Auto maker Mahindra and Mahindra Ltd’s (M&M) reported net profit of Rs413.7 crore was nearly 20% short of consensus estimates. Not surprisingly, the company’s shares fell by 5.2% on the Bombay Stock Exchange. But the market has itself to blame for overtly aggressive estimates. M&M had beaten estimates by a decent margin in the September quarter, but that was primarily because of higher-than-expected other income.

There were signs that margins in the September quarter were not sustainable, and it was presumptuous of analysts to expect only a marginal decline in the December quarter. According to Bloomberg’s compilation of earnings estimates, analysts were expecting an operating margin of 16.28% for the December quarter, compared with 16.54% in the September one.

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Instead, the company reported a margin of 14.54%, or a drop of 200 basis points compared with the September quarter. The fall in profitability isn’t entirely surprising since commodity prices have been rising. Raw material costs rose by 170 basis points as a percentage of sales compared with the September quarter. One basis point is one-hundredth of a percentage point.

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According to Pawan Goenka, president (automotive sector) at M&M, the company has increased prices of vehicles by 1-2% between December and January, which is half of the increase in material cost.

Thanks to the aggressive expectations, the M&M stock has outperformed its peers by a considerable margin in the past year. Since January 2009, it has risen by 279%, much higher than the 187% rise in the BSE Auto Index.

Of course, some of this also has to do with the rerating of subsidiary company Tech Mahindra Ltd. But the outlook on the auto business has also been good, especially based on the view that the company faces relatively less competition in both the tractor segment as well as the utility vehicles space.

While much of this is true, the overtly aggressive earnings estimates meant that room for disappointment was rather high. The outlook for the business continues to be strong on the volumes front. But based on the performance last quarter, margins are likely to be under pressure owing to rising commodity costs.

Graphics by Yogesh Kumar/Mint

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