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Hero Motocorp is amongst the least loved large-cap stocks today.
- The auto sector is in a cyclical downturn
- The auto sector has been affected adversely by input cost inflation, fuel inflation and supply chain challenges due to COVID.
- Within the auto sector, 2 wheelers have the weakest demand today
- Legacy 2 wheelers have the highest risk of disruption with the number of PE-VC backed EV players entering the industry increasing by the day
- Within the legacy 2 wheelers, Hero Motocorp is the least diversified outside of domestic mass-market 2 wheelers.
As a result of the above, Hero Motocorp has given miniscule share price returns this last decade and is available at throwaway valuations of approx. 30k cr for its base business (Ola Electric is rumored to be valued at 37.5k cr in the private market). As the less popular call from Niranjan Gupta, CFO, Hero Motocorp, “if you still want to pick a winner company, just Google the synonyms of the word “winner” and you will have your answer”, we argue that Hero Motocorp is amongst the better-placed legacy players to benefit from the upcoming demand upturn and resist market share loss from the impending EV assault by the new players.
Hero MotoCorp Limited (HMCL) is the world’s largest manufacturer of motorcycles and scooters, a position it has held for the past 20 consecutive years. With presence in over 40 countries across the globe, the Company’s vision is to ‘Be the Future of Mobility’ and through its R&D, manufacturing, products, services and sustainable approach, it strives to set benchmarks of excellence in the industry. Every second motorcycle and third 2W sold in India, is made by Hero Motocorp.
The company is the leader in mass market commuter bikes, mostly in the 100-110 cc range and has the most extensive rural distribution.
Hero Motocorp recently reached the 100 million vehicles milestone in 2021 and by the words of its Chairman and CEO, Dr. Pawan Munjal, wants to double it to 200 million vehicles this decade.
No movement in share prices over the last decade. Hero Motocorp has hardly given 10% stock price appreciation over the last 10 yrs.
The share price underperformance is contributed by a number of factors, but the graph below summarizes it best. From having growth rates of 25%+ in the early 2000s to negative growth rates in the last 3 years, Hero’s revenue and profit growth has come to a halt.
Lowest industry growth in the last 30 yrs.
Some factors causing this are broad consumption & growth slowdown, various disruptions affecting the small & unorganized, increased emission standards leading to price increases, cost of ownership increase and supply chain disruptions due to COVID.
Of all the existing listed 2W players, Hero has the least representation of high-value and high-margin products. These high-value products viz. Premium, scooters and exports help in getting better diversification and makes revenues less dependent on the economic cycle in the domestic market.
Hero is almost non-existent in the 150cc+ category, with 3% market share. This is in contrast to Hero’s market share in 100-110 cc and 125 cc.
Scooters, being predominantly an urban product, provide good shielding from the prevailing economic cycle and have more resilient demand in comparison to the entry-level motorcycles. Hero has lost share over the last 5 years and is a small player now in the scooter segment.
Hero’s exports have stagnated at the 2 lakh mark over the last 5 years till FY21, whereas TVS and Eicher Motors have more than doubled their exports in the last 5 years. Not to mention, the king of exports, Bajaj which is still the largest 2W exporter by far, selling more than its domestic sales in FY20 and FY21.
Hero is a strong player in rural parts of the country. And whenever there is a cyclical downturn, rural areas get affected more than urban ones. And being the most rural-focused mass market player, Hero has had to bear the biggest volume loss amongst 2W. This is reflected well in the below chart, showing the movement in 100-110cc motorcycles from 66% share in 2016 to 57% share in 2020.
- Input price inflation - Metals and other commodities price increase requiring price hikes. This has affected demand
- Fuel price increases - 100-110 cc, Hero’s breadwinner is the most price-conscious segment and it has been the most affected because of increase in cost of ownership.
- COVID-led challenges
- Rural slowdown
The current valuation pretty much summarizes the market sentiment on Hero.
Current Hero Mcap is 50k cr.
Hero has cash & short-term investments of 10k cr in its books.
Hero’s stake in Hero Fincorp is 41%. As per prices in the unlisted market, this is approx. worth 5.5k cr.
Hero stake in Ather is 38%. Ather hasn’t raised equity capital in these elevated market levels. The valuation immediately after COVID was 2.8k cr. But, since then, they have scaled up sales at least 10x. Considering Ola’s private market valuation, even assuming Ather has a $1bn valuation will mean that Hero’s stake is worth 2.5k cr roughly.
All put together, Hero’s base business is available for roughly 30k cr. In comparison, Ola Electric recently raised $200mn at a $5bn valuation, which is higher than Hero’s base business. Hero generates between 3-4k cr free cash flow every year and has a dividend yield of 3.5%.
Growth headwinds abound with the market assumption that 2W is a mature category, EV disruption will result in Hero losing the leadership position. As a result, it is expected that the terminal value is at risk and that Hero’s volumes from here on are expected to go down.
Margin headwinds persist from inadequate margin accretive offerings like premium products and exports, commodity price inflation and expected profit pool sharing with multiple manufacturers as EVs are expected to bring in a number of new players.
In short, everything that can go wrong is almost in the price today.
Hero has articulated its new vision to “Be the Future of Mobility.” This entails exploring emerging opportunities in the mobility space, while continuing to excel in the core mobility segments the Company operates in. Key strategic highlights are below:
The company is addressing the EV opportunity through different angles
Ather is the largest EV 2W maker in India today by value. Hero started investing in Ather in 2016 and is the largest shareholder with 38% stake. Apart from the benefits of Ather’s growth, this stake gives a great optionality in terms of partnerships on EV technologies and know-how. Hero is already going to use Ather’s fast-charging network for its products.
Developing in-house range through R&D centres in India & Germany. Hero is working on launching its 1st EV scooter in Mar 2022. This scooter is expected to be without battery swapping option and is expected to be a mass market scooter. Going forward, every year, new EV products are expected to come out of the in-house R&D centers. Also, recently, the company has hired Swadesh Srivastava, with tech background in Apple, Intel, Flipkart and Ola Electric, to lead the EMBU. This could be seen as another signal of the company ready to change its genes in accordance with the changing times.
One of the projects introduced is a concept vehicle, which is the world’s first class changing vehicle and can be used as a two-wheeler (2W) and three-wheeler (3W). The second project is around digitising the used 2W, with data-driven technology
- Hero Motocorp AR, FY2020
We have already declared our next ambitious goal – we will achieve the target of the next 100 million within this decade. In keeping with our vision - ‘Be The Future of Mobility’, our 200 millionth vehicle may not be a two-wheeler!
- Hero Motocorp AR, FY2021
The partnership with Gogoro Inc, which was announced earlier this year, is one of global significance. This partnership will be a key to the propagation of electric vehicle charging technology and network, supporting the EV products in India, and across our global markets. Through this partnership, we will bring Gogoro’s battery swapping platform to India, collaborate on electric vehicle development and develop Hero-branded, Gogoro-powered mobility solutions for the market. Gogoro is a hyper-efficient battery swapping platform with more than 400,000+ riders and 2,100 battery swapping stations. Gogoro is a global leader in open platform for battery swapping and smart mobility services, delivering a fresh alternative to legacy fuel. Gogoro’s expertise in connectivity, artificial intelligence and machine learning solutions are expected to bode well with our market leadership in India, and bring a whole new perspective to mobility going forward.
- Hero Motocorp AR, FY2021
Also, with this Gogoro partnership, Hero can develop a new stream of revenue in battery as a service. Outside of the revenue stream, battery swapping stations can give excessive data on usage patterns, swaps, battery status and when done on scale, could lead to a sustainable competitive advantage.
And Hero is probably the only legacy 2W, which has openly committed that it is ready to go into debt, to gain market leadership in EVs. Also, Hero has committed 10k crore investments across ICE, EV over the next 5 yrs. We feel that if the legacy players don’t succeed in the EV world, it would be because of the lack of agile and market share oriented mindset, and Dr. Pawan Munjal has stressed time and again that they will not make that mistake. We feel that this mindset, even if value-destructive in the short term, will be cheered on with higher terminal values by the market and lead to value-creation and market leadership in the long term.
With all these steps, Hero hopes to lead the challenge for EV share which is reflected in the below views of the management on the war of words between legacy and new EV players. .
“Recently of course there has been lots of talk on who will win in EV and you have several names that have been floating around. While I would not get into betting, let me just talk about what we believe success in EV will require. It will require focus on customers, on cost, and on collaboration and not necessarily on competition. Having said that, if you still want to pick a winner company, just Google the synonyms of the word “winner” and you will have your answer.”
- Niranjan Gupta, CFO, Hero Motocorp, Q2FY22 Concall
Majority of R&D spend on new products to be focused on the premium range. New launches are incrementally already being seen in the direction. Hero has assured investors that in the future, ⅔ of its investments will be focused on premium, scooters and EVs. The company has also planned to launch 10 models every year for the next 5 years. This shows the aggression of the management in gaining share in the under-penetrated segments.
“Our Centre for Innovation and Technology (CIT) at Jaipur, is a world-class facility with an in-house campus for National Accreditation Board for Testing and Calibration Laboratories (NABL) accredited labs and test tracks. The CIT houses more than 1,000 professionals and automotive experts from around the globe, working in an environment of excellence to develop future-ready products. In addition, the Hero Tech Center Germany (HTCG) near Munich is a hub of excellence, focusing on new product development for global markets, keeping us on the right track to meet evolving customer demands.
Our R&D expenditure was nearly twice that of our nearest competitor during the year under review. We continue to aggressively ramp up our R&D capabilities with a host of innovations. We were among the first in the industry to successfully transform and launch all our products under the BS VI emission norms. Our sustained investments in R&D will result in a range of new product launches in 2021 and beyond.”
- Hero Motocorp AR, FY21
“Currently, last couple of months we are at 6%+ market share and we are on target to cross 10% by March, and therefore that is actually now giving the outcome of the portfolio strategy that we have. You have seen couple of launches that we have done in the quarter - Xtreme 160R Stealth, XPulse 200 4Valve, and you will continue to see more and more actions on the product side as we had already promised as part of our premium strategy, and the focus is not just on premium, it is on premiumization within segments as well. Accordingly, Glamour Xtec was launched with more than ₹4,500 price premium. It is already actually garnering more than 50% demand within the Glamour segment. Similarly, in scooters, we launched Pleasure Xtec and connected Maestro Edge. So we will continue to have the premiumization story as the key theme within the segments as well.”
- Hero Management, Q2FY22 concall
As the world’s largest manufacturer of motorcycles and scooters, we are now moving ahead to leverage our market leadership to build a strong portfolio of motorcycles in the premium segment. The new collaboration with Harley-Davidson Inc. - the iconic motorcycle manufacturer - marks a significant step towards enriching mobility experience for riders. As per the distribution partnership, Hero MotoCorp has commenced the sale and service of Harley-Davidson motorcycles in India through a network of brand-exclusive Harley-Davidson dealers. Hero MotoCorp also sells Harley Davidson Parts & Accessories, General Merchandise riding gear and apparels. As part of a Licensing agreement, Hero MotoCorp will develop and sell a range of premium motorcycles under the Harley-Davidson brand name.
- Hero Motocorp AR, FY21
In a significant milestone in our global journey we made an entry into Mexico, a key motorcycle and scooter market, with Grupo Salinas as our partner. This has enabled us to form one of the largest retail sales channels in the country. Our expectation is that Mexico will become a key international market for us in the foreseeable future. Our Global Business is already making strides in re-establishing itself in some of the territories in South America. New distributor partners have been appointed in Honduras and Nicaragua. Hero MotoCorp has also taken immense strides in Nigeria and have launched a new product called Hunter in that market. The initial results are extremely promising and we expect to gain significant market share in Nigeria.
- Hero AR, FY21
Hero, between 2015 to 2020, was maintaining an annual run rate of 2,00,000 export units. In this year, the current run rate is above 3,00,000 which is a good 50% jump.
Hero has accelerated its retail footprint on spare parts from 20,000 retailers 3 years back to 30,000+ retailers by FY21. Additionally, as the premium products share of revenues start inching up, it gives additional opportunities in accessories and customisations. Already, Hero has moved from its usual average of 8.5% sales from spare parts to 10% of revenues in FY21 and 13% of revenues in Q1FY22
LEAP was launched for fixed cost optimisation and has focused on material cost reduction with a target of ~50 bps of annual savings. We have now launched LEAP-II with double the target of LEAP to ~100 bps targeting substantial savings
- Hero Motocorp AR, FY21
After witnessing a fall in the first quarter of the financial year, commodities have seen a sharp increase. Most of the ferrous, non-ferrous and precious metals are at their multi year highs which has adversely impacted the margins across the industry. Cost management as you would have seen in the commentary that we have released yesterday, not just on variable cost, but actually on fixed cost as well has yielded handsome dividend with LEAP savings giving us more than 300 basis points of savings, helping us offset large part of the cost inflation as well as the overhead management and that has helped us sequentially improving margins
- Hero Q2FY22 concall
The biggest proof of the success of Hero’s cost saving programme can be seen from the material cost increase/unit between FY20 and H1FY22 for the listed 2W OEMs. Hero seems to have managed commodity inflation the best.
Beyond all these factors, the biggest factor that could cause earnings growth and re-rating in our opinion is the industry growth revival in 2W. If you look at the history of 2W volume growth from the 1990s, there are usually 4-5 years of strong volume growth followed by 2-3 years of volume stagnation or degrowth.
If we start looking at the industry growth data as 3-year rolling averages to even out demand changes year-on-year, we notice that the long-term range has been 10% average between 1990-2012 and 8% from 1990-2021. And currently, volume degrowth has been its worst in the last 30 years. We don’t believe there are structural reasons for this demand level to sustain. This past 2010-2020 decade has been one where growth has stagnated, and it is not restricted to autos. It is across financials, real estate, infrastructure, etc. In short, all economy focused sectors are down. If we believe the capex cycle is coming back, real estate boom is here to stay, credit growth is going to pick up, there is no reason to not stay optimistic on 2W volume growth.
India’s 2W penetration is still way below South East Asian countries, leaving enough headroom to grow.
Hero Motocorp owns 41% of Hero Fincorp. Hero Fincorp is a retail-focused NBFC, which started out as the captive financing unit of Hero Motocorp. It is the largest 2W financier in the country and has grown its assets at a CAGR of 31% and book value CAGR of 25% over the last 5 years. Hero Fincorp is currently valued around 13k cr in the unlisted market. FY20 and FY21 have been difficult years given COVID disruptions. But, under better expected circumstances in the coming years, if Hero Fincorp grows at a similar rate, it could be worth 50k crores by itself in the next 5 years.
- The biggest risk is failure to become a meaningful player in EVs. Even if EV adoption doesn’t grow very fast, Hero’s position in the EV space will determine what terminal value investors are willing to give
- Prolonged economic slowdown. As the most domestic focused 2W, any continuation in the economic slowdown of the last decade could result in continuing mediocre performance.
- Hero, in its previous attempts, haven’t been so successful in establishing itself as a strong player in premium, scooters or exports. If the current attempts fail, that could result in the margin going down even further with more competition.
- Quick adoption of alternate channels like online for 2W purchase can dent some competitive advantages built by Hero through its large distribution network.
- Might sound counter-intuitive, but in the era of PEs financing new EV players to gain market share, excessive focus on margins over market share can be detrimental. Till now, Hero hasn’t given signs on going down this route, but any future change in strategy could be detrimental.
- Continued commodity inflation could delay or derail the expected demand upcycle. As Hero caters to the most price conscious segment, continued increase in total cost of ownership could mean postponement of demand.
With the self-proclaimed best EV product, building the largest 2W factory in the world, won’t Ola be the leader? We feel that it is too early to expect great things from Ola. It has 1 product which was bought over from Etergo, the Dutch EV scooter.
Ola is very new into manufacturing EVs and its EV know-how is at the same level, if not inferior, to the legacy 2 wheelers. Plus, 2W need not have the most sophisticated tech understanding and autonomous capability. So, it is not too different from ICE apart from the powertrain, basic tech and infotainment.
Yes, Ola has the best specifications in the market today. But, do we know anything about its unit economics? Is it expected to make money at this price? Is it purely an attempt at gaining market share or is there a strong business model underlying? 2W manufacturing has a good amount of labour intensity, and doesn’t offer scale benefits beyond a point. And it is not a platform business like Ola’s cab business to aggressively acquire customers and hope for profits later on. Today, the private market environment is the most bullish it could be on EVs and with liquidity aflush, it is finding its way to fund companies showing even miniscule potential. If the liquidity situation turns, can Ola access the private markets with the same ease?
Yes, Ola is building the largest factory. But, can’t the legacy 2 wheelers do it too? Bajaj can build capacity equalling half of the total world 2W demand (ICE + EV) with just its cash on book, and TVS and Hero are not far behind. Today, they haven’t done it as they don’t see the demand. They can easily create the capacity in short notice.
And Ola by taking the uber aggressive route, has woken up the legacy players from their slumber. We prefer the Ather route of building good products, rectifying mistakes, giving great experiences and expanding slowly to build a successful and trustworthy EV franchise. The benefit is the lead it affords the new player to learn, make mistakes and build expertise. Ather is probably the only company to have a know-how lead over the legacy players given its learnings over the last 8 years. People who are comparing Ola to Tesla, should read about the lead Tesla had with respect to legacy auto makers. Tesla was started 15 years before other car makers took EV seriously, and had a close to 10-yr lead from its first production vehicle.
To its benefit, Ola has no base business to worry about, is agile and can become a challenger in the future, with its PE-backing. Bottomline, we are not writing off Ola, but just warning not to over-expect and discount the legacy players.
P.S.2: Why should anyone bet on 2W OEMs. Isn’t it a better option to rely on auto ancs as they will benefit regardless of who wins?
It’s definitely not a bad option to bet on auto ancs over OEMs. It seems to be the safer option. And precisely for that reason, the valuations also reflect that. Most auto ancs, which are B2B players with 10-15% operating margins and similar ROCEs, are priced way above the OEMs. And these auto ancs have lower pricing power than the OEMs to withstand commodity inflation. On the other side, the current 2W OEMs have insane ROCEs(50-100%) and are huge FCF generating machines with loads of cash on books. Though this is expected to moderate, we still believe that the incremental ROCE for OEMs would be superior to auto ancs and hence, the right OEM will outperform the auto ancs.