Risk to estimate of Ebitda margin rising to 13.9% in FY20; re-rating catalysts are missing; ‘Buy’ maintained.
MM’s core business faces headwinds in the form of (a) an uncertain tractor demand outlook due to the cyclical downturn and the initial forecast of El Nino, (b) a weak product lifecycle in UVs, as no major launches are likely till BS-6, (c) a huge product skew toward diesel segment (96%), wherein prices are likely to increase by ~10-12% and (d) a deteriorating margin profile, with the share of FES likely to decline over FY19-21. However, ~40% correction in its core business valuations from 18.4x in Aug’18 to 11x in Feb’19 largely factors in these challenges, in our view. We, thus, maintain Buy with an SOTP-based TP of `790 (Mar’21).
Tractor: Monsoon forecast, high base putting FY20 volume trajectory at risk
The domestic tractor industry is in its third year of upcycle in FY19, with 17% CAGR in volumes over FY16-19. While fortunes of the tractor industry are heavily influenced by monsoon, tractor cycles are generally four years long (three good years and one down year). Volumes will at best grow 7-8% in FY20. Further, monsoon forecasts have been mixed, with Skymet’s expecting below-normal monsoon and the IMD forecasting an easing El Nino impact in FY20.
UVs – product lifecycle to deteriorate
MM’s UV business is likely to grow strongly in FY20, led by the full-year benefit of new product launches and the potential pre-buying ahead of BS6 implementation from Apr’20. Post two attempts to crack the compact UV space with TUV 3OO and KUV 1OO, MM launched its third compact SUV XUV3OO. While initial bookings/inquiries are healthy, more launches by competitors in this segment can impact MM’s target to capture more share of the UV1 segment.
Risk to margins
With the tractor business faced with cyclical pressures in FY20, the share of the automotive business is likely to increase from 65% now to 66.5% of volumes. However, auto business PBIT margins would be impacted by the higher contribution from new products, where initial margins are lower. Hence, we believe there is a risk to our estimate of a blended Ebitda margin improvement of 20bp to 13.9% in FY20.
Valuations: Challenges priced in, though re-rating catalyst missing
MM’s core valuations have corrected from the recent peak of 18.4x in Aug’18 to 11x in Feb’19. Such significant correction factors in the medium-to long-term challenges. M&M’s core business (excl. subsidiaries value) is trading at very attractive valuations of 16.2x/16.5x FY20/21 EPS (MM+MVML). While valuations would provide support to stock price, we do not foresee any near-term triggers for stock re-rating.