Stock trades at 13x FY18E earnings for the core auto business vs sector average of 17x — it could rise more
ET Intelligence Group: Mahindra & Mahindra (M&M) is set to harness the revival in rural liquidity and higher far m-gate prices to drive tractor sales, helping offset a deceleration in demand for utility vehicles after the demonetisation drive, announced on November 8.
The country’s biggest maker of tractors, which is better known to consumers for a stable of tough and rugged home-grown utility vehicles (UV) such as Bolero, Thar, and Scorpio, will likely be among the major beneficiaries of the government’s move to set remunerative floor prices for far m produce. Enhanced acreage of the wintersown crop, called Rabi locally, will also benefit Mahindra & Mahindra, whose stock still trades 7% below the l eve l i t h a d r e a c h e d by November 8.
The stock is trading at 13 times its FY18 projected earnings for the core automotive business, a valuation that compares with the sector average of 17 times. Hence, revival in agricultural growth, which is key to both UV and tractor sales, should help the stock gain significantly. Mumbai-based M&M continues to outperform the tractor industry’s growth with new launches such as Yuvo. M&M’s tractor volumes rose 22% in the December 2016 quarter as compared with the industry average of 13%. This resulted in M&M’s market share touching a record high of 44%. Demand for tractors has been quite robust this fiscal because of rising sowing areas and increase in average rural income. Tractor volumes increased 25% between April and October 2016 and after demonetisation, most of the major tractor markets, bar ring Punjab and Karnataka, have shown sharp recovery. The Street is pricing in M&M’s volume growth at 22% and 13% in the current and next fiscal, respectively. The company will launch new tractors by September of the next fiscal year, and will expand the Swaraj range. The company’s management, in the call after the quarterly earnings, has indicated that tractor sales volumes will likely rise about 10% in March 2017. Higher tractor sales are positive for the earnings growth of M&M as margins in this segment are twice as those of the automotive segment.
In the third quarter, operating margins of the tractor segment expanded 210 basis points year-on-year to 17.4%, while automotive margins dropped 310 basis points YoY to 7.1%. The increase in tractor margins helped limit the blended margin decline t o 1 3 0 basis points. The tractor segment contributed 59% of the total operating profit (after depreciation) in the first nine months of FY17 against 43% in the previous fiscal.
In the automotive segment, the company took several steps to arrest a decline in its UV market share. M&M has been able to post a 170 basis points sequential gain in market share by launching the new Bolero that attracts less excise duty. The launch of petrol variants of XUV500 and Scorpio and two new launches (one MPV in the second half of FY18 and a compact UV in FY19) may help consolidate M&M’s market share in UV space.