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M & M: In the limelight

Feb 22, 2001

Mahindra & Mahindra ( M & M) share price has been rising consistently on the bourses in the past few weeks. M & M continues to shine in the top gainers list. The pure fundamental basis of its 3QFY01 performance is unlikely to be the reason for this buying interest.Though the company has managed to increase its market share in the tractor industry, its performance in the utility vehicles (UVs) continues to be dismal. The entry of Toyota Qualis in the past year has given tough competition to the already existing UV manufacturers and this continues to be the case currently too.

For 3QFY01, the company's operating margins at 8.1% declined by 420 basis points YoY. As compared to 2QFY01 this is an improvement of 380 basis points, mainly due to price revisions across the board for their vehicles. However, the ratio of new product sales vis--vis their older models is higher in the current year than in previous years. This has put pressure on its operating margins since the new products have relatively lower margins. The company's overall sales declined by 5% YoY in 3QFY01 due to dismal performance in the UV market. In the tractor division the company has managed to increase its volumes in a declining market by higher market share gains.

We feel that the buying interest has stemmed from the likelihood that import of second hand vehicles are unlikely to be allowed very easily in the auto policy which is expected to be announced next month. This has lead to overall buying interest across the automobile sector. As increasing domestic competition and decline in rural demand has taken its toll on the auto sector, the industry has been worried about second hand imports flooding the market.

Another reason we feel that has resulted in a spurt in M & M's share price is that its subsidiary Mahindra British Telecom (MBT) will be going public soon. The IPO consists of a primary issue of 5,318,633 equity shares of face value of Rs 2 each and will also involve a divestment by two existing shareholders of Mahindra-British Telecom, of a total of 6,382,267 equity shares of the face value of Rs 2 each by way of an offer for sale. As a part of the offer for sale, 1,063,700 equity of face value of Rs 2 (16.6% of offer for sale) is proposed to be reserved for allocation to eligible shareholders of Mahindra & Mahindra.

As MBT continues to do well in the current financial year and also receives business from British Telecom, the prospects for this subsidiary are bright. In FY2000, MBT reported a net profit of Rs 630 m, which works out to an EPS of Rs 5.9 on a fully diluted basis. Assuming that MBT will report a 30% growth in net profit in the current financial year, the EPS works out to Rs 7.7.

MBT's closest competitor, Hughes Software is currently trading at 54x FY01E currently, hence on a conservative basis we can assume a price to earnings multiple of around 25x for MBT. Based on this the issue price works out to about Rs 193. On the positive side, M & M's consolidated other income will go up by Rs 702 m, by selling its stake in MBT by way of offer for sale.

On the other hand as only 1.1 m shares are to be offered to shareholders of M & M, this accounts for hardly anything of M & M's total share outstanding of 110.5 m shares. The ratio of shares works out to 1 share of MBT for nearly 100 shares of M & M.

On the current price of Rs 183, M & M is trading at 15.5x FY01E EPS of Rs 11.8. Given the above scenario, there is nothing exciting about the current fundamental prospects of the company. If one were buying M & M based on the MBT hype, then also the gains to small shareholders are minimal. Caution is the buzzword.

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