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Mahindra & Mahindra (MM) remains our top pick in the Indian auto sector. The
company has a strong brand and distribution network in rural India and faces low
competition. It is also well positioned to benefit from various government policies on
rural growth and development. The standalone auto business trades at 11.7x
FY12F EPS, at a 22% discount to Indian OEMs. Given the 43% volume growth in
tractors in November 2010, we will review our tractor growth estimates and price
target. We reaffirm our BUY rating.
Catalysts
Improved UV volumes led by de-bottlenecking, sustained tractor growth and
successful new launches could be key catalysts.
Anchor themes
Nomura’s economics team estimates 4.8% agricultural GDP growth for 2011F, vs
0.2% in 2010F. Strong agricultural GDP growth should drive rural incomes.
Leveraging rural growth
Key beneficiary of rural development
Rural India has been on the development agenda of India’s
government for the past few years. The rural development budget has
doubled from Rs288bn in FY08 to Rs661bn in FY11F. In addition,
minimum support prices for crops have consistently been increased,
leading to strong income growth for farmers. We believe MM is likely
to benefit from improved rural incomes, as it derives nearly 80% of its
revenue from rural India.
Volume growth likely to improve
MM’s volume growth in the utility vehicles (UV) segment had lagged
the industry, as the company was facing production constraints. We
estimate volume growth will pick up in 2H FY11F as component
supply issues are resolved.
Several new launches in pipeline
Over the next 18 months, MM will be launching several variants of the
Xylo and Maaximo, a new SUV, a new pick-up truck in the US,
refreshed Bolero and Scorpio models, and an entire range of heavy
trucks. We, therefore, believe that the company has the potential to
surprise on volume growth.
The stock remains undervalued relative to the sector
MM’s standalone auto business trades at 11.7x FY12F EPS, below
the sector average of 15x. We think the discount reflects: 1) market
uncertainty over tractor growth, given historical cyclicality, although
we think as growth comes through, valuations could improve; and
2) weakness in MM’s recent UV volumes, growing by only 10% due to
production constraints. As the company tides over these constraints,
volume growth should improve, in our view. We value MM at Rs892.
We value the standalone business at 13x one-year forward rolling
EPS of Rs51.2 and investments at Rs226/share.
Valuation methodology
We value MM at Rs892, based on a sum-of-the-parts methodology. We value the
standalone auto business at 13x average standalone EPS for FY12F and FY13F (ex
subsidiary dividends) - Rs51.2 at Rs665.8/share. We value investments at
Rs226/share after a 20% holding discount. We note that the stock still trades at a 22%
discount to our coverage universe and that there is scope for multiples to re-rate, if
tractor growth is higher than our estimate of 14% for FY11F. The SAAR for December
2010 implies 20% growth for tractors in FY11F.
Key risks
Acquisition of Ssangyong Motors: MM is planning to acquire Ssangyong Motors,
Korea (announced in August 2010) - the fact that it is not a free cash flow positive
company will pose a risk to MM’s cash flows.
Below-normal rainfall in 2011: We have assumed a scenario of normal rainfall in
2011. However, if the rainfall is significantly below normal, it could have a material
impact on our volume estimates.
Excise duty increases: We have assumed that the excise duty will not be increased
from the current 10%. However, if the duty is raised further, it could have a materially
negative impact on our margin estimates, as the company may not be able to pass
through the increases in excise duty on tractor components.
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