M&M: Cost control gains

M&M's farm equipment division has been a drag

Mahindra & Mahindra results for the fourth quarter ended March 31, 2005, were surprising to say the least. Profit before tax and exceptionals grew 39.2 per cent on the back of a 27.3 per cent growth in sales, in line with the trend for the rest of the year.

In the nine months till December, profit had grown 88.9 per cent higher than the sales growth of 36.9 per cent.

It wasn't the drop in growth that surprised "" after all, the company reports monthly sales numbers and it was already known that volume growth was lower last quarter because of uncertainty about VAT and emission norms.

What was surprising was the 155 basis points drop in raw material cost as a percentage of sales last quarter, after having jumped by 290 basis points in the first nine months of the year. Equally strange was a 310 basis points jump in other expenditure as a percentage of sales in the March quarter.

Especially so, since these expenses had dropped by 240 basis points as a percentage of sales in the first nine months. The company points out that quarterly variations in expense heads don't make much sense and one needs to look at the full-year results. Last year's fourth quarter had seen a big drop in inventory, while this wasn't the case last quarter.

As a result, raw material costs appear higher. Without adjusting for changes in inventory, raw material cost is higher by about 350 basis points. Similarly, on the other expenses front, a step up in the company's overseas initiatives meant that expenses such as export promotions and travel were higher last quarter.

Sticking with the fourth-quarter results, the farm equipment division saw a huge 530 basis points drop in segment margin, after a splendid performance in the first nine months, which saw margins jumping 320 basis points. Again, the company pointed out that the drop in margin in one quarter should not be taken as a trend.

But analysts point out that the drop in the segment's margin is a cause for concern, especially since it came despite an increase in prices towards the end of Q3FY05. This simply means that the price increases taken were not enough to offset raw material cost increases in the farm equipment business.

The full-year results offer a much better picture "" while sales grew 34 per cent, profit before tax and exceptionals jumped up by 71.4 per cent thanks to an improvement in operating margin and a steep cut in interest cost.

For the whole year, raw material cost rose by 150 basis points, but this increase was offset by a cut in both staff cost and other expenses. The net result was a 73 basis points improvement in operating margin.

This makes M&M among the best managers (among auto majors) of the increase in raw material cost last fiscal. And it was not only the farm equipment division that propped up margins thanks to the uptrend in the tractor segment. The automotive segment reported a 142 basis points improvement in segment margin, which was better than the 57 basis points improvement in the margin of the farm equipment division.

The other highlight in M&M's results was the announcement of the acquisition of a forging unit from Amforge. This adds to the string of auto ancillary companies the company bought last year.

Having control over component supply could help M&M contain raw material pressures going ahead. Volume growth, meanwhile, is expected to drop this fiscal, not only for the industry but also for M&M.

With raw material cost threatening to impact margins further, earnings growth is expected to be substantially lower than that in FY05. Yet, at about 11 times trailing earnings, the M&M stock doesn't price in aggressive growth.

HPCL

HPCL reported a 55.8 per cent drop in its profit before tax to Rs 368.91 crore in the March quarter, despite net sales rising 12.57 per cent. Crude throughput dropped 8.85 per cent on a y-o-y basis in the last quarter to 3.19 million metric tones (MMT).

Analysts point out that the Mumbai refinery was shut for a brief period in the March quarter due to annual maintenance. Further, gross refining margins fell to $5.3 per barrel in the March quarter as compared to $7.2 per barrel in the same period last year. Although gross refining margins were lower on a year-on-year basis, they were broadly in tune with the benchmark Singapore refining margins.

Subsidy losses on account of LPG and kerosene amounted to approximately Rs 910 crore in Q4 FY05, a growth of about 26.4 per cent on a y-o-y basis. On the cost side, other expenditure jumped 53.4 per cent in the last quarter to Rs 1154.14 crore.

As a result, the operating profit fell 47.2 per cent to Rs 456.42 crore in the March quarter and operating profit margin shrank 316 basis points to 2.78 per cent. Earlier, BPCL had also reported a 32.3 per cent drop in its profit before tax in the March quarter, largely due to lower GRMs and rising subsidy losses.

Going forward, gains on refining margins seem to be capped in the short term.

However, the government's much anticipated petro-product pricing policy is expected to play a key role in determining the company's future subsidy burden and consequently, its profitability.

With contributions from Mobis Philipose and Amriteshwar Mathur