M&M?s recurring Q2 profit was 21% ahead of estimates at Rs 7.12 bn, driven by better auto margins and lower net interest/depreciation charges. Although the stock has outperformed the auto sector marginally, we upgrade our rating to Buy from Underperform following revision of EPS (earnings per share) forecast by 8%-7% over FY11-12e and expected re-rating. Our revised PO (price objective) is 35% higher at Rs 850.
Contrary to expectations, Ebit (earnings before interest and taxes) margins of auto business (Uvs/CVs?utility vehicles and commercial vehicles) grew 340 bps (basis points) QoQ to 15.6%, narrowing the gap with tractors, which registered flat QoQ Ebit of 17.1%. These trends allay our concerns that a shift in sales mix to autos would pull down margins, and therefore profitability.
M&M?s H1 sales grew 21% in constituent businesses of autos (UVs/CVs) and tractors. We expect the momentum to sustain, driven by (i) franchise and limited competition in UVs, (ii) new products in CVs, both light and heavy trucks, and (iii) farm mechanisation leading to increasing tractor usage.
Revised PO factors: (i) revision in core EPS forecasts, (ii) expected re-rating of core EPS to 14x from earlier 12x, (iii) rollover multiple to FY12e, and (iv) inclusion of Ssangyong and two-wheeler subsidiary in SOTP ((sum-of-the-parts) valuation.
We rate it Buy, driven by strong business outlook of key operating segments in autos and tractors, and a much better margin profile, leading to improved growth visibility.