M&M: In-line Q4 numbers; attractive valuation makes it a long-term buy

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Highlights:
– Decent volume growth in auto segment whereas farm equipment segment remained weak
– Operating profitability under pressure due to rise in raw material prices
– Moderate outlook for tractor segment, near-term weakness in auto segment
– Accumulate in staggered manner
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A weak demand environment in automotive and farm equipment segments has impacted performance of Mahindra and Mahindra Ltd ( M&M). The automaker posted mid-single digit growth in top line and saw contraction in operating profitability.

The company is trying to hook investors for the long term on the back of its strong leadership in farm equipment segment (FES), the government’s focus on rural growth, a slew of new auto launches and reasonable valuation.

Quarter in a snapshot

Key highlights
Hit by subdued demand owing to multiple challenges being faced by automobile and farm equipment (FES) industries, the company saw a decline of 0.4 percent in volume year-on-year (YoY). Tractor volume took a knock of 14.5 percent, which got partially offset by 7.2 percent growth in UV (utility vehicle) volume. Tractor segment came under pressure after lower than expected Rabi sowing and subdued farm sentiment. Realisation, however, grew 5.1 percent YoY, driven by lower discounts in the quarter, especially in the auto space, which ticked up 6 percent on lower discounts.

The overall earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted by 160 bps (YoY). The contraction was on the back of significant rise in raw material (RM) prices. However, lower other and staff expenses partially offset the impact of the rise in RM prices.

Automotive segment’s EBIT margin fell by 170 bps, weighed down by higher RM prices. FES segment’s margin contracted by 330 bps.

M&M also reported an exceptional loss of Rs 105 crore related to provision for impairment of certain investments.

Following are the factors that give us comfort on the company:

FES – A positive outlook
The company has been the market leader in tractors with a market share of 36.4 percent. The leadership is primarily attributed to its product innovations.

Though the segment has not been doing well in the past couple of months due to lower Rabi sowing than expected and subdued farm sentiments, the management expects it to grow 5 percent in FY20, steered by growth in H2 FY20. It believes that H1 FY20 would be muted for the tractor industry as the medium-term growth outlook, however, is pegged at 8-10 percent. The management is of the view that M&M would be able to do better than the industry on the back of its large exposure to rural and semi-urban areas.

Automotive segment – Sluggish in near term
Demand outlook for the automobile segment continues to be muted due to multiple factors such as increasing cost of total ownership on the back to rising interest rate and insurance cost, coupled with weaker festive sales and liquidity crunch. The demand is expected to be sluggish in the near term. However, long-term outlook continues to be very positive.

With the new launches, M&M remains on a strong footing. In fact, M&M has a portfolio of successful products such as Scorpio and XUV500 in UV segment. The response to its newly-launched Marazzo, Alturas G4 and XUV300 has been very encouraging.

Attractive valuation The underperformance of the stock, which corrected 33 percent from the 52-week high in August 2018, has rendered the valuation attractive. Sum-of-the-Parts (SOTP) valuation methodology gives 26 percent upside potential. We advise long-term investors to accumulate M&M for the long term.

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