Mahindra & Mahindra tractor-led portfolio to cushion revenue fall

Higher tractor margins, cash on books and better capital allocation policy are positives

The stock of Mahindra & Mahindra (M&M) has witnessed sharp recovery since the beginning of the month, gaining 25 per cent, against a 20 per cent uptick in its peer index, BSE Auto. 

The gains have come on the back of expectations that the company’s rural portfolio and better capital allocation will help it navigate the slowdown better than other players.

With the resumption of agricultural activities from April 20, retail outlets selling agricultural machinery and spare parts are expected to resume operations. Further, the interstate movement of harvesting- and sowing-related machines, such as combined harvesters, is also exempt.

M&M will be a major beneficiary of the relaxations given to agricultural activities. About 35 per cent of its volumes are from tractors, and a significant percentage of the auto verticle volume comes from rural areas.

On an overall basis (auto, tractors, and light commercial vehicles), about two-thirds of volume and about 70 per cent of revenue come from the rural segment. 

Given the record rabi sowing, steady harvesting activities and expectations of a normal monsoon, brokerages expect demand in the tractor segment to be resilient in 2020-21. Further, the government’s focus on the rural segment should boost demand, helping strong recovery, especially in the festival  months later in the year.

 

 

Volumes in the tractor sector are expected to be 5-10 per cent lower, compared to a fall of over 20-25 per cent for all other segments. Analysts expect the company to maintain its market share at 40-41 per cent in the year. The higher sales of tractors to its overall volumes are a positive for M&M, as margins in the farm equipment segment at 18 per cent are thrice the auto segment’s.

Though a large chunk of the volumes in the auto space comes from the rural segment, analysts believe M&M will struggle to sell even the Bolero and Scorpio, as demand for discretionary spends is expected to pick up only gradually, as retail showrooms (utility and light commercial vehicles) continue to be under lockdown. 

Demand worries and plant shutdown impact were visible in March for the auto segment, which witnessed an 88 per cent decline year-on-year in volume.

The other positive from the Street’s perspective is the improvement in the capital allocation policy. Recently, the firm decided not to invest more capital in its subsidiary SsangYong Motor Company, given the risks from Covid-19. The firm will invest $32 million, compared to $406 million over the next three years. 

Analysts believe the firm could delay or review investments across its loss-making subsidiaries as well as capital expenditure plan for core operations.

In the near term, the key triggers would be the March quarter results. The company is expected to post a 38 per cent fall in revenue, led by the auto segment, while margins are expected to decline by 

220 basis points to 11 per cent. 

Though analysts expect a 60 per cent fall in net profit to about Rs 400 crore, compared to over Rs 1,000 crore in the year-ago quarter, there is no balance sheet risk. The company, according to IIFL, is expected to end 2019-20 with net cash of Rs 3,000 crore.

While there are positives on tractor sales, capital allocation policy, and valuations (reasonable on a price-to-book basis of around 1x), investors should be cautious as there are little signs of recovery for the utility and light commercial portfolio of the firm.