Saturday, March 28, 2009

Mahindra & Mahindra - Buy

S. Hamsini Amritha

Investors with a three-year horizon, wanting to take exposure to auto stocks, can consider accumulating the Mahindra and Mahindra (M&M) stock. Currently priced at Rs 344, M&M discounts its trailing four-quarter earnings by about 11 times. There could be a modest dilution in earnings due to a 7 per cent increase in equity following the acquisition of Punjab Tractors.

After a severe slowdown in the October- December 2008 quarter, the automobile industry has been showing signs of revival since January. Aggressive reductions in interest rates by the RBI are beginning to reflect in automobile financing options. Helped by easing of credit, auto sales have been showing signs of recovery since January 2009. M&M has posted a growth of over 15 per cent in volume terms in the first two months of 2009. Excise duty cuts on vehicles have also helped lower prices and stimulate demand.

M&M’s revenues originate mainly from the automotive and farm equipment sectors in the proportion of 58 and 41 per cent respectively (in nine months ended December 2008).

Automotive segment

M&M derives about 65 per cent of its automotive revenues from utility vehicles (UVs), where it has steadily improved market share from 45 per cent in 2004 to 53 per cent now. Interest from institutional buyers such as small and medium businesses and cab operators has helped the company manage the slowdown better than most other vehicle-makers. Backed by sales of Scorpio and Bolero, M&M’s UV sales volumes were flat in 2008, after averaging a 14 per cent growth in the preceding three years.

Though the segment did witness deceleration in the December quarter, growth has picked up to 20 per cent in the first two months of 2009, driven by launches. LCVs and three-wheelers constitute 20 per cent of M&M’s automotive revenues (though it is not a prominent player in this segment) and this segment relies largely on rural demand.

Introduced in January 2009, Xylo, targeted at retail buyers, infused the much-needed buoyancy to M&M’s sales (4,000 units sold until February). Since it is strategically priced below other sedans and MUVs such as Toyota Innova and Chevrolet Tavera, Xylo appears well-positioned against competition.

Apart from this, the company launched an upgraded model of Scorpio this month. M&M has recently passed on to consumers the excise duty cuts, which , may be visible from the next quarter. The demand for SUVs usually accelerates ahead of elections and that may deliver a short-term boost to sales as well.

Farm equipment

M&M holds 40 per cent market share in the farm equipment segment. After sustaining growth in the first half of this fiscal, the segment witnessed a 7 per cent decline in volumes during October-December 2008. Going by favourable factors such as adequate monsoon and increased credit availability in the hands of farmers, the segment appears well-placed to sustain sales growth this year. Punjab Tractor’s amalgamation with M&M, which is to take effect from this quarter, may add market share and strengthen M&M’s presence in the Northern market, though it is unlikely to have a material near term impact on the per share earnings.

Financial Aspects

After a sustained net profit growth of 25-30 per cent (excluding exceptional gains) in the five years to 2006-07, M&M saw a sharp deterioration in the profit picture in the first nine months of 2008-09, concentrated mainly in the December quarter. While revenues on a consolidated basis grew 13.2 per cent to Rs 21,652 crore, net profit after minority interest declined by 26 per cent to Rs 809.5 crore from Rs.1095 crore.

On a standalone basis, the December quarter saw the company report a loss of Rs 26 crore (before other income, interest and exceptional items), compared to a profit of Rs 280 crore in the same period last year. However, profits were depressed to a significant extent by forex losses of Rs 182 crore (gain of Rs 13.9 crore last year) taken this quarter. This pertains to cancellation of forward contracts and revaluation of foreign currency borrowings. Of this, Rs 136 crore may be of a one-time nature and is unlikely to impact profitability in the coming quarters.

While forex losses did play a role in depressing the profit picture, lower production and revenues — the company sold mainly from inventories — higher raw material costs and possible inventory losses on excise duty cuts also contributed to the decline in profit margins. However, with the company substantially drawing down its inventories in the December quarter and raw material costs (steel, aluminium and paint) easing significantly, profit margins may stage a sharp improvement, from here on. A recovery in sales volumes and the recent excise duty cut will also help improve revenues, helping better recovery of fixed costs. Going forward, though forex losses on existing loans (due from 2011) will remain a drag, lower interest rates on working-capital borrowings may help lower financing costs.

Expansion plans

Fairly ambitious capex plans have also weighed on the M&M stock’s valuations. The company had previously lined up a capex of around Rs 7,500 crore. Due to the overall slowdown in the sector, the company has revised its plans downward to Rs 5,000 crore, phased out over the three years to 2012.

M&M appears to have funded the major portion of this by means of FCCBs and ECBs and is setting up a new UV plant in Chakan with a capacity of 3,50,000 vehicles. This plant would be operational from FY 2010. Debt-equity ratio, which stood at 0.6 at end-March 2008, continues to be at the same level.