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M&M: Another good quarter! - Views on News from Equitymaster
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M&M: Another good quarter!
Jan 31, 2006

Performance Summary
M&M announced its 3QFY06 numbers yesterday, wherein it reported a robust 25% YoY topline growth. Efficient management of operating costs enabled the company to expand its operating margins by 100 basis points. Significant increase in other income (dividend from subsidiaries increasing by 64% YoY) coupled with a marginal decline in the effective tax rate enabled the company to report a 40% YoY increase in net profit (excluding extraordinary income).

(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Net sales 17,723 22,072 24.5% 47,499 59,339 24.9%
Expenditure 15,606 19,231 23.2% 41,901 52,417 25.1%
Operating profit (EBDITA) 2,116 2,841 34.2% 5,597 6,922 23.7%
EBDITA margin (%) 11.9% 12.9%   11.8% 11.7%  
Other income 222 403 81.2% 678 901 32.8%
Interest (net) (89) (21) - (55) (123) -
Depreciation 455 558 22.7% 1,322 1,491 12.7%
Profit before tax 1,972 2,706 37.2% 5,008 6,455 28.9%
Extraordinary item (15) 469 - 174 469 -
Tax 626 841 34.3% 1,583 1,565 -1.1%
Profit after tax/(loss) 1,332 2,335 75.3% 3,600 5,359 48.9%
Net profit margin (%) 7.5% 10.6%   7.6% 9.0%  
No. of shares (m) 116 232   116 233  
Diluted earnings per share (Rs)*         30.7  
Price to earnings ratio (x)*          
(* trailing twelve months)            

What is the company’s business?
Mahindra & Mahindra (M&M) is engaged in the manufacture of utility vehicles (UV), tractors, light commercial vehicles (LCV) and three-wheelers. In FY05, automotive division comprising UV, LCV and three-wheelers contributed 63% of FY05 volumes sales. The farm equipment division accounted for 37% of the volume sales. Through investment in its subsidiaries, the company has interest in other sectors like software, hotels, real estate and financial services as well. In FY05, M&M had a 51% market share in the MUV segment. Similarly, it’s share in the tractor and LCV segment stood at 27% and 12% respectively.

What has driven the performance in 3QFY06?
Volumes – continued to be a mixed bag: The tractor segment has recorded another quarter of robust growth. Though volume growth in 3QFY06 was slower than 9mFY06, it is nevertheless a commendable show. However, it should be noted that M&M has comprehensively outperformed the industry growth of around 12% to 15% YoY in 9mFY06.

Sales snapshot…
(units) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
UVs 28,497 29,594 3.8% 78,995 81,040 2.6%
LCVs 1,656 1,541 -6.9% 5,977 5,232 -12.5%
3-wheelers 5,756 6,260 8.8% 15,992 15,283 -4.4%
Automotive 36,728 38,827 5.7% 102,815 105,665 2.8%
Tractors 18,977 24,018 26.6% 47,812 63,389 32.6%
Total 55,705 62,845 12.8% 150,627 169,054 12.2%
Exports 1,791 2,888 61.3% 5,237 8,825 68.5%
Domestic 53,914 59,957 11.2% 145,390 160,229 10.2%

On the Utility Vehicles (UVs) front, the performance of the company has been mixed. While ‘Scorpio’ continued to report commendable double-digit growth, the demand for other UVs (excluding ‘Scorpio’) continued to decline. Also, the overall UV volumes are capped by the fact that the demand for hard tops (like ‘Scorpio’ and ‘Bolero’) is cannibalising sales of soft tops (like ‘Gypsy’). To give a perspective, soft-top sales (as a percentage of total units sold) were around 13% last year for M&M. However, the share has comedown to around 9% in the current fiscal. Apart from this, increased competition and premium pricing also restricted volume growth to some extent. LCVs and the three wheeler goods carrier volumes continued to decline on account of exceptionally good response to Tata Motors’ ‘Ace’, a sub one tonne four-wheeler. It should be noted that though the volume sales of LCVs are included in the above table, from November 2005, the revenue generating from the same would not be recorded in the book of M&M. It would be reflected in the books of the joint venture (sold in November 2005).

Despite 11% YoY volumes growth, the topline grew by an impressive 25% YoY. This partly due to improving product mix and also due to price hikes that the company announced during the current fiscal year.

Operating margins - on an upturn: As is the case with other automobile companies, raw material costs has decreased as a percentage of sales during the quarter. Going forward, we expect auto companies to benefits from the weakness in steel prices. For the full year, we expect raw material costs (as a percentage of sales) to stabilise around 68.2% for M&M. However, spurt in other operating costs capped the overall margin expansion. The increase in other operating expenses is on account of one-time expenses of R&D and maintenance. Similarly, a change in accounting policy with respect to the excise on the closing stock also increased other operating expenses.

Cost break-up...
(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Raw materials 12,522 14,875 18.8% 32,682 40,668 24.4%
% sales 70.7% 67.4%   68.8% 68.5%  
Staff cost 1,199 1,413 17.9% 3,474 4,115 18.5%
% sales 6.8% 6.4%   7.3% 6.9%  
Other expenses 1,886 2,943 56.0% 5,747 7,592 32.1%
% sales 10.6% 13.3%   12.1% 12.8%  

Looking at the segmental margins, both the automotive segment as well as tractor segment have witnessed a improvement in EBIT margins on the back of high capacity utilisation. Going forward, we expect limited upside in tractor division margins. But there exists some room for margins expansion in the auto division.

Other income boosting the bottomline: As compared to the topline growth of 25%, net profit in 3QFY06 grew by 75% YoY. This was primarily on account of the one-time income arising from sale of LCV business to the joint venture with International Truck and Engine Corporation (M&M holds 51% stake). Even after excluding the extraordinary income, net profits grew by 40% YoY.

What to expect?
At Rs 563, the stock is trading at price to cash flow of 12 times our FY08 estimates. The first nine months performance, excluding extraordinary income, is in line with our estimates (9mFY06 net profit accounting for 72% of FY06 estimated profits). Recently, we had recommended a buy on the stock with a target price of Rs 570 from a two-year perspective. Considering the company’s expansion plans (both geographically and product wise), we recommend the investors to hold the stock. We have not factored in the benefits that could accrue from its Chinese and the Romanian venture. Similarly, there is a significant upside on the cost saving front, considering the aggressive plans of the company in the auto ancillary segment. Apart from this, the subsidiaries, which were a drag two years back at the consolidated level, are delivering sound results. The company has indicated their intention to unlock the value in some of these subsidiaries (red hearing prospectus for one of the subsidiaries, Mahindra and Mahindra Financial Services Limited, has already been filed with the SEBI). Overall, positives outweigh risks from a long-term standpoint.

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