Mahindra and Mahindra?s (M&M) volume growth is dependent on the rural economy. M&M derives nearly 80% of its standalone revenues from non-urban segments. We believe that the Indian government?s increased focus on the rural economy has put structural drivers in place for improved tractor growth. Initiatives such as NREGA have created a labour shortage that is likely to result in increased mechanisation at farms. In addition, rural incomes are likely to remain buoyant with normal monsoon rainfall and high food prices. Rural infrastructure development activities are leading to increased use of tractors in non-farming activities, thus making it more affordable for smaller farmers.
M&M has reported improving UV (utility vehicle) market share over the past few years. While there has been some loss of share in FY11 due to constraints on components, the company should be able to regain its market share, once the problem is resolved. We believe M&M has become the strongest player in the UV space because of three reasons:
(i) Capturing opportunity from rural India that others have missed: Over the years, M&M has developed a strong brand in rural India. Competitors do not have a strong product to compete with M&M?s Bolero. Initially, it was because they did not focus on this segment as it was difficult to build a brand and network across rural India. However, now it will be difficult to dislodge the leader in this segment. Thus, competition is not a significant threat to the company in this segment, in our view.
(ii) Support from financing arm: Mahindra Finance has established a strong network. In many cases, the company helps finance customers who have high incomes but are unable to provide proper documentation for a bank loan. While Tata Motors also has a financing arm, it is not as strong.
(iii) Specific focus on UVs: Of the main car companies in India, M&M remains the only one with a specific focus on the UV space. General Motors and Toyota have cars as their main focus area. Tata Motors has lost significant market share in the UV space to MM.
MM?s products such as Bolero have grown at a CAGR of 25% over past two years ? virtually unchallenged. It is difficult to a build brand and sales/service network in rural India, so the threat from competition is likely to remain low. We value M&M based on SOTP (sum-of-the-parts) at Rs 814/ share, representing 18% potential upside. We value the auto business at 13x FY12 EPS (earnings per share), or Rs552/share. We increased the multiple from 12x (times) to factor in higher growth expectations. We note that the standalone auto business trades at 11.2x FY12 EPS currently, versus 15.2x for our coverage universe. We value investments at Rs 213.9/share after a 20% holding discount.