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Mahindra & Mahindra Limited
True Son of the Soil!
Investment rationale
Core businesses couldn’t be stronger
M&M's two "bread and butter" segments - UVs (45% of volumes) and tractors
(37% of volumes) - are relatively less competitive, which gives it a strong
pricing power. In UVs, it has consistently gained market share (currently at
52%) led by its strong brand image and unmatched grip in tier 2 & 3 cities.
Furthermore, the tractor industry is in a sweet spot due to enhanced focus on
farm credit, higher MSP prices, increasing commercial usage of tractors and
most importantly higher labor wages (attributable to NREGA). M&M is clearly
the biggest beneficiary from the same given its 42% market share in tractors.
Mahindra ~ Ssangyong - A match made in heaven
The Mahindra ~ Ssangyong alliance has multiple synergies for both parties.
While Ssangyong benefits from access to the lucrative Indian markets,
Mahindra will benefit from access to Ssangyong's superior technology, namely
Euro V & VI compliant products and engines with power up to 175hp.
Furthermore, Ssangyong's huge dealership base in markets relatively untapped
by M&M (Europe, South America, Middle East, Africa), will help the company
realise its aspirations of becoming a truly global SUV player. In our view, this
is the strongest synergy of the alliance.
Force to reckon within the CV space
M&M has now become a strong force to reckon within CVs driven by bright
prospects and savvy product placement of its two products ~ 'Gio' &
'Maxximo'. It is poised to garner a commendable 15% market share in the
INR40bn mini-truck segment within just 12-14 months of its launch. This also
gives us confidence in M&M’s foray into larger commercial vehicles.
Valuation and outlook
At the CMP of INR750, after adjusting for the current value of M&M's key
listed subsidiaries, its core auto business is available at a P/E of 10.6x,
discounting our FY12e EPS. This, in our view, is a steep and unjustified
discount to its peers given the company's strong business model. We reiterate
a BUY with an SOTP-based target price of INR932 (24% upside from current
levels)
Investment rationale
Core businesses could not be stronger
UV dominance to continue
Mahindra & Mahindra (M&M) is the largest UV and tractor player in the country with
a market share of 52% and 42%, respectively. It has been continuously gaining market
share in both these segments driven by its strong brand image (result of a very strong
parentage), widespread distribution networks and unmatched grip in the rural markets.
Margins are likely to remain firm as the company's pricing power remains intact (a
function of a benign competitive scenario). As a result, its invincible position looks
secure for a long time, which is a major contrast from the leaders of other segments
(cars, motorcycles and CVs).
Tractor Industry on a strong footing
On the back of the government's strong focus on the agriculture sector coupled with
improving farm mechanisation and a good monsoon, the tractor industry is in for a
good run. Our outlook on the tractor division too is extremely positive given the
structural shift in the tractor industry. The tractor industry has grown by 14% from
FY03-FY10, led by increase in disposable incomes on the back of rising MSPs over
the past few years, coupled with an enhanced focus on increasing farm credit. Farm
mechanization is on the rise attributable to a low availability of labour and sharp
increase in labour costs ~ a function of various policy measures including the increase
in allocation for NREGA (National Rural Employment Guarantee Act), which has
made rural labor scarce and expensive.
With buoyancy in construction activities, work has been aplenty and labour costs have
risen significantly. This has diverted rural labour (mainly unskilled) from agriculture related
activities to more rewarding and secure NREGA led construction/infrastructure based
activities. This is solely responsible for a high proportion of farm mechanization, which
has led to the recent buoyancy in tractor demand.
Besides NREGA, the increase in agricultural credit, coupled with the farm loan waiver
and increasing commercial usage of a tractor has also been strong contributing factors
to this growth in the Indian tractor Industry. With a large proportion of the rural population
still dependent on core farming activities, we expect the thrust on rural development,
agriculture and infrastructure to continue - all of which bodes very well for sustainable
tractor growth over a longer term.
M&M is the undisputed leader in the domestic tractor industry. Post the PTL (Punjab
Tractors Ltd.) merger, its market share stands at 42% (30% pre-merger). PTL and M&M
now share distribution and service networks, the synergies from which have resulted in
tractor profitability being miles ahead of competition. The company now plans to increase
focus on the marginal farmers (<2.5 acres) and smaller farmers (2.5 - 5 acres), where
penetration is relatively much lower (at just about a percentage) as these farmers normally
use bullocks for farming.
For the same, it has recently launched the 15hp tractor at an affordable price - Mahindra
Yuvraj (priced at around INR162,000), the usage of which is estimated to entail cost
saving of INR20,000 p.a. - compared to the cost of owning a pair of bullocks.
Comparatively lower tractor penetration and consequently lower levels of farm productivity
in these farm households, provides headroom for tractor growth.
Mahindra ~ Ssangyong - A match made in heaven
Multiple Synergies
The Mahindra ~ Ssangyong alliance has multiple synergies for both parties. As both
cater to different segments within UVs, there is no product overlap - in fact it is more of a
continuum. Ssangyong with its superior product line comprising Rexton, New Kyron
Korando C and Actyon caters to the middle to upper UV segment which complements
M&M's current product portfolio very well as it caters to lower to middle UV segment.
Furthermore, possibility of sharing components/vendors in the future provides headroom
for cost savings for both parties going ahead.
M&M would also get a huge technological leap as Ssangyong's products are far superior
and about 2 life cycles ahead of M&M’s (Euro V and soon to be Euro VI compliant in
comparison to M&M's Euro IV). Ssangyong also has engines which go up to 175hp,
whereas M&M's engines capacity stretches only up to 140hp. M&M can leverage on
Ssangyong's superior technology to improve its own domestic portfolio. It also plans to
assemble some of the popular Ssangyong’s SUV brands in India, which will further
strengthen its leadership position in the domestic UV market. Ssangyong on the other
hand benefits from access to the lucrative Indian automobile market.
M&M also stands to gain from Ssangyong's strong dealer base which gives it direct
access to relatively untapped markets like Europe, Russia, South America, Middle East,
Africa and Asia through Ssangyong's 1,300 dealers across 90 countries. This in our
view is the strongest synergy of the alliance as it will help M&M realise its dream of
becoming a truly global SUV player.
No financial strain - Icing on the cake
The fact that the acquisition does not strain M&M's balance sheet is an icing on the cake.
The deal size of USD464m for a 70% stake would be met easily through a combination
of debt and internal accruals (cash reserves of INR25bn and FCF of INR5bn per quarter).
Even assuming the deal is fully funded by debt, gearing levels would remain comfortable,
increasing from 0.22x to 0.44x.
Furthermore, Ssangyong is debt free and going ahead, barring basic working capital, we
do not expect M&M to pump in additional funds into Ssangyong to augment capacity
since its current capacity of 120,000 units (with engine capacity of 150,000 units) is being
utilised by only 70% (considering the current run-rate of 85,000 units pa).
Ssangyong has been prone to labour disputes resulting in production disruptions in the
past. Post the deal they have been co-operative with M&M as it is their best chance to
restore the past glory of the company and secure their own jobs. The labour unions of
both companies have signed a Tripartite Agreement containing provisions for employment
protection, long-term investment and commitment towards no labor dispute.
Force to reckon within CVs
M&M is soon becoming a force to reckon within the LCV space (especially in the sub
one tonne category), kick-started by the savvy product placement of 'Gio' and 'Maxximo'.
The mini-truck market is estimated at around 200,000 units, growing by 20% pa (as
against 15% for the CV industry). It is a booming category in India, driven by growing
popularity of hub-and-spoke distribution model and rising importance of small
transporters' role in the road freight process.
The trend of these mini-trucks was popularised by the Tata Ace, which single-handedly
shrunk the 3W goods carrier industry. Currently, with clocking volumes of approximately
15,000 units per month, it has a 90% market share in this mini-truck segment. M&M
is now giving Tata Motors a run for their money in this segment, with the recently
launched, powerful and economical - Maxximo.
The company is expected to garner sales of 30,000 units for the Maxximo in FY11e,
which would give it a market share of over 15% in INR40bn mini-truck segment, within
just 12-14 months of its launch. A passenger variant of the same is also in the pipeline.
Another savvy product by M&M in the mini-truck segment is the ‘Gio’, which targets
the three-wheeler goods carrier. Gio has an RTO passed payload capacity of 500kgs
(which could be loaded up to 800kgs), as against 300kgs for a three-wheeler. However,
the USP of Gio lies in its extremely competitive pricing and smart product placement.
Before the Gio, there was a huge price gap between a three-wheeler goods carrier
(priced at around INR160-170,000) and the next four-wheeler (at INR345,000).
Currently priced at INR206,179 (on-road Mumbai), Gio is now the cheapest upgrade
from a three-wheeler goods carrier to a four-wheeler, a position once enjoyed by the
Tata Ace (at almost INR140,000 more expensive). While Gio is the first product in
0.5-tonne segment, it will not be for long as Tata Motors plans to launch the Penguin
in the same segment. Even Bajaj Auto and Piaggio are reported to launch their products
in this segment. The 0.5-tonne segment has now caught the fancy of all players,
however, M&M spotted this trend much earlier, and thereby, it would enjoy the firstmover
advantage.
Mahindra enjoys a parentage, probably as strong as the Tata's and given the already
well-established brand name and strong sales and distribution services, all it needs is
the right product. We believe that with the Maxximo and Gio, M&M has two potential
winners on its hands and the company has got it spot on as far as the product
placement is concerned. This further reinstates our positive view on M&M as it becomes
a force to reckon within the CV space and also gives us confidence in its foray into the
MHCV space - launch of 25, 31, 40 and 49-tonne trucks in FY11e; and further, 9, 11
& 16-tonne trucks and 16-tonne buses in FY12e and FY13e, respectively.
Valuation and outlook
At the CMP of INR750, after adjusting for the current value of M&M's key listed
subsidiaries, its core auto business is available at a P/E of 10.6x our FY12e EPS,
which is a steep and unjustified discount to its peers given the company's strong
business model.
We reiterate a BUY on the stock with an SOTP-based target price of INR932, which
provides a 24% upside from the current levels.
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