Published on 13/09/2019 11:11:55 AM | Source: LKP Securities Ltd

Buy Mahindra & Mahindra Ltd For Target Rs.600 - LKP Securities

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Results below than expectations, FES may drive numbers on improved monsoon

Weak Auto margins leads to subdued profitability

M&M has posted subdued performance in Q1 FY20 on weak and challenging market environment and heightened competition. M&M’s standalone Q1FY20 revenues fell by 4.4% yoy and 7.7% qoq at ₹129 bn. Automotive volumes in the quarter dropped by 6% yoy better than the industry decline while falling by 24.6% qoq. Launches done in Q3 and Q4 of last year led to some market share gains in the quarter. FES volumes de-grew by 14.3% yoy better than industry, (which declined 15.6%) while growing 41.6% sequentially. While the auto revenues moved down by just 1.1% yoy, the sequential dip was 22.4%. FES revenues were down by 12.5% yoy, they were up by 36.7% qoq. On profitability front, EBITDA margins went down to 12.6% from 13.8% yoy and were up from 11.7% qoq. Auto EBIT margins were sluggish at 4.7% due to negative operating leverage led by deceleration of demand. FES margins zoomed up at 19.3% qoq , while dropped 160 bps yoy from 20.9%. Higher other income (by 20% yoy) was offset by higher depreciation related with 3 new launches. This led to adjusted net profits to fall by 20.7%, however, reported net profits (including a one off item worth ₹13.7 bn on gain on sales of long term investment in Tech Mahindra) grew by 173% to ₹23.2 bn.


Auto business outlook stays uncertain

On the back of challenging market environment, M&M has also faced the pressure like other auto manufacturers. SUV, 3W as well as CV segments have reported drop in sales, though they have managed to increase market share in SUV segment on recent launches and the drop in its fall is lesser than the industry. Going forward, the management is getting ready for the BS VI transition and EV wave. We believe with increasing rural thrust from the government the sales may move up in H2 over Q1 and on low base of H2 last year. We believe the newly launched XUV 3oo will gain success and contribute to the volume growth hereon. Any tax incentive or reduction in registration costs and insurance costs of vehicles may provide some stimulus for the demand hereon. However, with uncertainty still around, the management has not given any sales outlook for the Auto business. We believe this business to de-grow by 6% in FY 20E v/s YTD July growth of -8.3% and at grow at 7% in FY 21E.


Reduction in monsoon deficit may lead to recovery in tractor sales

Domestic FES segment of the company has posted 14.2% YTD July de-growth in volume on delayed monsoon and overall weakness in rural income. With current monsoon deficit down at 7% from the highs of June end, further consistency and widespread, proper distribution of rainfall, we expect recovery in tractors sales to follow. Management believes that the worst for this segment is behind and a positive growth in rest of the year may result in a flattish growth in FY 20E. Non agri usage of tractors is also quite strong as construction and infrastructure industries are also expected to gain momentum in H2. The segment reported 19.3% margins in Q1, which going forward in FY20E, we expect the segment to continue to improve on benign RM costs and anticipated growth in volumes. We expect -2%/7% growth in FES business in FY20E/21E.


Margins to get impacted by BS VI costs, auto slowdown and competition

In Q1 FY20, the company posted subdued margins at 12.6% as the Auto segment (~60% of volumes) posted weak margins at ~4%. This was due to higher inventory costs resulting from slowdown across segments, higher marketing expenses in line with promotion of three newly launched products amidst competition and BS VI related expenses. Going forward, in rest of FY 20E too we see these headwinds to have an impact on margins. Softening RM costs, improvement in FES business and price hikes may provide tailwinds for the margins. We expect FY 20E margins to be lower than Q1 levels at 11.7%, while expect them to grow to 12.6% in FY 21E.


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