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M&M: On the right track

Aug 3, 2005

Introduction to results
M&M, the largest tractor manufacturer in the country announced its 1QFY06 results last week. While the topline has witnessed another good quarter of growth led by buoyant demand for tractors, rising advertising and administration expenses together with increasing input costs have restricted the operating profit growth. However, savings in interest costs coupled with dividend income and a significant fall in tax outgo, the bottomline has registered a 40% YoY growth.

(Rs m) 1QFY05 1QFY06 Change
Net sales 14,232 18,119 27.3%
Expenditure 12,419 16,190 30.4%
Operating profit (EBDITA) 1,812 1,929 6.4%
Operating profit margin (%) 12.7% 10.6%  
Other income 83 204 144.1%
Interest 18 (54) -399.0%
Depreciation 427 466 9.2%
Profit before tax 1,451 1,720 18.6%
Extraordinary items - (15) -
Tax 412 253 -38.7%
Profit after tax/(loss) 1,039 1,453 39.9%
Net profit margin (%) 7.3% 8.0%  
No. of shares (m) 116 116  
Diluted earnings per share (Rs)* 35.8 50.1  
P/E (x)   13.6  
(* annualised)      

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. While automotive division comprising UV, LCV and three-wheelers contributed 63% of FY05 sales volumes, the farm equipment division accounted for 37%. 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 1QFY06?
Tractors lead the growth: As can be seen from the table below, the farm equipment division of the company has recorded another quarter of good performance. After a three-year period of negative growth, the tractor industry started displaying signs of turnaround since early 2004. This much-expected turnaround (on a lower base) enabled the company to register a 19% YoY growth in 1QFY06, thus outperforming the industry growth of 11%. While much of the improvement in the tractor industry has already taken place, over the next 2 to 3 years, we expect the growth to be in the range of 8% to 9%. This of course depends upon the timing, quantum and spread of the monsoon, as approximately 60% of the gross cultivated area is dependent upon this for a bumper harvest. On the UV front, the below par performance can partly be attributed to two reasons. First being the delayed introduction of ‘Bharat-II' emission norms. This resulted in production constraints, as company was not able to meet the demand for ‘Bharat-I' stage vehicles. Secondly, Tata Motors' ‘Sumo Victa' and Toyota's ‘Innova' have also dented the company's volume growth.

Segmental break up (volume sales)...
Segment 1QFY05 1QFY06 % change
U.Vs 23,581 24,845 5.4%
LCVs 2,082 1,808 -13.2%
3-wheelers 4,197 3,754 -10.6%
Automotive 29,860 30,407 1.8%
Tractors 16,048 19,013 18.5%
Total 45,908 49,420 7.7%
Exports 1,601 3,043 90.1%
Domestic 44,307 46,377 4.7%

In the LCV segment, while on an over all basis, the industry has performed well, the domain in which M&M operates i.e. load carrying capacity of less than 4 MT has registered a degrowth of 11%. M&M's performance should be viewed in this perspective.

In the large three-wheeler segment, the company has done well to restrict the fall in growth to 11% as compared to 19% of the industry. The primary reason for the poor performance of the industry appears to be the after effect of the launch of Tata Motors' ‘ACE', a sub one tonne four-wheeler vehicle.

Other expenditure – a surprise: The company has managed well to restrict the impact of rising steel prices especially when its peers have been burdened by significant rise in raw material costs. It should noted that the prices of major raw materials like steel and rubber are ruling at higher levels in spite of showing signs of softening. However, the entire effort of the company on raw material front has been overshadowed by the increase in other expenses. Though the exact reason for the jump is not ascertainable, it can partly be attributed to new launches scheduled by the company.

Cost break-up...
(Rs m) 1QFY05 1QFY06 Change
Raw materials 9,710 12,501 28.7%
% sales 68.2% 69.0%  
Staff cost 1,236 1,438 16.4%
% sales 8.7% 7.9%  
Other expenses 1,474 2,251 52.7%
% sales 10.4% 12.4%  

Interest and other income save the day: In the current quarter, M&M has reported a net interest income as against interest expenditure in 1QFY05. This is the result of the on going effort of the company to improve on its efficiency and ensure optimum utilisation of resources. This has enabled the company to generate surplus cash, which M&M has utilised to prepay old debt/replace high cost debt. Secondly, taking advantage of the favourable macro economic environment, the company had issued zero coupon interest bearing FCCBs amounting to US$ 100 m to meet its future expansion plans over a period of two years. Almost half of this funding was a part of investible surplus with the company as on 31st March 2005.

There has been a 144% YoY increase in the other income of the company during the quarter. This is largely due to dividend income of Rs 135 m in 1QFY06, as compared to Rs 11 m in 1QFY05. Of the Rs 135 m, Rs 106 m is received from subsidiaries. It should be noted that in FY05, the consolidated profit of the group was approximately 40% higher than the standalone results. Going forward we expect the subsidiaries to continue to perform well. This could provide some cushion to the bottomline by way of increasing dividend income to the standalone entity.

What to expect?
At Rs 680, the stock is trading at price to earnings multiple of 13.6 times its 1QFY06 annualised earnings. Though the exponential growth witnessed during the last few quarters is difficult to sustain (due to high base effect), any reduction in input prices, especially steel, can provide additional cushion to margins. Apart from this, the management's thrust on the auto component sector, IT services and real estate ventures, though invite caution, but can help the company in derisking its business model. This can act as an insulating factor in recessionary periods, especially considering that the performance of the tractor industry is highly dependent on monsoons.

We had recommended a buy on M&M in January 2005 with a price target of Rs 800 from a two year investment perspective. We maintain our view on the stock.

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