A sharp jump in raw material consumption has hit Mahindra & Mahindra's margins in the third quarter
Automobile major Mahindra & Mahindra's (M&M) stock price has been in reverse gear for the past three weeks. Reason: the company failed to match up to analysts' expectations. To put it differently (rather more accurately), analysts overestimated the company's earnings potential for the third quarter.
Riding on the overall bullishness and the excitement created by Scorpio sales figures, the stock jumped from Rs 82 on October 1, 2002, to Rs 113 on January 22, 2003. Ever since, it has backtracked to less than Rs 100.
Also Read
Analysts had expected the company's operating margins to touch 11 per cent for the third quarter of the year, about 200 basis points over what it had achieved in the second quarter of this fiscal.
Instead of improving, operating margins actually declined to 7.89 per cent from 9.01 per cent last quarter. Obviously, the squeeze in operating margins resulted in poor net profit figures as well.
Had it not been for the increase in other income, which rose from Rs 6.19 crore to Rs 38.41 crore, the company would have recorded a loss at the net level. During the quarter, the net profit showed an increase of Rs 4.23 crore to touch Rs 30.78 crore. Of this, around Rs 33.86 crore was other income on account of dividend received and profit on sale of current investments. Without this component, the net profit would have turned into a net loss of Rs 1.44 crore.
The prime culprit for this was the tractors division. The net margins of the farm segment, which contributes 32.26 per cent to M&M's total sales, fell from 12.35 per cent to 6.35 per cent during the quarter.
A close look at the third quarter figures suggest that margins were affected by a sharp increase in raw material consumption. The proportion of raw material consumed to total sales increased from 63.84 per cent in the third quarter of fiscal 2002 to 68.35 per cent in the same period this fiscal.
Analysts attribute this to a reduction in tractor inventory. For the third quarter of fiscal 2002, the inventory increased by Rs 113.79 crore compared with a rise of Rs 347.57 crore for the second quarter.
"As inventory build-up in the farm segment reduced, the cost of raw materials has been incurred in the third quarter. Earlier, this was not recognised as expenditure because it had been transformed into inventory. This led to the increase in the raw material cost for both the farm segment and the company, overall, reducing operating margins," said Avinash Gorakshakar, automobile sector analyst, Emkay Securities.
The performance of the automotive segment, which contributes around 65 per cent to the company's total sales, was, however, in line with analysts' expectations.They had expected the margins to improve owing to good sales in multi-utility vehicles and three-wheelers. And, margins did improve significantly. Compared to the second quarter when net margins in the automotive segment had fallen to 3.54 per cent, they firmed up smartly to 6.40 per cent in the third quarter. But on an year-on-year basis the margins did not show any improvement.
The company's three-wheeler sales grew from 1,413 units for April-December 2001 to 6,608 units in the same period. Analysts estimate that operating margins in this segment could be as high as 25-30 per cent.
"Going forward, the three-wheeler segment will serve to be a stable source of income for the company," says Gorakshakar.
Though company officials are hesitant to disclose the likely sales figures in this segment, analysts feel that M&M will be able to notch sales of around Rs 125 crore in three-wheelers by the end of this fiscal.
Some analysts prefer to be more cautious. They say that the growth story in the three-wheeler segment may be over. "Three-wheeler sales were affected by robust replacement demand as well as good exports, both of which may not be there next year," says Kalpesh Parekh, automobile sector analyst, Investmart.
For the fourth quarter, analysts expect margins to be slightly better. Operating margins may be up to 8.3 per cent, though margins in the tractor segment are expected to be sluggish till the first half of next fiscal.
"The margins in the tractor segment will remain depressed in the next few quarters as the inventory correction will continue," says Parekh.
Overall, there is consensus among analysts that revenues for fiscal 2003 will be up around 11-12 per cent, which translates into a revenue growth of 15 per cent for the fourth quarter.
Including the extra-ordinary income on account of equity stake sale of Mahindra Sintered Products, its subsidiary, profits for the fiscal will be Rs 140 crore.
In other words, one could expect a 42.94 per cent growth in net profit in the fourth quarter. At the current price of Rs 99, analysts think the stock is fairly priced.