M&M rides on strong outlook for farm equipment and reasonable valuation

Nitin Agrawal
Moneycontrol Research

India’s largest tractor and utility vehicle (UV) manufacturer Mahindra and Mahindra (M&M) has posted a very good set of numbers for the second quarter ended September 2017. The company reported the highest ever quarterly net revenues and profit after tax, highest ever quarterly EBIT (earnings before interest and tax) in the farm equipment segment (FES) as well as the auto segment.

Strong leadership in FES, revival riding on rural growth, a slew of new launches and reasonable valuations make it a stock worth accumulating for long-term investors.

Quarter in a snapshot

The net revenue witnessed a growth of 19.4 percent (YoY) and achieved the highest ever net revenues of Rs 12,018 crore of (M&M and MVML). This was attributed to 16.3 percent overall volume growth, driven by 31.2 percent growth in tractors on the back of a good monsoon and 11.3 percent growth in UV volumes led by healthy demand for power brands. The average realization was up 2.7 percent led by a price hike of 1-1.5 percent on auto and 2-2.5 percent on tractors.

The EBITDA margin expanded by 190bps (YoY) and reached a multi-year high of 16 percent on the back of price hike taken in the quarter and favorable product mix. Automotive and farm EBIT margins expanded by 130bps (YoY) and 100bps (YoY), respectively.

Net profit was up 22 percent (YoY), driven by strong operating performance and low interest cost.

We draw comfort from the following:

FES – Strong outlook

M&M is the market leader in tractors and has been gaining market share. This was attributed to the new launches that took place in the last two years.

On the back of good monsoon and improved rural sentiments, the management has increased the volume growth outlook to 12-14 percent from 10-12 percent earlier for the industry and it believes that the annual volume growth of 8-10 percent is sustainable for the industry.

M&M, being the leader, is in the sweet spot to take advantage of the growing industry. The management believes that M&M would be able to do better than the industry growth on the back of its large exposure in rural and semi-urban areas and the launch of new platform which is expected to come in 2HFY18.

Auto – positive impact of GST
With all regulatory headwinds waning, the management believes M&M could ride well and believes that GST will augur well for auto volumes in long-term.

On the volume front, domestic volumes were higher by 13 percent whereas exports witnessed a significant decline of 32 percent, mainly because of the financing issues in Nepal and regulatory issues in Sri Lanka. The management pegs 10 percent volume growth in passenger vehicle segment for the industry.

Portfolio revamp?
M&M has a portfolio of very successful products such as Scorpio and XUV500 in the UV segment. The company continues to expect good momentum in the UV segment driven by three refresh launches in 2HFY18 and S201 (MPV) in this year and a Tivoli based vehicle in FY19.

Focus on electric vehicle (EV)
The company has earmarked Rs 600 crore to be invested through Mahindra Electrics for building plants for battery, electric motors, transmission and for power electronics. The company plans to manufacture all these in-house and expects to have the capacity to manufacture 5,000 vehicles per month. The management indicated that they would participate in a full range from three-wheelers to buses. The company has also finalised long-term sourcing of Li-ion cells.

Undemanding valuationThe underperformance of the stock has rendered the valuation extremely undemanding. If we follow a sum of the parts valuation (SOTP) and exclude the value of the subsidiaries, the core automobile business trades at close to 12 times FY19 projected earnings. Albeit the lacklustre performance, this is at a steep discount to peer groups that typically trade at multiples of 17-20 times. We believe that there is headroom to catch up riding on rural recovery and product innovation. Long-term value investors should use the weakness to accumulate M&M.

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