Mahindra and Mahindra Ltd Time to get on board… With 3 healthy back-to-back cropping seasons and good monsoon, which has Vishal Srivastav Research Analyst resulted in strong rural sentiment, we reiterate our stance that the tractor [email protected] upcycle may last for a couple of years. Being the market leader in the tractor segment, Mahindra & Mahindra (M&M) the key beneficiary of this surge. The re-rating catalyst will be new management’s ability towards achieving key milestones it has laid down viz. 1) Gradual improvement in the financial health from FY22; and 2) Boost cash flow and Return on Equity (RoE). Hence stock is a CMP: INR 614 Tactical BUY with a target price of INR 758 per share, based on SoTP valuation. Rating: Tactical BUY FES business to benefit from a revival in rural India Target price: INR 758 Our report, titled: ‘Automobile Industry - Coronavirus deals a decade blow’, lays Upside: 23% our case of the rural economy leading the economic revival. We continued to maintain our positive stance on the tractor industry is poised for multi-year upcycle (refer our report on Escorts dated July 6, titled: ‘Escorts – Journey from turnaround to excellence’). Back-to-back bountiful harvest seasons, increased government procurement, healthy monsoon are the key drivers. With over 45% market share, M&M is best placed to reap benefits of this surge. Bloomberg: MM:IN Automotive business to gradually recover from H2FY21 The light commercial vehicle (LCV) segment will drive growth for the automotive 52-week range (INR): 245/667 business in the short term. Being market leader, M&M will significantly benefit Share in issue (crore): 119 from the gradual revival in LCV demand. Course correction by the management in the utility vehicle (UV) segment off late and renewed focus towards strengthening M-cap (INR crore): 74,853 its strong hold in the conventional mid-size SUV segment through new launches Promoter holding (%) 19.58 may help it arrest the sharp market share loss. Focus on improving RoE across businesses – A key re-rating driver The new management’s focus on improving cash flows and RoE across all businesses and subsidiaries is encouraging. Willingness to exit business that do not fall in its strategic growth path or those unable to achieve 18% RoE is a clear change of stance. Turning around loss-making subsidiaries and scaling up its market share in the UV business will result in a significant valuation re-rating. Outlook and valuation We see a valuation re-rating catalyst will be new management’s ability towards achieving key milestones viz. 1) healthy revival in the standalone operations driven by FES business; 2) focus on gradually improving the financial health of subsidiaries from FY22; and 3) emphasis on improving cash flow and RoE across all businesses. The stock is a Tactical BUY with a target price of INR 758 per share. Year to March FY18 FY19 FY20 FY21E FY22E Revenue (INR crore) 47,577 52,848 44,865 40,773 47,332 Revenue growth (%) 13.5 11.0 -15.0 -9.0 16.0 EBITDA (INR crore) 7,043 7,530 6,350 5,178 6,484 Adjusted PAT (INR crore) 4,320 5,418 3,889 3,025 4,031 P/E (x) 16.4 13.1 18.2 23.4 17.6 25.8 40.9 23.3 Price-to-book value (x) 2.3 2.0 2.0 1.9 1.7 EV-to-EBITDA (x) 9.7 9.0 10.9 13.0 10.0 RoACE (%) 19.9 20.0 14.6 10.6 13.1 Date: 6th November, 2020 RoAE (%) 15.1 16.5 11.1 8.4 10.3 Edelweiss Professional Investor Research 1 Mahindra and Mahindra Investment hypothesis I. Rural India – The bright spot and key to economic growth In our April 28 research note, titled: ‘Automobile Industry - Coronavirus deals a decade blow’, we presented our case of the rural economy leading the economic revival. Back-to-back bountiful harvest seasons, increased government procurement, healthy water storage levels and expectations of a normal monsoon were the key drivers buttressing our expectation. Six months from the release of our report, we see strong rural demand momentum. Despite increasing COVID-19, infections off late, sentiment remains buoyant, influenced by high income visibility, because of record kharif sowing this season and plentiful monsoon. Strong revival in tractor sales, 40% YoY growth since June, after easing in lockdown restrictions is evidence of healthy rural sentiment. We continue to maintain our positive stance on the tractor industry. In our initiation coverage on Escorts Ltd on July 6, titled: ‘Escorts – Journey from turnaround to excellence’, we estimated tractor demand to clock 2-4% growth and industry is poised for a next upcycle that would be for couple of years. We continue to maintain our view on the tractor cycle, however our channel checks indicates buoyancy in rural sentiments may push domestic tractor sales growth towards double digit levels for FY21. Exhibit 1: Tractor industry to clock double digit growth in FY21 significantly surpassing our earlier expectation 20% 42% 18% 12% 12% 12% 23% 25% 7% 7% 12% 13% 5% 6% -6% 4% -10% -12% -14% -14% FY20 FY21E FY22E FY23E -5% -10% Q4FY20 Q1FY20 Q2FY20 Q3FY20 Q1FY21 Q2FY21E Q3FY21E Q4FY21E Pessimistic Optimistic Realistic Pessimistic Optimistic Realistic Source: TMA, Industry and Edelweiss Professional Investor Research M&M: FES business will continue to provide strong support during challenging times Business-wise With over 45% market share in the tractor industry, Mahindra & Mahindra (M&M) will be one on the share in revenue major beneficiaries of the surge in tractor demand. Its farm equipment business (FES) contributes and profits around one-third of standalone topline and over two-third to Profit Before Interest and Tax (PBIT). 34% Exhibit 2: FES contributes one-third to topline and more than two-third to profits 69% 71% 62% 69% 30% 59% 61% 52% Revenue PBIT share 49% share 34% 31% 31% 32% 31% 34% Automotive FES Others FY15 FY16 FY17 FY18 FY19 FY20 Topline share PBT share Source: Company reports and Edelweiss Professional Investor Research Edelweiss Professional Investor Research 2 Mahindra and Mahindra Investment hypothesis Despite increase in competition intensity in the last 6-7 years, the management has been able to maintain its market share of ~40-42% on the back of frequent model launches. The company plans to launch a new light weight tractor platform ‘K2’ in collaboration with Mitsubishi, which will help it strengthen its domestic market share going forward and also scale up exports. Exhibit 3: FES business to reap significant benefits from the surge in tractor demand 22,000 20% 16% 15% 20,000 11% 15% 18,000 10% 5% 16,000 5% 14,000 19,753 0% 17,104 16,562 15,762 12,000 15,402 -5% -7% 10,000 -10% FY18 FY19 FY20 FY21E FY22E FES revenues (INR cr) Growth (RHS) Source: Edelweiss Professional Investor Research UV segment: Last decade’s concerns still persist Dropping market share in the utility-vehicle (UV) segment has been a key concern for M&M’s automotive business. Although it has been at the forefront of new launches and has introduced models in high growing lower engine capacity UV market, it has not been able to rein in the market share slide. The company has been unable to lure customers as newer entrants like Maruti Suzuki, Hyundai Motor Co. and Kia Motors Corp. continued to eat into its market share. Exhibit 4: M&M’s market share dropped by over 50% in the last decade… 11% 10% 13% 20% 18% 19% 15% 15% 27% 13% 13% 8% 31% 6% 3% 2% 6% 8% 12% 7% 17% 5% 12% 11% 11% 21% 19% 4% 13% 14% 15% 11% 12% 13% 28% 48% 29% 25% 25% 42% 38% 19% 54% 56% 37% 26% 28% 28% 25% 14% 12% 12% 16% 2% 2% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Maruti Suzuki M&M Hyundai+Kia Toyota Kirloskar Tata Motors Others Source: Edelweiss Professional Investor Research Edelweiss Professional Investor Research 3 Mahindra and Mahindra Investment hypothesis Exhibit 5: … as it couldn’t make significant inroads in the rapidly growing small SUV market despite a slew of model launches Segment FY11 FY12 FY15 FY16 FY17 FY18 FY19 FY20 Large SUV Scorpio Large SUV Bolero Large SUV Xylo Small SUV Quanto Large SUV XUV500 Small SUV KUV100 Small SUV NovoSport Small SUV TUV300 Large SUV Thar Large SUV Alturas Large SUV Marazzo Small SUV XUV300 Source: Edelweiss Professional Investor Research Exhibit 6: Market share loss in smaller SUVs was even Exhibit 7: …as the sub-segment saw significant growth in sharper… overall UV market in the last decade 77% 74% 22% 29% 29% 33% 37% 42% 45% 51% 66% 68% 45% 36% 32% 78% 71% 30% 71% 67% 63% 25% 58% 55% 21% 49% 17% 34% 14% 32% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Large SUV % in overall UV market Small SUV % in overall UV market Source: SIAM and Edelweiss Professional Investor Research FY21 will continue to remain a challenging year for M&M… A stronger revival in this segment is encouraging for M&M’s UV business. However, a sharp increase in competition from other leading players like Maruti and Hyundai through their new launches of Vitara Brezza, S-Cross, Creta, and Venue, coupled with successful launches of Seltos and Sonet from new entrant Kia, will only make the job tougher for M&M. Although M&M has the XUV300, which is a popular model, the company dearly requires the success of recently launched Thar (upgrade), near term expected launches of W601 (i.e.