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Mahindra & Mahindra (MM)
Automobiles
All set to reap the next harvest. Recent underperformance offers a good entry point
in our view given strong volume growth outlook, stable margins and cheap valuations
(trades at 11.8X PE on our FY2012E EPS excluding subsidiary value). Turnaround in lossmaking subsidiaries coupled with 12% earnings CAGR over FY2011-13E in parent
business could lead to re-rating of the stock, in our view. We reinitiate the stock with a
BUY rating and target price of Rs875 based on SOTP valuation.
Volume growth expected to remain robust
We expect the company to report 15% volume CAGR over FY2011-13E driven by improving
personal income levels, strong business confidence and strong growth expected in construction
activity. All these indicators should aid strong growth in Mahindra’s business segments – utility
vehicle, tractors and LCV business. Reducing sensitivity of tractor volumes with agriculture crop
output is also expected to extend the tractor growth, in our view.
EBITDA margins to decline marginally due to escalating cost pressures
We estimate parent business EBITDA margins to decline by 60 bps over the next two years due to
escalating cost pressures. Richer product mix (higher share of tractors and LCVs) coupled with
strong pricing power in the tractor segment is likely to offset decline in EBITDA margins in the
utility vehicle business. We forecast Mahindra to lose 100 bps market share in FY2011-13E in the
utility vehicle business due to new launches planned by competitors (especially Maruti Suzuki).
Stock could re-rate due to strong earnings growth and easing concerns on loss-making businesses
Mahindra has always traded at a significant discount to its auto peers due to (1) multiple business
streams, (2) losses at some subsidiary which dragged overall profitability of the firm, and (3)
cyclicality of the tractor business. We believe stock could trade at higher multiples going forward as
losses at subsidiaries reduce (especially two-wheeler and Systech businesses) and parent business
earnings grows at a robust 12% CAGR over FY2011-13E.
Lack of clarity on Ssangyong makes it difficult to take a view at this juncture
Mahindra will acquire 70% stake in Ssangyong Motors and will pay $463 million ($378 million in
new stocks and $85 million in corporate bonds). The deal is expected to be concluded after the
approval of corporate rehabilitation plan by creditors by March 2011. However, lack of clarity on
financials and product development expense required in Ssangyong makes it difficult for us to
value the business at this juncture.
Reinitiate with target price of Rs875 and BUY rating
We reinitiate on Mahindra with a target price of Rs875 and BUY rating. Our SOTP price
target comprises – (1) standalone business value of Rs688 based on 14X PE on our FY2012E
EPS (less dividend incomes from subsidiaries) and (2) subsidiary value of Rs186 based on a
20% discount to the KIE target prices/current market value. We believe Mahindra is wellplaced in two stable businesses – utility vehicles and tractors and emerging as a strong
player in the fast-growing light commercial vehicle business. We expect Mahindra to report
a 12% earnings CAGR over FY2011-13E driven by (1) 15% volume CAGR and (2) 60 bps
decline in EBITDA margins due to raw material cost pressures. Mahindra trades at 11.8X PE
on our FY2012E EPS (ex-dividend income from subsidiaries) after excluding subsidiary value
offering a good entry opportunity, in our view.
New product launches to drive UV volume growth but market share loss likely
We expect utility vehicle domestic industry volumes to grow at 14% CAGR over FY2011-13E
driven by (1) robust business confidence which should drive strong growth of utility vehicles
for commercial use, (2) double-digit growth in personal incomes should keep demand fairly
buoyant among the salaried class, and (3) fairly robust growth in rural incomes should drive
growth of lower-end SUVs like Bolero.
Utility vehicle has grown at a slower pace than passenger cars due to increase in share of
MPV/vans in the overall passenger vehicle mix which we believe is due to (1) cheaper cost of
ownership of MPV/vans as compared to utility vehicles and (2) higher utility of vans as it is
also used for carrying goods in rural areas. Mahindra is not present in the MPV/vans
segment and Maruti has capitalized on the strong growth in this segment.
We believe Mahindra could lose 100 bps market share over the next two years due to
aggressive plans of Maruti to enter the utility vehicle space and estimate Mahindra UV
volumes to grow at 12% CAGR over FY2011-13E. Maruti plans to launch a compact SUV
and a new RIII utility vehicle in CY2011E. Mahindra also has plans to launch a variant of Xylo
and a new SUV in 2012E to maintain its market share, but we believe given Maruti’s
distribution network and rural knowhow it could take market share from existing players
(Toyota, Mahindra, Tata Motors and General Motors). We believe UV business EBITDA
margins are also expected to decline as competition heats up in this segment.
Tractor volume growth cycle is likely to be extended
We believe tractor volume growth cycle which generally lasts around 3 years is likely to get
extended driven by (1) increased use of tractors for commercial applications, (2) increase in
purchasing power of farmers driven by substantial increase in rural incomes over the past 5
years, and (3) likely scenario of strong growth in credit availability to the farmers. Over the
past 5-6 years, tractor growth has accelerated despite muted growth in foodgrain output
which we believe was due to significant increase in minimum support prices of crops. We
believe tractor volume growth will remain strong over the next two years driven by strong
growth in credit availability to tractors, increase in rabi crop output this year and increase in
farmer incomes driven by high food inflation.
We estimate tractor volume growth of 13% over FY2011-13E and expect market share of
Mahindra to remain stable at current levels. However, significant pick-up in Yuvraj sales
(low-cost tractor) could lead to gain in market share for Mahindra, in our view.
Aggressive plans for the LCV business should aid market share gains
Mahindra has gained 2.7% market share YTD FY2011 (till Nov) in the less-than-3.5 ton
goods LCV segment due to success of Maxximo and Gio models. The company plans to
launch 6-7 new variants both in passenger and goods segment to challenge Tata Motors’
dominance in this space. Tata Motors also plans to launch Ace Zip next year to focus on the
less-than-0.5 ton segment, but we believe Mahindra is likely to increase its market share in
the less-than-3.5 ton segment due to its much more aggressive model launches than its
competitors. We estimate Maxximo and Gio segment to grow at 20% yoy in FY2012E and
15% yoy in FY2013E.
Sedate growth in three-wheelers expected
After a strong growth period in FY2009-2011E (21% CAGR) in domestic three-wheeler
segment due to issue of fresh permits by state governments, we believe we could enter a
phase of moderate growth due to (1) high base effect and (2) increase in personal vehicle
ownership. Mahindra has increased its market share by 1.4% in FY2011YTD (till Nov) from
Piaggio. We forecast Mahindra’s three-wheeler sales to grow at 10% CAGR between
FY2011E and FY2013E.
Earnings to remain robust driven by strong volume growth and stable margins
We estimate Mahindra’s earnings to grow at 12% CAGR over FY2011-13E driven by strong
volume growth, improvement in product mix and slight decline in EBITDA margins. Higher
share of Maxximo, Gio and tractor sales in the overall product mix should help offset the
increase in commodity prices, in our view.
Mahindra two-wheeler business ramping up better than expectations
Mahindra’s two-wheeler business is growing at a rapid pace and sales are expected to more
than double from 71,640 units in FY2010 to 150,000 units in FY2011E. The company has
already taken an 8% market share in the scooter segment and has recently launched its
motorcycles. We expect the losses to reduce significantly from Rs970 mn in FY2010 and
believe business could break even in FY2012E. The company has a capacity of ~450,000
units and as the capacity utilization rates improve, we expect the profitability to improve too.
We are confident that Mahindra could be successful in the two-wheeler business due to its
strong brand value in the rural areas.
Stock could re-rate: Strong growth in earnings of parent business + decline in
losses in some subsidiaries should boost consolidated profits
Mahindra has always traded at a significant discount to its auto peers due to (1) multiple
business streams, (2) losses at some subsidiaries which dragged overall profitability of the
firm, (3) cyclicality of the tractor business. We believe stock could trade at higher multiples
going forward as losses at subsidiaries reduce (especially two-wheeler and Systech
businesses) and parent business earnings grows at a robust 12% CAGR over FY2011-13E.
In FY2010, Mahindra Renault, two-wheeler and Systech businesses were the main lossmaking subsidiaries which dragged the overall consolidated profits of the firm. However, all
these businesses are at a turnaround stage and we believe losses could reduce significantly
in these businesses over the next two years. The company plans to launch sub-4-metrelength Logan to get benefit of lower excise duty and improve sales of Logan while in the
Systech business the company has taken restructuring actions to reduce breakeven point in
the European businesses.
Ssangyong Motors: Lack of clarity makes it difficult to take a constructive view
Mahindra will acquire 70% stake in Ssangyong Motors and will pay $463 million ($378
million in new stocks and $85 million in corporate bonds). The deal is expected to be
concluded after the approval of corporate rehabilitation plan by creditors by March 2011.
Mahindra has signed a tripartite agreement with labour union and Ssangyong Motors which
contains agreement for employment protection, long-term investment and no labour
dispute. We have not valued Ssangyong separately due to (1) lack of clarity on product
development expense required over the next few years, (2) export strategy of the company,
(3) nature of labour agreement which the company has signed, and (3) lack of clarity on
financials. Hence, we have also not included the investment made by Mahindra into
Ssangyong as part of our valuation methodology.
Ssangyong Motors filed bankruptcy in February 2009 which led to a significant fall in sales in
CY2009. The company has started improving its volumes quite significantly driven by new
export orders and slight improvement in domestic market share. Till Nov 2010, the company
had sold 85,262 vehicles and is likely to end CY2010E with a 49% yoy growth in volumes.
Gross profit margins have also improved over the past few quarters.
Mahindra gains from wide global distribution network (more than 1,200 dealers) and access
of Euro 5 engine technology which Ssangyong possesses. Mahindra may also launch
Ssangyong products in India but it may take some time given the time taken to localize the
parts. Initially, Ssangyong SUVs could be brought as completely built units in India to testmarket the product.
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