M&M's triple decker

SPECIAL REPORT

The M&M scrip has been the favourite of auto analysts for quite some time now and the recent upbeat results of the country's leading utility vehicle (UV) and tractor manufacturer vindicate their stand.

The going is yet to get better, say analysts who remain bullish on the company's domestic tractor business which is indicated to do well going forward.

Analysts say the government's focus on agriculture and expectations of good rainfall this year are expected enhance growth.

In fact, the government's focus on farm reforms may be just what the doctor ordered for the ailing tractor industry - one of M&M's mainstays. Though the last two quarters saw a huge recovery in the tractor business, analysts say there is yet more to come.

Analysts say a good monsoon, as forecast by the Council of Scientific Industrial Research (CSIR), would not only provide a sentimental positive for the tractor industry but serve to spur rural demand.

In fact, they maintain that M&M would be among the main beneficiaries of any increase in rural demand which, in turn, would result in a literal 'pick up' in its UV and light commercial vehicles (LCV) demand along with three-wheelers.

Reaffirms Sachin Patil, auto analyst at SSKI Securities, "Even if this year's monsoons are normal, the lag effect of last year's good monsoons would see the company benefiting from the rural push."

The company posted impressive Q4FY04 and full-year results. While the topline for FY04 has grown by 33 per cent y-o-y, profit before exceptionals and taxes jumped 193 per cent to Rs 408.7 crore, thanks mainly to improved operating performance and interest savings.

For Q4FY04, the corresponding figures stood at 35 per cent and 199 per cent respectively on a y-o-y basis. Needless to say, analysts are impressed.

"The company has brought down its inventory levels while increasing volumes and efficiencies. This has reduced the break-even point and any incremental volume growth would flow directly into the bottomline," says S Ramnath, auto analyst at Enam Securities.

Tractors plough ahead
The tractor division staged a spectacular comeback after remaining in the wilderness for two years, posting sales growth of 21 per cent and 50 per cent in Q3 and Q4 respectively and a 5.4 per cent volume growth y-o-y.

The segment had been beset with problems in the last couple of years but the tide seems to be turning, feel analysts. A drought-like condition in Madhya Pradesh, Rajasthan, Gujarat and the southern region in calendar year 2001 and a drought all over India in calendar year 2002 affected tractor sales.

Moreover, the pile-up of nearly 65-75 million tonnes of food in government godowns led to a squeeze in purchasing, resulting in lesser income in the hands of the rural populace.

Also, on account of low recoveries of debt, banks became skeptical of lending to farmers which led to a fall in the availability of credit. All these reasons led to a lower demand for tractors and impacted industry sales.

However, starting Q2FY04, volumes have been on the rise and the company being the market leader has reaped the benefit of the same. From being a drag on the company's financials, the tractor division is now contributing to growth in a strong way. The segment had margins of 12.26 per cent in the second half, much higher than the 9.2 per cent margin of the automotive segment.

However, the results have not been perfect. There are a few areas where the lines blur. Mahindra's tractor exports have taken a beating with its subsidiary Mahindra USA recording a 17 per cent dip in its annual sales in fiscal 2004.

In fact, the decline in exports has impacted the company's tractor sales, which have grown only 5.4 per cent y-o-y compared to the 11 per cent industry growth.

Analysts say M&M's tractors are more tuned to Indian conditions. Therefore the domestic demand for tractors would be the driver while increasing contribution from exports in the future would increase the leverage.

'Pick up' in UV demand likely
The UV division continued to power the company's growth, with a sales growth of 33 per cent for FY04. However, M&M seems to have faced heat from rival products such as Sumo and Safari which were upgraded.

As a result, UV sales growth slowed down to 24 per cent in Q4, compared to a growth of 37 per cent in the first nine months. Sales of its premium offering in the segment - Scorpio - saw some stagnation, averaging around 2,300 units in the last few months.

However, it sold just 1,900 odd units in May. Analysts say Scorpio seems to face some resistance to growth and blame the present demand-supply mismatch on the component suppliers' side.

However, analysts say Scorpio accounts for barely one fourth of M&M's sales of UVs which are expected to see significant demand going forward.

In fact, they maintain that the demand for UVs is expected to grow at a faster pace than that for passenger vehicles this year once the monsoon demand kicks in.

The light weights
M&M seems to have milked the changing structural dynamics in the transport system to its advantage and the proof of that is a slew of innovative launches like Champion three-wheeler or Load King LCV which continue to do well.

The company's three-wheeler sales rose by an impressive 50.6 per cent in Q4, but lower than the 84.5 per cent growth recorded in the first nine months. But that may not be a cause for worry as growth in three-wheeler sales reverted to 85 per cent in April.

Analysts say the company's timing in coming out with the right offerings in the three-wheeler segment has worked in its favour.

Jolly ride ahead?
M&M improved its operating margins by a significant 250 basis points during the year. The growth came in despite the pressure on steel prices, thanks to improved product mix and higher capacity utilisation.

Sales volumes of M&M's automotive division have improved 80 per cent in the last two years and, combined with the volume improvement in the tractor division, have spread the company's fixed costs over a larger base, contributing to the improvement in operating margins.

The company expects a 8-10 per cent growth in domestic tractor sales in the current fiscal. Going forward, analysts say though UV sales may lose some of its sheen this fiscal, the revival in tractor business augurs well for M&M.

They say valuations look attractive from a medium- to long-term perspective, and peg an FY05 EPS target of Rs 34-37. At the current price of Rs 430, the stock trades at a price-earnings ratio of 11-13x FY05 earnings.

However, they warn of caveats in form of rising input costs, poor monsoons and hike in interest rates.