Margins face multiple headwinds despite the success of new model
WE evaluate in this note the importance and impact of the SsangYong progress on the long-term investment thesis of M&M. Firstly, M&M holds 73% of SsangYong Motor Company (SYMC), which is a listed company with a market cap of $1.1billion. Consequently, SsangYong stake contributes nearly R85, or c6% to the M&M stock price (cR65 assuming a 25% holding company discount).
In that regard, SsangYong is not the most important aspect of our M&M target price valuation. However, we believe the success of SsangYong is critical for M&M’s long-term business sustainability–both in terms of product development and global reach. In the recent times, SsangYong had its share of headwinds, however the successful launch of the Tivoli means that on the balance the SYMC outlook is getting better and we believe that bodes a positive read across for M&M.
Recent Russia collapse derailed the volume recovery: Since its acquisition by M&M (in August 2010), SsangYong volumes have grown by 8% CAGR (CY2011-14). This was led by the refurbishment of most of the existing models and a backdrop of a robust market. Both exports and the local Korean market grew well. SYMC continues to enjoy a brand recall of robust outdoor vehicles and high value for money. The SYMC models are usually at a 10-15% lower price to competing models from other OEMs (manufacturers.)
However, the recent collapse of the Russian market (which has contributed 23% of the total volumes in 2013) has led to a sharp deterioration of the export business. Exports now contribute only 51% of the volumes from 56% in 2013. At the peak, Russia contributed nearly 43% of the export volumes and 25% of the total volumes of SsangYong. It doesn’t look like Russia will revive in the near term. Consequently, volume growth has also been impacted.
Tivoli has revved up the volumes: SYMC launched the Tivoli in January 2015. This is the first newly designed SUV by SYMC after the acquisition by M&M. Even though the Tivoli launch has been limited to the domestic market and gasoline engines, it sold 9,800 units in the first three months with a strong bookings pipeline. The China launch and diesel engines in the Korean and European markets can lead to stronger volumes for the Tivoli. This is a very encouraging start to the product cycle for SYMC, which is expected to launch one new vehicle each year over the next three-four years.
Importantly, with the Tivoli, SYMC has entered the smaller UV (utility vehicle) market or compact SUV segment, which is globally growing much faster within the SUV (sports utility vehicle) market. SYMC has used a new 1.6L (both petrol and diesel) engine for the Tivoli on a new platform costing them nearly $350m. This is the first time SYMC has designed a monocoque model and the learnings from the platform will be significantly value accretive for M&M’s future pipeline in India.
Profitability may struggle near term: While volume growth has picked up, led by the Tivoli launch; margins still face multiple headwinds–Russia, rising labour costs; increased competition in Korea and costs related to Euro 6 adoption in the existing portfolio. Overall, we are more encouraged by the success of Tivoli, from the technology and market acceptance perspective and that is a much more relevant and critical read across for M&M.
We expect a re-rating of the stock given impending UV launches and a tractor volume revival and upgrade our target EV/Ebitda (enterprise value/ earnings before interest, taxes, depreciation and amortisation) multiple to 10x (from 9x) to arrive at a fair value target price of R1,400.