Core businesses set to deliver double-digit growth in FY17-18
With rural India contributing 72% to standalone profit after tax (PAT) and 64% to SOTP value, MM would be one of the biggest beneficiaries of a normal monsoon. After a four-year gap, both UVs and tractors are set to deliver double-digit volume growth. With several levers to offset headwinds on margins—estimate 100bp improvement by FY18. Upgrade to buy, with SOTP-based TP of Rs 1,724—upside of 18%.
The monsoon plays an important part in MM’s fortunes, as the rural market contributes 56% to revenue, 72% to standalone PAT and 64% to SOTP value. After a four-year gap, we expect both the businesses—Tractors and UVs—to deliver 14.5% volume CAGR over FY16-18 (v/s flat volumes over FY14-16). This would be supplemented with recovery in key subsidiaries like MMFS, TECHM and Ssangyong.
Normal monsoon, low base to drive growth for tractors
We expect MM’s tractor volumes to recover sharply, with 18.4%
CAGR over FY16-18, driven by normal monsoon and low base (over FY14-16, volumes had declined at 11% per year).
The government’s target to double farm income in five years would not only help in reducing volatility in tractors, but also act as a catalyst to drive penetration of implements (2% of MM’s FES revenue v/s global average of 66%).
UVs back on track, driven by plugging of gaps
MM has addressed product gap issues, with three new launches in the UV1 segment, the full benefit of which would be reflected in FY17/18. KUV1OO, targeted at compact car buyers and priced at Rs 501k, could expand the addressable market for MM by 1.8x of its existing segment. MM could also reduce prices for Scorpio and XUV5OO by 13.5% by launching mild hybrids, which enjoy concessional excise duty. Lastly, with 57% market share in LCVs <3.5ton, MM’s pick-up volumes are likely to grow at a CAGR of 15% over FY16-18, driven by economic recovery.
Levers to improve margins
MM has several levers—mix, lower MTBL losses, lower marketing spend, operating leverage—to offset the impact of exhaustion of the Haridwar plant incentive and commodity price inflation. Despite these headwinds, we expect Ebitda margin to expand 80bp over FY16-18 to 12.9% (based on IndAS), translating into 21% Ebitda CAGR over FY16-18.
Upgrading to Buy
The worst is over for MM not only in its core businesses of Tractors (driven by normal monsoon) and UVs (driven by recent launches), but also in key subsidiaries. We expect 34% CAGR in consolidated EPS over FY16-18 (v/s a decline of 14% per year over FY14-16). The stock trades at 17.5x FY18e standalone EPS, 15.3x FY18e consolidated EPS, and 5.2% FY18e FCF yield. Considering the strong earnings cycle ahead, we upgrade the stock from Neutral to Buy. Our SOTP-based target price is Rs 1,724 (16x FY18e core EPS + subsidiaries at 20% HoldCo discount).
Both core businesses on growth track after four-year gap
FY14-16 was one of the worst periods for MM, during which volumes declined 4.6% per year, standalone PAT declined 7.6% per year, and consolidated PAT declined 14% per year. Its performance was impacted by one of the worst monsoon failures in three decades and gaps in its UV product portfolio. The monsoon plays an important role in MM’s fortunes, not only for Tractors (90% rural exposure) and Autos (40% rural), but also for key subsidiaries like MMFS (over 80% rural exposure). After a four-year gap, both of MM’s businesses – Tractors and UVs—are set to deliver double-digit growth in FY17/18, driven by normal monsoon and benefit of recent launches. Also, MMFS is likely to return to normalcy, with stabilisation in asset quality and return to normal growth path. Credit cost, which stood at a decade high of 3.68% in Q3FY16, normalised to 1.15% in Q4FY16. Provisions normalised from 67% of operating profit in 9MFY16 to 16% in Q4FY16. Similarly, the worst is over for TECHM, with early signs of growth visible in the Telecom segment and restructuring of LCC largely completed.
Structural changes in farming to help reduce volatility in growth
We expect MM’s tractor volumes to recover sharply, with 18.4% CAGR over FY16-18, driven by normal monsoon and low base (worst monsoon in three decades had led to 11% decline per year over FY14-16). The government’s strategy aimed at doubling farm income in five years has the potential to deliver and should incentivise farmers to invest in farms. This would not only reduce volatility in tractor volumes, but also act as a catalyst to drive higher penetration of implements in India. Agricultural implements currently contribute just 2% to MM’s FES revenue (v/s global average of 66%). We believe this is a highly underpenetrated segment and offers long-term potential for MM considering its well-placed alliances with Mitsubishi Agri Machinery and Sampo Rosenlew.