Mahindra and Mahindra (M&M) is a diversified conglomerate with primary interest in auto manufacturing (utility vehicles and tractors). Its other businesses include IT services, financial services and hospitality.
Although the UV and tractor markets are going through a slow phase, M&M’s strong franchise, as indicated by market-share gains in both these segments, will help it to benefit when the tide turns.
With interest rate cuts and higher liquidity, the turnaround in these industries is a matter of “when” rather than “if”, since underlying demand drivers are in place.
M&M offers significant margin expansion potential due to falling commodities. At 6.5x FY10 core auto business EPS and 1.2x P/B with FY10 ROE of 19.2%, we believe the stock is a strong value proposition.
We believe M&M is relatively better placed than peers to brave the current slowdown due to its significant exposure to rural and semi-urban demand.
Nearly 75% of M&M vehicles are sold in rural/semi-urban areas, which are relatively immune to an economic slowdown. With tractors accounting for 40% of revenue, M&M will be a beneficiary of rural demand on the back of a good monsoon season and higher minimum support price.
With steel price (steel makes up nearly 25% of revenue) correcting 50% from its peak, we estimate a 90/60bp improvement in EBIT margins in FY10/FY11. We believe FY10 will largely be a margin expansion story with volume recovery starting in the second half of the year.
We expect near-term weakness due to softness in industry fundamentals, which should be viewed as opportunity to BUY the stock for its long-term earnings growth potential.
Our target price of Rs393 is based on Rs257 for the core auto business (at 9.0x FY10 EPS) and subsidiary valuation of Rs136.