Ideas for Profit | Leadership position, attractive valuation make M&M a long-term buy

Nitin Agrawal
Moneycontrol Research

Highlights:
- Strong volume growth in the farm equipment segment
- Decent volume growth in the automobile segment
- Operating profitability under pressure due to rise in raw material prices
- Moderate outlook for tractor segment, near-term weakness in auto segment
- Accumulate in a staggered manner
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Subdued consumer sentiment in the automotive segment impacted the performance of Mahindra & Mahindra (M&M). However, buoyant tractor segment helped the company deliver a decent showing. While the company posted double-digit growth in net revenue, its earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted significantly. EBITDA was marred by rise in raw material (RM) prices and discounts.

The stock is worth accumulating for long-term investors on the back of its strong leadership in the farm equipment segment (FES), revival riding on rural growth, a slew of new launches and reasonable valuations.

Quarterly snapshot

Key positives
Net revenue rose 12.2 percent year-on-year (YoY) driven by a 11.1 percent growth in overall volume and a percent growth in realisation. Domestic tractor and automobile segment volumes grew 13.1 percent and 9.6 percent, respectively. Strong demand for the tractor segment’s  was driven by three consecutive years of an almost normal monsoon, continued government focus on agricultural and rural development and sustained investment in infrastructure and road projects.

Key negatives
Earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted 151 basis points (100 bps=1 percentage point). The contraction was on the back of significant rise in raw material (RM) prices and discounts. However, lower other expenses partially offset the impact of a rise in RM prices.

Earnings before interest and tax (EBIT) margin for the automotive segment contracted 258 bps led by higher RM prices, discounts and higher cost associated with its new launch: XUV300. Margin for the FES segment contracted 129 bps.

M&M also reported an exceptional loss of Rs 80 crore due to provision for impairment of certain investments.

The management has slashed its tractor industry growth target to 10 percent in the current fiscal from 12-14 percent earlier. It expects flat growth in the last quarter of the current fiscal as well.

Following are the factors that give us comfort on the company:

FES – outlook positive
The company has been the market leader in tractors and commands a market share of more than 40 percent. Leadership is primarily attributed to constant product innovations.

Though the segment has been performing well on the back of a bountiful monsoon over the past three years, increase in minimum selling price (MSP) and government’s focus on rural areas, the near-term outlook is challenging.

M&M, being the leader, is in a sweet spot to take advantage of a growing industry. The management believes that M&M would be able to do better than industry growth on the back of its large exposure to rural and semi-urban areas.

Automotive segment – sluggish in the near-term
Demand outlook for the automobile segment continues to be muted on the back of various factors such as increasing cost of total ownership (rising interest rates, higher insurance cost, weaker festive sales and liquidity crunch). Demand in the near term is expected to be sluggish. However, its long-term outlook continues to remain very positive.

With new launches, M&M continues to remain on a strong footing. In fact, the company has a portfolio of very successful products such as Scorpio and XUV500 in the utility vehicle (UV) segment. The response to its refresher Pulse XUV500 is also very strong. It newly launched Marazzo has also been well received. New product - XUV300 - is also witnessing strong traction and has seen 3,000 pre-bookings.

Attractive valuationThe underperformance of the stock (corrected 33 percent from its 52-week high in August 2018) has rendered the valuations attractive. Sum-of-the-parts valuation (SoTP) methodology offers 20 percent upside potential. We advise long-term investors to accumulate M&M for the long-term.

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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here