We performed a state-level penetration analysis for the tractor industry. Total penetration of tractors is in the range of 4-5%, and more importantly, penetration in the addressable land-parcels (medium and large) is only c30%. In our view, over the next 5-10 years, this penetration rate will continue to go up, and land consolidation (pooling) in the small-and semi-medium holdings will increase tractor demand. High income states like Punjab and Haryana have tractor penetration rates of about 20% followed by states like Gujarat and Rajasthan at 8-10%. A number of states, especially the South Indian states, have a long way to catch-up. Admittedly, in the near-term, tractor volumes may be hit from the cyclical downturn, but our medium- to long-term outlook remains bullish. Additionally, the monsoon miss so far in 2021 is restricted to few states while M&M’s stronghold states have had better monsoons.
Auto business (SUV and CVs) appears under-rated: In our reverse sum-of-the-parts analysis of the current stock price, we estimate the SUV business has a negative value of Rs 107 although its fundamentals have improved significantly in the recent quarters. M&M now has a solid presence across four product lines: Bolero, Scorpio, Thar and XUV300. Success of the impending XUV700 could further strengthen portfolio. The outlook for the pickup business (medium to long term) is also solid.
Valuations undemanding: The past year has been eventful for M&M. Amid the outbreak of COVID-19 in April 2020, M&M’s stock was trading at historical bottom valuations of 4-5x core P/E. Since then, the divestment of SsangYong and the significant restructuring of US farm business have helped to revive the consolidated earnings. The company has also restricted investments in non-core areas (GEMs). Most importantly, the SUV business has emerged much stronger, in our view, with the success of Thar while expectations run high for XUV700. The stock is trading at 10x core FY23 PE, which is the least expensive valuations in the sector amid our FCF estimate of Rs c40 bn for FY23e.
Non-core subsidiary investments: As discussed in a Jan’21 note and also reinforced by the management in the Q1FY21 call, non-core investments are capped at Rs 11-12 bn per year. Based on the business momentum in the subsidiaries, the company is prepared to bring down these investments. With TechM starting to do well, we believe bulk of the investments will be funded from TechM dividend itself, thereby not impacting the FCF of core business.