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M&M: Margin pressure - Views on News from Equitymaster
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M&M: Margin pressure
Jul 30, 2007

Performance summary
  • Led by 14% growth in volumes, standalone topline grows by 17% YoY

  • Jump in other expenses leads to operating margin contraction of 150 basis points

  • Bottomline falls by 6% YoY due to lower other as well as interest income and higher depreciation charges.

  • Excluding special and exceptional items, bottomline growth stands at 15% YoY

(Rs m) 1QFY07 1QFY08 Change
Units sold 62,413 70,915 13.6%
Net sales 22,362 26,128 16.8%
Expenditure 19,660 23,357 18.8%
Operating profit (EBDITA) 2,702 2,771 2.5%
EBDITA margin (%) 12.1% 10.6%  
Other income 454 316 -30.4%
Interest (net) 147 51 -65.1%
Depreciation 463 571 23.3%
Profit before tax 2,840 2,567 -9.6%
Extraordinary income/(expense) (15) (16)  
Tax 784 640 -18.4%
Profit after tax/(loss) 2,042 1,912 -6.4%
Net profit margin (%) 9.1% 7.3%  
No. of shares (m) 236.6 238.2  
Diluted earnings per share (Rs)* 34.3 32.1  
Price to earnings ratio (x)**      
(* annualised, ** on trailing twelve months earnings)

What is the company’s business?
Mahindra & Mahindra (M&M) is engaged in the manufacture of utility vehicles (UVs), tractors, light commercial vehicles (LCVs) and three-wheelers. While automotive division comprising UVs, LCVs and three-wheelers contributed to 65% of FY07 revenues, farm equipment division accounted for 29% of revenues. Through investment in its subsidiaries, M&M has interests in sectors like software, hotels, real estate and financial services as well. While M&M has a 42% market share in the UV segment in FY07, it had a 31% share in the tractor sector. The company has been a dominant player in both tractors and utility vehicle segments for a number of years. The company is also reaping the benefits of diverting its excess cash towards high growth industries like IT and real estate development as these companies have now achieved critical mass and have started contributing handsomely to the company’s growth.

What has driven performance in 1QFY08?
Automotive drives topline growth: The company’s standalone revenues have grown by 17% over the corresponding previous quarter. These were driven by the 14% growth in volumes (excluding ‘Logan’) of both its divisions combined. The chief contributor though was the automotive division, where volumes were higher by an impressive 24% YoY, thanks to a similar growth recorded by the company’s UV offerings. ‘Scorpio’ and ‘Bolero’, both its key badges were bought in large numbers, thus enabling the company to significantly outperform the industry and improve its market share to 50% in the segment, an impressive jump of 630 basis points. Among its other segments in the division, both LCVs and 3-wheelers also grew a robust pace and recorded volume growth of 39% and 11% respectively. Spearheaded by its ‘Scorpio’ offerings, exports too grew by a strong 84% YoY during the period.

The performance of the tractor division on the volumes front however remained lackluster. After growing its volumes for four consecutive years, industry volumes seem to be headed for a negative growth rate in FY08, as volumes were lower by 4% YoY. M&M fared better as volumes were higher by 1% for the company. However, with the company’s exports falling by 11% YoY, overall volumes for the division fell marginally. Topline growth though, came in at an acceptable 9% YoY.

Segmental break up…
Segment 1QFY07 1QFY08 % change
Automotive
Units sold 35,055 43,624 24.4%
Revenues 12,438 15,045 21.0%
PBIT 1,230 1,317 7.1%
PBIT margin 9.9% 8.8%  
Farm Equipment Segment
Units sold 27,358 27,291 -0.2%
Revenues 9,463 10,385 9.7%
PBIT 1,274 1,390 9.1%
PBIT margin 13.5% 13.4%  
Other segments
Revenues 926 1,301 40.4%
PBIT 35 37 5.4%
PBIT margin 3.8% 2.9%  

Other expenses hurt margins: The company has emerged as the best in terms of maintaining its material costs and the current quarter has been no different, as raw material costs as a percentage of sales have again tended lower. However, it is the jump in other expenses that has spoiled the operating margin scenario for the company as margins for the quarter have contracted by 150 basis points. This has had an adverse impact on operating profits, which have grown by just 3% YoY as compared to the 17% YoY growth in topline.

Cost break-up…
(Rs m) 1QFY07 1QFY08 Change
Raw materials 15,441 17,874 15.8%
% sales 69.0% 68.4%  
Staff cost 1,629 1,891 16.1%
% sales 7.3% 7.2%  
Other expenses 2,589 3,591 38.7%
% sales 11.6% 13.7%  

It is not just the lower operating margins, but lower other as well as interest income and higher depreciation charges have also impacted the bottomline performance of the company, where profits have shrunk by 6% YoY. However, if one were to exclude the special and exceptional items, then the bottomline growth stands at a respectable 15% YoY.

As far as the consolidated performance is concerned, the bottomline of the company has grown 3% YoY during the quarter on the back of a 41% jump in gross revenues (including other income).

What to expect?
At the current price of Rs 751, the stock is trading at a multiple of 12 times our estimated FY10 standalone cash flow. While the company has exceeded our expectations on the automotive volumes front, performance in the tractor segment has come below our expectations. Operating margins have also come in lower than our full year projections of 12.7%. However, we would like to wait for one more quarter before we revise our estimates. Hence, we maintain our current view and continue with our ‘HOLD’ stance based on our fair value estimate.

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