory costs (insurance, road tax, etc); i.e. higher cost of ownership. But compared to 4W, the 2W market is relatively less affected and due to much higher mileage, the adverse impact of higher fuel cost also lower in the case of 2W. In India, the closest rival of Hero Motors is Honda, TVs, and Bajaj Auto.

Looking ahead, Hero Motor is quite confident of demand revival, easing of higher raw material costs, and supply chain disruptions along with a robust export market. HM’s core focus on premium motorcycles (150-200 CC like Xpulse 200 and Xtreme) and EV scooters (urban market) along with cost-saving initiatives and moderate pricing power, may result in better-operating metrics and improvement/revival in EBITDA margin. Also, HM has a formidable market share in the 110-125 CC motorcycle rural market (Glamour, Splendor). This along with a strong balance sheet, limited debt, healthy cash positions, and targeted capex (for EV expansion), the present adversity led by the IT raid may be a wonderful opportunity to buy a good business model under temporary disruption.

Fair Valuation: 3571/- by Mar’23

HM reported actual core operating EPS at 202.86 for FY21 against FY20 figure 200.97; both are substantially lower than FY19 for 249.37 and FY18 at 265.11 amid COVID disruptions. For FY22, considering the quarterly EPS run rate and overall yearly decline in sales units, HM may eventually report the core operating EPS around 178.56, almost -12% lower than FY21 due to the 2^nd wave of COVID and certain other issues as discussed above.

Looking ahead, considering all the pros & cons as discussed above, HM may report FY23, FY24, and FY25 core operating EPS around 214.27, 257.13, and 308.55, considering a reasonable CAGR of 20%. And assuming a reasonable PE of 15, the FY23, FY24, and FY25 fair valuation may be around 3571/-, 4285/- and 5143/-.

Technically, the stock has already taken good support from around 2155 levels after the IT raid news. Now if there are no major corporate governance/unaccounted money issues, and the IT department clarifies its search & seizure operations, the HM scrip may recover above 2450 towards 2875 and above that further scale 3625 by Mar’23, if there is substantial improvement in operating metrics.

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