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M&M: Tractors show the way
Oct 26, 2005

Performance Summary
Mahindra & Mahindra (M&M) has announced its 2QFY06 results. While the company's net sales has grown at 23% YoY in the second quarter, net profit grew at a faster clip of 28% YoY on account of lower tax incidence and higher other income. The key growth driver during the quarter was the farm equipment divisions i.e. tractors, which saw a 43% growth in volume sales. The performance of the other divisions were lacklustre.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 15,544 19,148 23.2% 29,776 37,267 25.2%
Expenditure 13,672 16,981 24.2% 26,295 33,186 26.2%
Operating profit (EBDITA) 1,872 2,167 15.8% 3,481 4,081 17.2%
EBDITA margin (%) 12.0% 11.3%   11.7% 11.0%  
Other income 373 294 -21.1% 456 498 9.2%
Interest (net) 17 (48) - 34 (102) -
Depreciation 440 466 5.9% 867 932 7.5%
Profit before tax 1,788 2,044 14.3% 3,036 3,749 23.5%
Extraordinary item (14) - - 189 - -
Tax 545 472 -13.5% 957 724 -24.3%
Profit after tax/(loss) 1,229 1,572 27.9% 2,268 3,025 33.4%
Net profit margin (%) 7.9% 8.2%   7.6% 8.1%  
No. of shares (m) 116 232   116 232  
Diluted earnings per share (Rs)* 21.2 27.1   19.6 26.1  
Price to earnings ratio (x)         14.0  
(* 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. In FY05, automotive division comprising UV, LCV and three-wheelers contributed 63% of FY05 volumes sales. The farm equipment division accounted for 37% of the volume sales. 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 performance in 2QFY06?
Volumes – a mixed bag: On the utility Vehicles (UVs) front, the performance of the company has been mixed. While ‘Scorpio’ continued to report commendable growth (24% YoY), the demand for other UVs (excluding ‘Scorpio’) registered declined of 9% YoY. This primarily appears to be the outcome of improved performance of Tata Motors’s ‘Sumo Victa’ and general weakness in rural demand. The performance of M&M in the LCV and the three wheeler goods carrier continued to decline on account of exceptionally good response to Tata Motors’ ‘Ace’, a sub one-tonne four-wheeler.

Sales snapshot…
(units) 2QFY05 2QFY06 change 1HFY05 1HFY06 change
UVs 26,877 26,601 -1.0% 50,458 51,446 2.0%
LCVs 2,239 1,883 -15.9% 4,321 3,691 -14.6%
3-wheelers 6,039 5,269 -12.8% 10,236 9,023 -11.9%
Automotive 35,827 35,575 -0.7% 66,047 66,838 1.2%
Tractors 12,737 18,171 42.7% 28,785 39,371 36.8%
Total 48,564 53,746 10.7% 94,832 106,209 12.0%
Exports 1,845 2,897 57.0% 3,446 5,940 72.4%
Domestic 46,719 50,849 8.8% 91,386 100,269 9.7%

The tractor segment has recorded another quarter of robust growth. What is more heartening is that the company has comprehensively outperformed the industry growth of around 14% YoY. However, we would like to bring to the notice of investors that such high rate of growth is not possible to maintain going forward. While we expect export of tractors to grow faster, as far as the domestic market is concerned, volume growth in the range of 8% in the long-term seems sustainable. The graph here highlights the 3-month average monthly volumes since June 2000. As is evident, volume growth peaked in 2000, after which the tractor sector went into a downturn owing to oversupply situation. On the back of reasonably good monsoons in the last year and a half, tractor sales have once again gained momentum. Basically, it is a reveral to mean average monthly volumes and therefore, from here on, the growth is likely to be on the slower side.

Operating margins down: As is the case with other automobile companies, raw material cost to sales has increased as a percentage of sales during the quarter and in the first half of the fiscal. We expect auto companies, in general, to benefit from lower commodity prices, as price negotiation takes place. However, control over other expenses and a slower growth in salaries has cushioned overall operating margins. Looking at the segmental margins, while the automotive segment has witnessed a significant decline in EBIT margins (11.7% in 2QFY05 to 10.2% in 2QFY06), the farm equipment division, on the back of high capacity utilisation has witnessed a 470 basis points jump in margins. We expect limited upside in tractor division margins, going forward, even as there is potential for auto division margins to increase.

Cost break-up...
(Rs m) 2QFY05 2QFY06 change 1HFY05 1HFY06 change
Raw materials 10,450 13,292 27.2% 20,160 25,793 27.9%
% sales 67.2% 69.4%   67.7% 69.2%  
Staff cost 1,039 1,263 21.6% 2,275 2,702 18.7%
% sales 6.7% 6.6%   7.6% 7.2%  
Other expenses 2,183 2,399 9.9% 3,861 4,649 20.4%
% sales 14.0% 12.5%   13.0% 12.5%  

Lower other income limits the bottomline: As compared to the topline growth of 23%, PBT in 2QFY06 grew at a much slower pace of 14% primarily due to lower other income. The trend is reverse in the case of the first half numbers. We suggest investors not to read too much into this trend, as it depends not only the surplus cash with the company but also on the dividend record of its key subsidiaries. The net profit growth, nevertheless, is higher on account of lower tax incidence, like in the case of all companies.

Over the last few quarters: Looking at the sales and operating margins trend, while the rate of sales growth is coming down, operating margins have been hovering at the current level (with a downward bias) for reasons mentioned earlier. The reason for the decline in the rate of growth is on account of the fact that as compared to FY04 and FY05, the turnaround years for the tractor division, FY06 is on a higher base. As mentioned earlier, the sector has come a full circle and therefore, one should expect a much slower growth rate in the company's topline going forward.

What to expect?
The stock trades at Rs 364 implying a price to earnings multiple of 14 times annualised 1HFY06 earnings. We believe that it is very pertinent to look at M&M with a consolidated perspective, in light of many profitable subsidiaries. While we are cautious on the auto business of the company, we believe that the company's value is on the higher side when looked at from a consolidated standpoint. Therefore, the company remains one of the preferred play among auto stocks.

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