Tractor cycle, BS-6 remain headwinds; estimates cut over FY19-21 to factor in weaker volumes and lower margins; TP down to `780.
M&M’s Q3 EBITDA missed estimate by 10% due to lower revenue and margin. Management guided for margin pressures to continue and tractor growth to be flat in Q4. Despite recent correction and undemanding valuation, we maintain Hold noting multiple headwinds: (i) tractor cycle likely to peak in FY19e; (ii) BS-6 implementation from April, 2020 is a major overhang for M&M’s automotive business; (iii) Ebitda is likely to decline slightly over FY20-21e after peaking in FY19e.
Miss in Q3 Ebitda
M&M+MVML Q3 Ebitda was 10% below our estimate partly due to lower revenue and partly due to weaker margin at 13.2% vs. 14.5% estimated. Margins were weaker in both tractors and automotive. Management attributed weaker automotive margin to: (i) commodity price increase (-120bps impact y-o-y); (ii) extra discounts & incentives due to weak festive demand (-40bps); (iii) new launch expenses and lower margins on these; (iv) higher depreciation of XUV300 which will sell from Q4 (-70bps). Net profit was helped by couple of one-offs, viz. dividend income from unlisted subs (`2 bn) and tax write-backs (rs 4 bn).
Weak outlook for Q4; tractor growth to weaken in FY20e
Management expects margin pressures in automotive to continue in Q4 with launch expenses of XUV300; on tractors it expects flat growth in Q4. For FY20e, it expects lower commodity prices and easing of launch expenses to support margins; in tractors, it guided for growth to be lower than double digit given late stage of the cycle.
Impact of BS-6
Post BS-6 implementation in April, 2020, management expects small 1-1.2 litre engines to accelerate their shift to petrol from diesel but shift could be less for larger engines despite sharp price escalation. It expects pre-buying in 2HFY20 but a key challenge is estimating demand as any left-over inventory cannot be retro-fitted for BS-6 unlike in case of BS3 to BS-4 transition. In case of diesel 3-W, it expects shift to electric or CNG, more likely the former. For LCVs, it expects shift away from diesel to CNG only for single cylinder <2T pick-ups.
Cutting estimates, fair value
We cut our estimates over FY19-21e mainly to factor in weaker tractor & LCV volumes and lower margins. Our price target drops to Rs 780 (prev. Rs 860) as a result. Despite the recent correction in stock price and relatively undemanding valuation, we maintain Hold noting multiple headwinds ahead: (i) tractor cycle is likely to peak in FY19e following 3 years of strong up-cycle; (ii) overhang of BS-6 implementation on M&M’s automotive business; (iii) we expect slightly declining Ebitda over FY20-21e post strong growth over FY17-19.