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M&M: The going is strong

Oct 26, 2006

Performance summary
M&M, India's largest manufacturer of tractors and UVs, has posted healthy numbers for 2QFY07. While the topline has witnessed a rise of 30% YoY, operating margins have expanded by an impressive 340 basis points. Also, with other income increasing to the tune of 148% and an extraordinary income by way of stake sale in a group company, the bottomline of the company has jumped a steep 146% as compared to corresponding previous quarter. Even if one were to exclude the extraordinary income, the bottomline still maintains a healthy growth rate of 72%. Performance for 1HFY07 has also been equally impressive with the bottomline reporting a jump of 92%, on the back of a 27% increase in the topline of the company.

(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 19,148 24,905 30.1% 37,267 47,267 26.8%
Expenditure 16,966 21,209 25.0% 33,156 40,869 23.3%
Operating profit (EBDITA) 2,182 3,696 69.4% 4,111 6,398 55.6%
EBDITA margin (%) 11.4% 14.8%   11.0% 13.5%  
Other income 294 729 147.7% 498 1,184 137.7%
Interest (net) 48 155 221.8% 102 204 99.4%
Depreciation 466 501 7.6% 932 967 3.8%
Profit before tax 2,058 4,079 98.2% 3,779 6,818 80.4%
Extraordinary income/(expense) (15) 1,160   (30) 1,145  
Tax 472 1,374 191.4% 724 2,158 198.0%
Profit after tax/(loss) 1,572 3,865 145.8% 3,025 5,805 91.9%
Net profit margin (%) 8.2% 15.5%   8.1% 12.3%  
No. of shares (m) 232.0 236.6     236.6  
Diluted earnings per share (Rs)* 26.6 65.3   25.6 49.1  
Price to earnings ratio (x)**         14.7  
(* annualised, ** on trailing twelve months earnings)

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 2QFY07?
Farm equipment continues to reap rich harvest: As far as the sales performance is concerned, while the automotive division witnessed a 20% jump in volumes, growth in tractor sales stood at 28% over corresponding previous quarter. With more and more finance companies trying to tap the rural market, tractor industry has been witnessing good growth numbers for the past couple of years. The fact that the monsoons have been favorable in most parts of the country is also enabling the industry to record robust sales. M&M, with a 32% market share is a clear industry number one and hence, has benefited the most from this trend. Exports from this division have also been healthy and have witnessed a 63% jump in volumes over 2QFY06. With it recent foray into the Iranian tractor market, M&M now has presence in the top four tractor markets of the world viz., India, US, China and Iran and we expect the export volumes to remain strong in the coming years.

As far as the performance of the automotive division is concerned, volumes have improved by 20% with three-wheelers showing the biggest jump in sales with a growth rate of 69%. After performing poorly in FY06, the company's three wheelers sales seem to be back on track with the help of a some new launches in the past couple of quarters. UV sales were also higher by 11%, led largely by Scorpio, its immensely popular offering. Other UV offerings however, continued with their poor run. In order to stem the decline, the company has embarked on an all-new MUV platform, the first vehicle of which is expected to roll out by 2008. LCVs also performed poorly, managing a modest growth rate of 6% YoY. Just as the farm equipment division, exports from the automotive division also continued to shine (up 52% YoY).

Sales break-up (2QFY07)
Domestic 2QFY06 2QFY07 % change
Automotive Divn
UVs 26,601 29,505 10.9%
LCVs 1,883 1,990 5.7%
Three wheelers 5,269 8,887 68.7%
Total (automotive) 33,753 40,382 19.6%
Farm Equipment Divn      
Tractors 17,096 21,800 27.5%
       
Exports    
Automotive Divn 1,822 2,761 51.5%
Farm Equipment Divn 1,075 1,755 63.3%
Source: Company

Operating margin expansion comes as a surprise: In an era, where two-wheeler manufacturers have been facing strong pressure on margins, M&M has done exactly the opposite and has registered a 340 basis points expansion in margin. While raw material costs as a percentage of sales have increased for the company, it is the savings on the employee wages and other expenses front that has resulted into an improvement in operating margins.

Cost break-upů
(Rs m) 2QFY06 2QFY07 Change
Raw materials 13,292 16,213 22.0%
% sales 69.4% 65.1%  
Staff cost 1,263 1,642 30.0%
% sales 6.6% 6.6%  
Other expenditure 2,411 3,354 39.1%
% sales 12.6% 13.5%  

It should be remembered that the company has a stake in quite a few group companies and with most of them performing well, other income, which includes income in the form of dividends from the associate companies has witnessed a rise of 148% YoY. Besides, a 222% jump in net interest income and an extraordinary income to the tune of Rs 116 m has also enabled M&M to record a huge 146% jump in bottomline

What to expect?
At the current price of Rs 726, the stock is trading at an attractive price-to-cash flow multiple of 15 times our estimated FY09 cash flow per share. With the company derisking its business model by tapping new industries as well as geographies, we believe it is well placed to take advantage of the India growth story. While we are positive on the company's prospects, too much diversification might lead to a change in our view.

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