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Inline; strength in Auto offsets weakness in FES

* MM’s 1QFY23 operating performance was in line as the Auto business made up for weakness in the Tractor segment. While the Auto business is firmly on the growth path, led by a refreshed product portfolio, the outlook for the Tractor segment is uncertain, particularly for 2HFY23. The strong order backlog in SUV will continue to boost performance, aided by RM cost savings. Stability in the Tractor business will be a key performance driver.

 * We raise our FY23/FY24 standalone EPS estimate by 7% each to factor in a strong order backlog in the Passenger UVs and improving semiconductor supplies. We maintain our Buy rating with a TP of INR1,400/share (Sep’24E based SoTP

Cost inflation and weak mix hurt margin in 1QFY23

* Standalone revenue/EBITDA/adjusted PAT grew 67%/43.5%/57.5% YoY to INR196.1b/INR23.4b/INR14.7b.

* Volumes grew 46% YoY. Net realizations grew 14.5% YoY (but fell 4% QoQ) to ~INR721.1k/unit (est. INR705k/unit), led by ~15%/6% YoY growth (+4%/- 5% QoQ) in Auto/Tractor realizations

* Gross margin contracted by ~7pp YoY to 23.4% (est. 24.5%) due to higher RM cost and a weaker mix.

* However, the benefit of operating leverage diluted the ~200bp YoY fall in EBITDA margin to 11.9% (est. 12%). EBITDA grew 43.5% YoY to ~INR23.4b (est. ~INR23.7b).

*Lower tax boosted adjusted PAT to INR14.7b (est. ~INR13.9b), a growth of 57.5% YoY.

* The net contribution from Auto subsidiaries, at the PBIT level, was a loss of ~INR331m (v/s a loss of INR670m in 4QFY22).

* Its farm subsidiaries recorded an eighth consecutive quarter of positive PBIT of ~INR710m (v/s ~INR648m in 4QFY22).

Highlights from the management commentary

* The Tractor industry will see a 3-5% growth in FY23, despite a near normal monsoon and an acreage close to last year, as there are risks in the form of: a) unfavorable terms of trades for farmers, and b) lower government spending on agriculture and rural.

* Scorpio-N bringing in new customers as reflected in a) greater urban salience for the new model (77% v/s 45% for the old mode), b) shift in preference in South/West India (17%/28% for the new v/s 3%/21% for the old model).

* It is looking to substantially expand capacities in phases (the management didn’t disclose details) as it doesn’t want the waiting period to exceed beyond tree-tofour months. Semiconductor supply issues have resulted in a 10% loss of production.

* The benefit from lower RM cost will reflect from 3QFY23, given its inventory and contracts. Hence, the benefit won’t be much in 2QFY23.

* Peugeot was initially categorized as category A. However, COVID-19 has hurt the business fairly hard, impacting its performance badly. Since performance parameters have not been met in a time bound manner, it is under review now.

Valuation and view

* While the outlook for Tractors is murky, we expect the Auto business to be a key driver of growth over the next couple of years. Despite a deterioration in the mix, we expect a revenue/EBITDA/EPS CAGR of ~26%/33%/~31% over FY22-24. Implied core P/E for MM stands at 16.5x/12.5x FY23E/FY24E EPS.

* While the stock is still cheap as compared to its peers, it has got substantially re-rated over the last two quarters as the stock is now trading in line with its five- year average core P/E (against a discount of 30% earlier). The narrowing of the discount to LPA has been a reflection of its strong performance in the SUV segment, cyclical recovery in LCVs, and improvement in its outlook for the Tractor business (from Apr-Jun’22). We maintain our Buy rating, with a TP of INR1,400/share (Sep’24E based SoTP).

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