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M&M: Our key assumptions - Views on News from Equitymaster
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M&M: Our key assumptions
Nov 22, 2005

We have updated our research report on Mahindra & Mahindra. Considering the performance of the industry and based on the strength and weaknesses of the company, we have incorporated following key assumption in our report.

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 70% of FY05 revenues, farm equipment division accounted for 25% 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 46% market share in the UV segment in FY05, it had a 27% share in the tractor sector.

Our key assumptions…
Tractors: In India, demand for tractors is inherently cyclical in nature. This is primarily because of heavy dependence on monsoons for a good farm output. To put things in perspective, only 40% of the total arable land is irrigated. Based on the assumption of normal monsoons and considering the long-term rural development prospects, we have factored in 8% CAGR in tractor volumes. We expect M&M to outperform the industry growth, primarily because of strong rural network and its entry in the sub-30 HP category, where it had a relatively marginal presence. Also, the fact that the key competitors are caught up with their own internal issues helps matters.

Utility Vehicles (UVs): The direct impact of the improvement in the road infrastructure is the increase in the need of mobility of the Indian populace, both rural and urban. Apart from this, the current infrastructure thrust is also a positive for the UVs, as they are the preferred vehicles by the infrastructure related companies. This is primarily due to dual usage of UVs as goods as well as passenger carriers. These factors will result in the demand for UVs to grow at a faster pace in next three years. We have factored in 11% CAGR growth in the demand in next three years.

We expect M&M to lose market share in the next three years. This is primarily because the urban demand for UVs is growing at a faster pace than the rural demand. Though M&M’s strength in the rural areas is not easily replicable, the same is not the case in the urban area, where there is significant competition and is expected to grow in future. However, we would prefer to be conservative in our estimates.

Exports: Traditionally, M&M has been a strong rural-oriented domestic player. However, over the years, the management has been taking steps to increase exports. Hence, we have factored in an increasing share of exports from the current levels of 4% of the revenues to 8% by FY08. The management aims to increase the share of exports to around 20% in next three years.

Raw material costs: For FY06, we expect the raw material cost as a percentage of sales to increase by around 180 basis points due to change in product mix. However, beyond FY06, we expect the company to benefit from the falling steel prices and accordingly, expect the share of raw materials to reduce by 100 basis points from FY06 levels of 68.4%.

Acquisitions and Joint Ventures: It should be noted that M&M is in final stages of acquiring a Romanian tractor company. Similarly, it has announced joint ventures with Renault (for ‘Logan’) and International Truck and Engine Corporation (for trucks). We have not factored in any gains from these ventures in our projections.

Capex: We expect the company to incur around US$ 350 spread over next three years in expansion of product portfolio.

To conclude…
Based on the above assumption, at the current price of 412, the stock is trading at price to earnings multiple of 11.4x and price to cash flow of 8.7x our FY08 estimates. We had recently recommended the stock at Rs 397. We maintain our view on the same.

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