Mahindra & Mahindra (M&M) reported its weakest quarter in five years; however, the results were still a tad better than consensus and taken positively by the Street. The management reiterated that it does not foresee any delays in the utility vehicle (UV) launch pipeline. Importantly, the company is cognisant of the need to revamp the eco-system for these launches and is already preparing to upgrade the backend across the distribution chain.
The tractor business remains a monsoon call, and a good monsoon would mean 5% growth in FY16e and much stronger growth in FY17e. We believe the undemanding valuations, successful new UV launches and good monsoon could be significant re-rating triggers.
Tractor outlook: M&M expects the tractor market to grow 5% in FY16 vs Escorts’ guidance of a flat FY16. M&M’s expectations is built on normal monsoons this year. M&M or Escorts hasn’t raised discounting. Encouragingly, M&M’s inventory levels are close to historic low and wholesale revenues could be better than retail revenues this year.
Auto business: Product launches will start in earnest in the next few months with the launch of the first small UV, followed by another close to the end of 2015. M&M’s volume decline in the existing product portfolio has stabilised now and any success with these UVs will be incremental to existing volumes, potentially triggering a re-rating in the stock.
Q4 performance beats expectations: M&M and MVML (Mahindra Vehicle Manufacturers Ltd) reported net revenues of R91.2 bn, down 11% year-on-year and above our estimate of R89 bn. The automotive ASP (average selling price) was up 5% quarter-on-quarter, in line with our estimate, but the tractor ASP surprised positively, up 13% q-o-q. Overall net realisations were up 5.4% q-o-q.
Ebitda margins declined 70 basis points q-o-q to 11% on account of a lower contribution from tractors to overall revenues (27% vs. 37.4% in Q3) and lower tractor margins. Tractor margins saw a 300 bp dip q-o-q to 11.2%, while automotive margins rose 50 bp to 8.8%.The RoCE (return on capital employed) on the farm equipment business fell to 8.1% from 13.9% in Q3FY15. The RoCE on the automotive business improved to 7.3% in the quarter compared to 6.1% in the previous quarter.
Reiterate Buy: We raise our earnings estimates a bit to reflect higher realisations in the farm equipment business; however, our SOTP(sum of the parts)-based fair value target price is unchanged as a result of a decline in the marked-to-market valuations of subsidiaries, particularly TechM.
Auto set for a recovery: Product launches will start in earnest in the next few months with the roll-out of the first small UV, followed by another scheduled for close to the end of 2015. The existing portfolio has stabilised now and the success of these UVs will be incremental to existing volumes and trigger a stock re-rating.
Valuation and risks: We believe the stock has multiple re-rating triggers over the next six-nine months: the launch of the small UV in June-July, normal monsoons leading to a revival in tractor volumes from H2, and then the launch of the second UV in October. We revise up our FY16e and FY17e earnings estimates by 2.7% and 3.1%. But we maintain our fair value target price of R1,400 due to the lower marked-to-market valuations of subsidiaries, particularly TechM. We value the M&M and MVML at a 10x FY17e EV/Ebitda then add the market value of its stakes in subsidiaries, which total R391/share. Our fair value target price implies upside of 17% from the current market price.