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Above est.; strong performance in both FES and Autos Demand outlook positive; expect sharp reduction in FY22 subs loss

* Mahindra & Mahindra (MM)’s 3QFY21 performance was driven by good performance in both the Tractors (FES) and Autos businesses. Furthermore, it has guided for an almost 90% reduction in international subsidiary losses in FY22E, driven by the completion of phase-1 of the capital allocation exercise. MM has twin levers of core business recovery as well as benefits of tightening capital allocation for EPS growth and re-rating.

* We upgrade FY21/FY22E EPS by 14%/20% to reflect volume upgrade in Tractors & Autos, tighter cost control, lower depreciation, and higher other income. Maintain Buy, with TP of INR1,040 (Mar’23 SOTP).

Good performance, supported by mix and lower costs

* MM’s (incl. MVML) 3QFY21 revenue/EBITDA/PAT grew 15%/28%/72% YoY to INR139.7b/INR22.9b/INR16.9b, whereas 9MFY21 revenue/EBITDA/PAT declined 13%/5%/7% to INR311b/INR48.6/INR30.4b.

* Net realizations grew 11.5% YoY (+0.3% QoQ) to ~INR623.5k (v/s est. INR613k).

* Adj. EBITDA margins expanded 160bp YoY (-90bp QoQ) to 16.4% (v/s est. 16%). The margin beat was driven by lower staff and other expenses.

* EBIT margins for Tractors improved 400bp YoY to 23.4% (-130bp QoQ), while Autos margins were flat YoY (+198bp QoQ) to 7.4%.

* Higher other income boosted adj. PAT to ~INR16.9b (v/s est. INR12.7b). It has impaired investments in SYMC worth INR12.1b.

Highlights from management commentary

* Tractors demand outlook is very strong, at least up to 1QFY22, post which the monsoons would be the influencing factor. Supply-side issues are easing and market share has rebounded to 42% in Jan’21. Systemic inventory is among the lowest in the last 15 quarters.

* Semi-conductor shortage is expected to persist until Jun–Jul'21 and is very dynamic, with the company having supply visibility of just a week (for SUVs and Pick-ups). This issue could result in MM deferring its upcoming launch of the new XUV500 (planned for Mar–Apr’21).

* Commodity prices have seen unprecedented levels of inflation. It has taken price increases in Jan’21 (2% each in Autos/FES) and would take a price hike in 1QFY22 once again, if required. It did not take any price increase in 3QFY21.

* The SsangYong (SYMC) deal is still moving forward, but toward the PrePackage scheme rather than the ARS scheme under the bankruptcy court. It expects to complete this deal in the coming quarter.

* The capital allocation exercise is more or less complete. In 3QFY21, international subs (ex-SYMC) loss reduced to INR0.9b v/s INR4.65b in 3QFY20. It expects loss from international subs to be lower than INR3b in FY22 – from estimated losses of INR30b in FY21 (v/s INR34.3b in FY20).

* Among the notable subsidiaries, it expects Peugeot (2W) and MAgNA (Mahindra Ag North America) to have a clear path to 18% RoE. Post the restructuring, MANA (Auto USA) and Pininfarina are on track to move to achieving profitability. It is still evaluating Erkunt and Hisarlar.

Valuation and view

* Valuations for MM are still at a substantial discount to its five-year average (which captures both the pain points of deterioration in UV market share and subsidiaries' performances).

* Implied core P/E for MM stands at 14.4x/111.7x FY22/FY23E EPS. This implies an over 25% discount (on an FY23E basis) to five-year average P/E and P/B. We have lowered our holding-company discount from 40% to 20%, factoring in an improvement in capital allocation and expected reduction in subsidiary loss. Maintain Buy, with TP of INR1,040 (Mar’23E SOTP).

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