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M&M: The extraordinary impact

Oct 30, 2007

Performance summary
  • Led by 8% YoY growth in volumes (excluding Logan), standalone topline grows by 13% YoY during 2QFY08.

  • Jump in staff costs and other expenses leads to operating margin contraction of 1%.

  • Bottomline falls by 26% YoY led by an extraordinary income during the same quarter last year. Excluding the same, bottomline shows a modest growth of 6% YoY.

  • 1HFY08 net profits (excluding the effect of extraordinary income in 1HFY07) shows a marginal improvement of 1% on the back of a 15% jump in topline

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 24,905 28,024 12.5% 47,267 54,152 14.6%
Expenditure 21,209 24,170 14.0% 40,869 47,527 16.3%
Operating profit (EBDITA) 3,696 3,854 4.3% 6,398 6,625 3.5%
EBDITA margin (%) 14.8% 13.8%   13.5% 12.2%  
Other income 729 692 -5.2% 1,184 1,008 -14.9%
Interest (net) (155) 82   (302) 31 -110.4%
Depreciation 501 577 15.0% 964 1,148 19.0%
Profit before tax 4,079 3,886 -4.7% 6,919 6,453 -6.7%
Extraordinary income/(expense) 1,160 (19)   1,145 (35)  
Tax 1,374 1,008 -26.7% 2,158 1,647 -23.7%
Profit after tax/(loss) 3,865 2,859 -26.0% 5,907 4,771 -19.2%
Net profit margin (%) 15.5% 10.2%   12.5% 8.8%  
No. of shares (m) 236.6 238.7   236.6 238.7  
Diluted earnings per share (Rs)*         34.2  
Price to earnings ratio (x)*         22.0  
(* 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 2QFY08?
It’s the automotive segment again: M&M’s standalone revenues grew by 13% YoY during 2QFY08. These were driven by the 8% YoY growth in volumes (excluding ‘Logan’ since it forms a part of a different company and does not figure in the standalone performance) of both its divisions combined. As in the first quarter, the chief contributor once again was the automotive division, where volumes were higher by an impressive 16% YoY. This time around though, it were the badges other than the ‘Scorpio’ that remained the main contributor to volumes, growing by 26% YoY as opposed to 8% growth recorded by ‘Scorpio’ range of vehicles. Among its other segments in the division, while LCVs grew at a robust pace and recorded volume growth of 40% YoY, demand for ‘3-wheelers remained subdued and grew by just 3% YoY. Exports too, after witnessing a splendid growth of 84% during the first quarter, slowed down considerably and remained virtually stagnant over 1QFY08.

The performance of the farm equipment 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 domestic volumes were lower by 6% YoY during the quarter. With the company’s exports also falling by 1% YoY, overall volumes for the division fell by a little less than 6%. Topline growth though, came in at an acceptable 4% YoY.

Segmental break up…
Segment 2QFY07 2QFY08 % change 1HFY07 1HFY08 % change
Units sold 43,089 57,295 33.0% 78,144 106,094 35.8%
Revenues 15,565 18,019 15.8% 28,002 33,065 18.1%
PBIT 2,318 2,554 10.2% 3,548 3,871 9.1%
PBIT margin 14.9% 14.2%   12.7% 11.7%  
Farm Equipment Segment            
Units sold 23,565 22,227 -5.7% 50,923 49,518 -2.8%
Revenues 8,833 9,164 3.7% 18,297 19,549 6.8%
PBIT 1,255 1,148 -8.6% 2,529 2,537 0.3%
PBIT margin 14.2% 12.5%   13.8% 13.0%  
Other segments            
Revenues 1,151 1,650 43.4% 2,077 2,950 42.0%
PBIT 39 23 -40.7% 74 60 -18.8%
PBIT margin 3.4% 1.4%   3.6% 2.0%  

Salary costs hurt margins: As we maintained in the last quarter, M&M 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 and more importantly, the wage costs that has spoiled the operating margin scenario for the company as margins for the quarter have contracted by 100 basis points (1%). The huge 40% YoY jump in the latter could be attributed to significant new hiring being done as well as hike in salaries across the board.

Cost break-up…
(Rs m) 2QFY07 2QFY08 Change
Raw materials 16,213 17,855 10.1%
% sales 65.1% 63.7%  
Staff cost 1,642 2,303 40.3%
% sales 6.6% 8.2%  
Other expenditure 3,354 4,013 19.6%
% sales 13.5% 14.3%  

It is not just the lower operating margins, but lower other income and higher depreciation charges have also impacted the bottomline performance of the company, where profits have shrunk by 27% 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 fallen by 23% YoY (including extraordinary income arising from sale of stake in Tech Mahindra last year) during the quarter on the back of a 40% jump in gross revenues (including other income).

What to expect?
At the current price of Rs 754, the stock is trading at a multiple of 13 times our estimated FY10 standalone cash flow. However, it should be borne in mind that the market valuation of the company also takes into account its stake in various group companies like Tech Mahindra and M&M Financial Services and not to forget the future value unlocking from companies like Mahindra Resorts. Taking all of these into account, M&M is trading at a small discount to our estimate of the fair value of the company. However, the gap is not big enough to make the stock an attractive proposition. As such, we advise investors to exercise caution at the current juncture.

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