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M&M: The stage is set - Views on News from Equitymaster

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M&M: The stage is set

May 29, 2006

Performance summary
M&M, the diversified auto major, announced its full year results late yesterday. While the company's topline grew by a 24% YoY during FY06, much of the growth was led by better product mix. This is because, in FY06, total volumes sold (four-wheelers, three-wheelers and tractors combined) was higher by 12% YoY. Despite new product launches and higher input costs, operating margins increased, which was led by the farm equipment division. While the topline performance was higher by 7% as compared to our estimates, bottomline was in line, except for the extraordinary income (profit from sale of stake in M&M Financial Services through an IPO).

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 19,107 22,888 19.8% 66,606 82,227 23.5%
Expenditure 16,998 20,168 18.6% 58,900 72,554 23.2%
Operating profit (EBDITA) 2,109 2,721 29.0% 7,706 9,672 25.5%
EBDITA margin (%) 11.0% 11.9%   11.6% 11.8%  
Other income 406 138 -66.1% 1,085 1,039 -4.3%
Interest (net) (1) (61) - (56) (184) -
Depreciation 518 509 -1.7% 1,841 2,000 8.7%
Profit before tax 1,998 2,410 20.6% 7,006 8,895 27.0%
Extraordinary item (39) 1,661 - 136 2,100 -
Tax 432 859 98.8% 2,015 2,424 20.3%
Profit after tax/(loss) 1,527 3,212 110.4% 5,127 8,571 67.2%
Net profit margin (%) 8.0% 14.0%   7.7% 10.4%  
No. of shares (m) 116 233   116 233  
Diluted earnings per share (Rs)         36.7  
Price to earnings ratio (x)         17.2  

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. The automotive division, comprising UV, LCV and three-wheelers, contributed to 61% of FY06 volumes sales. The farm equipment division accounted for 33% while exports accounted for the rest (29% market share in tractors in FY06). Through investment in its subsidiaries, the company has interest in other sectors like software, auto ancillaries, hospitality, real estate and financial services as well. In FY06, M&M had a 51% market share in the MUV segment.

What has driven performance in FY06?
Tractors propel growth: As was the case in FY05, it was the farm equipments division that has played a major role in M&M's FY06 performance, both on the volumes and profitability fronts. Even as the total UV volume sales increased marginally by 3% YoY, tractor volumes grew by 30% YoY. If one were to break-up UV volumes sales, 'Scorpio' sales increased by 18% YoY. Excluding this, UV sales declined by around 2% YoY in FY06, which could be attributed to two factors - launch of a competitive product by Tata Motors in the goods carrier segment, and the increase in fuel prices. The impact of the new launch by Tata Motors (Ace) is also reflected in the fall in M&M's LCV and three-wheeler sales in FY06. As far as exports are concerned, this has been a focus area for the company and we expect it to grow faster, even though the net contribution may not be significant in the short-term.

Sales snapshot…
(units) 4QFY05 4QFY06 Change FY05 FY06 Change
UVs 32,183 33,648 4.6% 111,138 114,688 3.2%
LCVs 1,910 1,545 -19.1% 7,887 6,777 -14.1%
3-wheelers 6,951 7,136 2.7% 22,943 22,419 -2.3%
Automotive 41,044 42,329 3.1% 141,968 143,884 1.3%
Tractors - domestic 15,579 19,374 24.4% 60,005 78,048 30.1%
Exports 3,199 3,690 15.3% 8,436 12,515 48.4%
Total 59,822 65,393 9.3% 210,409 234,447 11.4%

Margins - Good show: Despite rising input costs, and that M&M invested heavily in new manufacturing facilities, expanded distribution network and launched new products, the fact that the company was able to improve operating margins in FY06 is commendable. While the automotive division's PBIT margins have declined marginally, the tractor division has witnessed significantly higher margins owing to higher volume growth and more than 250 basis points (2.5%) rise in market share in FY06. In fact, as a percentage of total PBIT, the farm equipment division's contribution has increased from 28% in FY05 to 37% in FY06. In order to diversify revenue mix (and reduce the dependence on monsoons), M&M has been focusing on non-tractor revenues, which include the sale of diesel generators. During the year, revenues from such operations stood at Rs 1.7 bn (6% of farm equipment division revenues in FY06). Though the pressure on automotive margins is likely to sustain in the medium-term, we expect margin expansion in the farm equipment division to continue in FY07 (volume sales in April 2006 was higher by more than 50% YoY).

Segmental break-up...
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Automotive segment 13,133 14,848 13.1% 45,682 52,403 14.7%
PBIT 1,350 1,455 7.8% 4,770 5,353 12.2%
% margin 10.3% 9.8%   10.4% 10.2%  
Farm equipment 5,744 7,641 33.0% 20,299 28,538 40.6%
PBIT 481 802 66.8% 1,911 3,192 67.1%
% margin 8.4% 10.5%   9.4% 11.2%  
Others 623 891 43.1% 1,993 3,071 54.1%
PBIT 47 35 -25.8% 82 125 51.7%
% margin 7.5% 3.9%   4.1% 4.1%  

Stake sale profits kicker: During the year, one of the subsidiaries of M&M i.e. Mahindra Financial Services tapped the primary market in which M&M sold almost 10 m shares resulting in substantial profits. While this is one-time in nature, the growth at the PBT level of 27% YoY is reflective of underlying robustness in the company's operations. Improved cash flow from operations has enabled M&M to prune debt in FY06 and the interest (net of other income) has decreased significantly. Apart from benefits from lowering of the corporate tax in the last budget, excise exemption at its Rudrapur plant (tractors) and tax deduction on R&D spending have lowered the effective tax rate, thus catapulting profit growth in FY06.

Over the last few quarters: As is evident from the segmental margin graph below, it is the turnaround in the farm equipment division margins that have helped M&M improve its overall profitability in the past few quarters. Even though sales growth has been decelerating, it has to be borne in mind that the initial growth was led by the turnaround in demand for tractors. In our view, the overall profitability at the standalone level will be influenced by the farm equipment division in the medium-term.

What to expect?
At Rs 631, the stock is trading at a price to earnings multiple of 17.2 times it FY06 standalone earnings. In the analyst meet yesterday, the entire M&M Group top management was present to share the future growth prospects for its key businesses i.e., automotive, auto ancillaries, leisure, real estate, financial services, steel trading and information technology. All the key businesses have posted significant improvement in profitability in FY06, which is heartening (subsidiaries were a drain at the consolidated level before four years). Apart from this, the company's venture on the commercial vehicle front (partnership with International Trucks of the US) and passenger cars (Renault) are progressing well and it hopes to launch models in 2007.

While we are positive on the current business, new ventures like CVs and cars are likely to dent overall profitability in the near-term. Amidst these concerns, over the long-term, we are very positive about M&M and therefore, have a 'BUY' rating on the stock. We will update our research report to reflect the consolidated value soon.

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