Non-auto businesses shine at M&M

Value of its subsidiaries -Tech Mahindra and M&M Financial Services in M&M's SOTP has multiplied 3 times and 2.2 times respectively over the past three years

Mahindra and Mahindra (M&M) has come a long way from being a pure-auto-play stock to become a diversified conglomerate over the past few years. Two of its non-auto businesses have achieved significant scale and grown profitability over the past few years. These subsidiaries are Tech Mahindra (TechM, M&M has 36.34% stake in the company) and M & M Financial Services (MMFS, 51.2% stake held by M&M).

Notably, TechM's contribution in estimated sum-of-the-parts (SOTP) valuation of M&M has multiplied 3.0 times to Rs 191 per share for FY15 estimated as against Rs 63 estimated for FY12. It now forms about 17% of M&M's FY15 estimated target price of Rs 1,145 (versus 7.8% in FY12). MMFS too has witnessed 2.2 times growth in its contribution to M&M's SOTP to Rs 113 per share for FY15 from Rs 52 estimated for FY12. About 9.9% of M&M's target price comes from MMFS for FY15 as against 6.5% in FY12 estimates.

Mahindra Holidays on the other hand is the laggard and its value in the SOTP has fallen from Rs 32 in FY12 to Rs 19 as estimated for FY15. Consequently, its share in the target price has come down to 1.7% for FY15 as against 4.0% in FY12 estimates.

While Satyam acquisition elevated TechM to the top fifth listed Indian IT services company, diversifying into non-M&M auto lending as well as product diversification has enabled MMFS to become a significant NBFC player. Most analysts remain bullish on these two companies, though MMFS scrip seems to be fairly valued.

Tech Mahindra

TechM's re-rating is largely driven by acquisition, successful turnaround and merger of a much larger company- erstwhile Satyam Computers. The merger enabled TechM to become a diversified player and reduce dependence on one client/business segment. Its largest client British Telecom now forms about 12% of the company's revenues as against over 65% in 2009. Despite client specific issues at British Telecom, Tech Mahindra has managed to grow its non-BT telecom business well (up 4-5% sequentially in the past 2-3 quarters).

Analysts expect Tech Mahindra to post revenue and net profit growth of 17% and 15% respectively in FY16 - a tad better than industry growth. Out of the 19 analysts polled by Bloomberg since March 2014, 15 have a Buy and 2 each have a Hold and Sell rating on the scrip. Their average target price stands at Rs 2,118 per share or nearly 17% upsides from current levels. Most analysts remain bullish on the stock (trading at 11 times FY15 estimated earnings) and expect the re-rating to continue.

"Tech Mahindra is our top pick in the IT space. Over FY14-16, earnings growth is likely to be ahead of its peers due to strong growth in the enterprise segment (53% revenues), improving traction in Europe and continued momentum in telecom on the back of improving market share and entry into new segments. We believe the stock has the potential to re-rate to 13 times one-year forward estimated earnings," says Pratish Krishnan, IT analyst at Antique Stock Broking. Going forward, Tech Mahindra plans to ramp up revenues from BFSI and manufacturing verticals which will compliment the strong traction witnessed in the Telecom vertical. The company is also scouting for attractive acquisition targets which in turn will drive growth.

MMFS

MMFS is a play on lending in rural/semi-urban areas and has expanded beyond auto lending (SME Financing, housing loans, Personal loans, insurance broking, old vehicles financing) to become a significant lender in the retail non-banking financial company (NBFC) segment. Large part of its growth since FY-09 has come by lending to non- M&M auto segment (M&M exposure down to 46% in December 2013 from 63% in FY09). Growth in its Assets under management (AUM) has moderated from 51% in FY11 to 40.6% in FY13, and is likely to moderate further to 24.8% in FY14 and 15-16% each in FY15 and FY16. However, this is partly a function of high base effect and the growth still appears decent given the macro-economic pressures. Though the company has witnessed some pressure on its asset quality, the net non-performing assets (NPA) ratio is likely to remain between 1.7-2.0% over the next 2-3 years, estimate analysts.

"We think problems in the agriculture sector are likely to accentuate in the near term, given recent crop failures in Maharashtra and Madhya Pradesh (MP). Hence, high NPL levels could be sustained for some time. However, we believe the probability of a favorable election outcome could lead the market to look beyond near-term issues in the sector and continue to give value to an otherwise-strong franchise," says Saurabh Kumar of J.P.Morgan.

Out of the 14 analysts polled by Bloomberg since March 2014, 6 have a Hold rating and 4 each have a Buy and Sell rating. Their average target price stands at Rs 255 per share which is closer to its current price. Thus, though most brokerages are positive on the company's prospects, the valuations seem to capture the positives.