Medium-term triggers for M&M

While volumes remain weak, analysts expect demand recovery and new launches to reverse the trend in 2nd half of FY16

Slowing sales of Mahindra & Mahindra (M&M) for its key product categories of utility vehicles (UVs) and tractors is expected to continue over the near term, due to a slowing rural economy and lack of new products. While domestic sales volumes for tractors were down 24 per cent year-on-year in the December quarter, sales in the UV segment were 11 per cent lower. For the 11 months ended February 2015, domestic tractor sales are down 13 per cent while UV sales are down eight per cent. Tractor sales have been coming down due to weak rural demand accentuated by deficient rains, lower crop production, lower MSP increase and weak global crop prices. This is also having an impact on M&M's UV portfolio. Thus, for the fiscal year-to-date, M&M's total (including exports) tractor sales are down 11 per cent while auto segment sales are down 7.9 per cent.

  Ashvin Shetty of Ambit Capital believes the moderation in rural demand for passenger vehicles would have the most impact on M&M (among auto companies) as Bolero and Scorpio are essentially sold in rural areas and constitute nearly 67 per cent of M&M’s total passenger vehicle volumes in the first nine months of FY15. As aggregate sales for the two models are down four per cent in the first nine months, there are already signs of demand stress in these models, according to him. The M&M management, however, has indicated that signs of rural slowdown have been seen in tractors but there has not been a slowdown in rural automotive sales.

Growth in the tractor segment is expected to pick up over the next couple of quarters. The slowing sales of tractors has a higher impact on M&M's profitability, given higher margins for the segment, which at 14.2 per cent is 600 basis points more than the auto segment. Analysts, however, say that the company has been hit by a sector downturn in tractor but has been able to maintain market share at around 40-41 per cent.

In the light commercial vehicle (LCV) space, which accounts for over a third of auto industry volumes, too, the slowdown has impacted the company’s volumes which were down eight per cent in 9MFY15. However, the company’s market share has grown by 400 basis points to 39 per cent during this period as the sector has performed worse. The slowdown in LCV segment is largely due to fall in freight availability. The recovery, however, is at least a couple of quarters away given that the LCV segment improves with a lag to the M&HCV segment.

While volumes across its product segments have been slowing, the key pain point, according to analysts, is the UV segment. While industry volumes have grown six per cent, the company's domestic UV sales are down eight per cent year-to-date. Given a weak product portfolio in the mini-SUV segment and launches by rivals in this fast growing segment, the company has lost market share, which has come down from about 50 per cent in Q1FY13 to 37 per cent in 9MFY15.

The company was caught off guard as market shifted to the compact UV segment. M&M did not have either the lower displacement engines nor a petrol variant which has impacted it adversely, say analysts. Given that product/engine development takes at least a year and a half, competitor models (Duster, Ecosport, Terrano) took the lead as they had petrol versions, and were able to position their products well in this key segment. M&M with its diesel dominated portfolio suffered as the price gap between petrol and diesel narrowed over the last two years from 31 per cent to about 19 per cent.

However, the trend could improve over the next 6-8 months. The company is trying to plug this anomaly by launching three new platforms in CY15, two of which will be in the compact sports utility vehicle (SUV) segment while one will be a small commercial vehicle. One of the SUVs, the urban compact crossover vehicle, will have newly developed 1.2 litre petrol and diesel engines. The company is also looking at refreshing three existing models and launching three new variants.

Positively, in the large UV space M&M continues to maintain its share even as sales are currently slow due to weak demand. Analysts expect the company’s UV sales to look up once the new models are launched in the second half of CY15.

However, part of the concerns are already priced in the stock, which has underperformed the S&P BSE Sensex in the last six months. The expected recovery in demand in second half of FY16 along with new launches should lead to better volumes. Given reasonable valuations and assuming success in new products, analysts thus are bullish on the stock as they see an opportunity to buy. The average target price of those polled by Bloomberg since January 2015 is Rs 1,395.