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M&M: Mixed signals

Sep 20, 2002

Among auto stocks, Mahindra & Mahindra (M&M) has been languishing at the current levels for quite some time. But the company's market leadership in the tractor and UV segments is a positive for the stock. The restructuring exercise undertaken has already started to reflect in terms of better profitability in 1QFY03. M&M derived 93% of its revenues from sales UVs, LCVs and tractors in FY02. While it is a dominant player in both tractor and UV segments, it has a smaller presence in the LCV category where CV major Telco dominates the market. The company's market share had been steadily declining due to stiff competition from Toyota and Telco. However, through innovative launches in FY02, M&M has arrested the slide in the UV segment in the last two years. Going forward, we expect the company to maintain its market share as it is well poised to capitalise on any upturn in industry volumes. Besides, new launch 'Scorpio' will enable M&M to garner incremental UV demand in the urban market. Moreover, competition has turned weak in the last two years with no new models in the lower-end of the UV segment that account for a bulk of demand.

On the tractors front, excess inventory in the system (estimated at more than 100,000 units) and overcapacity will continue to weigh heavily on realisations in the future. Though manufacturers like Punjab Tractors have taken prudent inventory reduction exercise, it is not the case with its peers. Tractor segment actually registered a 17% drop in sales in FY02 and in FY03, we expect demand to shrink by another 10%. Though M&M managed to buck the trend in 1QFY03, we expect the company to undertake a destocking exercise in the coming quarters. Given this backdrop, M&M's tractor sales could fall by around 8% in FY03.

However, we expect a sharp improvement on the operating margins front due to benefits accruing from VRS and lower raw material costs per vehicle manufactured. In 1QFY03, operating margins increased to 9% as against a meager 2% in the corresponding quarter previous year. A favorable interest rate scenario should also result in lower average interest costs in FY03. A combination of all the aforesaid factors saw the company posting a net profit of Rs 78 m in 1QFY03 as against a loss last year.

The stock currently trades at Rs 83 implying a P/E multiple of 8.8x FY03E earnings. Though standalone numbers could show a sharp improvement, few of its subsidiaries are still in the red and thus are a drain on overall profitability. Towards exiting from select non-core businesses, the company has sold its 51% stake in Mahindra Sintered for an estimated consideration of around Rs 600 m, which is a positive sign. The successful launch of its new utility vehicle (UV) and the ongoing restructuring could have a positive impact on the stock. At the same time, growth prospects of its tractor division remain challenging in light of over capacity in the market. This could keep sentiment at bay.

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