India Equity Research Automobiles January 28, 2021 MAHINDRA & MAHINDRA COMPANY UPDATE KEY DATA About (mis)perceptions and misfires Rating BUY Sector relative Outperformer Price (INR) 765 12 month price target (INR) 1,009 A few misfirings (ROIC drags) led to Mahindra & Mahindra (M&M) Market cap (INR bn/USD bn) 951/13.0 trading at steep discount to Maruti Suzuki (MSIL) post FY16 (at par till Free float/Foreign ownership (%) 81.1/33.4 What’s Changed then). As these get rectified, we expect the gap to bridge with Target Price Rating/Risk Rating ⚊ recognition that: 1) tractors and LCVs not only outgrow PVs, but also demand cyclicality for tractors is similar to PVs; 2) M&M’s tractor and INVESTMENT METRICS LCV franchise is as good as MSIL in PVs; and 3) ROIC drags–UVs and 275 unlisted subsidiaries–get a huge negative value (36% of our TP). 205 135 As these ROIC drags get addressed, we expect re-rating. Factoring that 65 -5 and EPS upgrade, we revise our TP to INR1,009 (earlier INR721). Sales Growth EPS Growth RoE PE (%) (%) (%) (x) Maintain ‘BUY’. Also, the ROIC drags can be value creators, given the Automobiles MM IN Equity huge negative value ascribed to them, once the restructuring is over. FINANCIALS (INR mn) Year to March FY20A FY21E FY22E FY23E Revenue 4,48,655 4,48,164 5,53,278 6,06,007 Business concerns: Some genuine, but plenty of misperceptions EBITDA 63,506 69,465 78,012 86,659 A few misperceptions are primary culprits for the steep valuation discount between Adjusted profit 43,534 42,245 49,227 55,684 Diluted EPS (INR) 36.5 35.5 41.3 46.7 M&M and MSIL. 1) MSIL’s franchise is superior: Market share mapping indicates EPS growth (%) (19.7) (3.0) 16.5 13.1 M&M’s tractor and LCV franchise is at par with MSIL; UVs is a weak link, but its RoAE (%) 10.2 11.6 12.2 12.3 minuscule contribution to profits does not warrant such sharp discount. 2) PV P/E (x) 20.9 21.6 18.5 16.4 outpacing tractors; less cyclical: In reality, not only tractors but also LCVs have EV/EBITDA (x) 14.8 13.0 11.0 9.4 outgrown PVs. Importantly, cyclicality in tractor demand is similar to PVs as demand Dividend yield (%) 0.5 0.5 0.6 0.6 is linked to reservoir levels, agri GDP and infra activities, not just monsoon. 3) UVs struggling: The worst is behind with BSVI transition. Also, M&M has shifted focus from market share to launches where it can command a premium. PRICE PERFORMANCE Does conglomerate warrant lower valuation? 850 50,000 730 45,000 M&M was trading at similar valuations as MSIL till FY16 and it was a conglomerate 610 40,000 even then. However, post FY16, efficacy of investments turned adverse, reflected in 490 35,000 mounting subsidiary losses and capex in UVs not yielding desired results. This led to 370 30,000 250 25,000 ROIC plunge--primary reason for the sharp de-rating. Renewed unwavering focus on Jan-20 Apr-20 Jul-20 Oct-20 returns from new and existing investments (18% RoE hurdle rate) will help M&M MM IN Equity Sensex bridge the valuation gap. We expect a delta swing of INR29/share in consolidated EPS alone from decisions already executed on this front. Explore: Outlook and valuations: In a sweet spot: maintain ‘BUY’ M&M is in a sweet spot as its key franchises tractors and LCVs are set for growth driven by high reservoir levels and cyclical recovery, respectively. Moreover, worst is behind for UVs with receding capital intensity over the next three years and end Financial model Podcast of sharp market share loss phase. Given the trend of preference for UVs and the company’s lineage, M&M can make a comeback – Tata Motors a case in point. Also, M&M is walking the talk with respect to its new capital allocation strategy. Hence, we raise our FY22 and FY23 core EPS by 19% and 15% respectively. We raise Corporate access Video our SOTP-based TP to INR1,009 (earlier INR721), ascribe 20x PER (earlier 16x) to June 2022E core EPS of INR33, maintain 30% holdco discount for its listed subsidiaries and cash per share of INR111. Our target PER implies a negative value to its UV business and unlisted subsidiaries (36% of our TP). We maintain ‘BUY/SO’. Chirag Shah Jay Mehta +91 (22) 6623 3367 +91 (22) 4088 6072 [email protected] [email protected] m Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited MAHINDRA & MAHINDRA Financial Statements Income Statement (INR mn) Balance Sheet (INR mn) Year to March FY20A FY21E FY22E FY23E Year to March FY20A FY21E FY22E FY23E Total operating income 4,48,655 4,48,164 5,53,278 6,06,007 Share capital 5,965 5,965 5,965 5,965 Gross profit 1,49,988 1,46,102 1,74,282 1,90,892 Reserves 3,40,326 3,77,038 4,20,455 4,70,039 Employee costs 32,237 31,820 37,070 40,602 Shareholders funds 3,46,291 3,83,003 4,26,420 4,76,004 Other expenses 54,245 44,816 59,201 63,631 Minority interest 0 0 0 0 EBITDA 63,506 69,465 78,012 86,659 Borrowings 31,530 31,530 31,530 31,530 Depreciation 23,631 23,457 24,197 25,662 Trade payables 72,006 83,494 1,03,076 1,12,900 Less: Interest expense 1,245 3,500 3,000 3,000 Other liabs & prov 51,305 52,784 61,630 66,067 Add: Other income 15,391 13,445 14,385 15,756 Total liabilities 5,18,179 5,68,710 6,41,450 7,06,235 Profit before tax 54,021 55,954 65,201 73,753 Net block 1,69,093 1,60,637 1,66,440 1,70,778 Prov for tax 18,513 13,709 15,974 18,070 Intangible assets 0 0 0 0 Less: Other adj (28,112) 0 0 0 Capital WIP 0 0 0 0 Reported profit 35,509 42,245 49,227 55,684 Total fixed assets 1,69,093 1,60,637 1,66,440 1,70,778 Less: Excp.item (net) (8,026) 0 0 0 Non current inv 1,53,433 1,68,433 1,76,433 1,84,433 Adjusted profit 43,534 42,245 49,227 55,684 Cash/cash equivalent 45,132 81,302 1,21,609 1,64,586 Diluted shares o/s 1,192 1,192 1,192 1,192 Sundry debtors 29,012 33,529 41,393 45,338 Adjusted diluted EPS 36.5 35.5 41.3 46.7 Loans & advances 6,511 6,055 6,313 6,469 DPS (INR) 3.8 4.0 4.2 4.5 Other assets 79,069 82,825 93,333 98,702 Tax rate (%) 34.3 24.5 24.5 24.5 Total assets 5,18,179 5,68,710 6,41,450 7,06,235 Important Ratios (%) Free Cash Flow (INR mn) Year to March FY20A FY21E FY22E FY23E Year to March FY20A FY21E FY22E FY23E Gross profit margin (%) 33.4 32.6 31.5 31.5 Reported profit 35,509 42,245 49,227 55,684 Staff cost % sales 7.2 7.1 6.7 6.7 Add: Depreciation 23,631 23,457 24,197 25,662 Other expenses % sales 12.1 10.0 10.7 10.5 Interest (net of tax) 355 2,643 2,265 2,265 EBITDA margin (%) 14.2 15.5 14.1 14.3 Others (5,287) (12,587) (13,650) (15,021) Net profit margin (%) 9.7 9.4 8.9 9.2 Less: Changes in WC (14,749) 6,001 10,694 5,731 Revenue growth (% YoY) (15.1) (0.1) 23.5 9.5 Operating cash flow 39,458 61,758 72,732 74,321 EBITDA growth (% YoY) (15.7) 9.4 12.3 11.1 Less: Capex (47,755) (15,000) (30,000) (30,000) Adj. profit growth (%) (19.7) (3.0) 16.5 13.1 Free cash flow (8,297) 46,758 42,732 44,321 Assumptions (%) Key Ratios Year to March FY20A FY21E FY22E FY23E Year to March FY20A FY21E FY22E FY23E GDP (YoY %) 4.8 (6.0) 7.0 6.0 RoE (%) 10.2 11.6 12.2 12.3 Repo rate (%) 4.4 3.5 3.5 4.0 RoCE (%) 14.6 15.0 15.6 15.9 USD/INR (average) 70.7 75.0 73.0 72.0 Inventory days 54 51 47 50 Tractor - dom. vol. (% (7.0) 14.0 8.0 5.0 Receivable days 27 25 25 26 YoY) Payable days 107 94 90 95 UV - dom. vol. (% YoY) (12.0) 8.0 8.0 8.0 Working cap (% sales) 1.4 0.3 (1.6) (2.2) LCV - dom. vol. (% YoY) (25.0) (20.0) 15.0 15.0 Gross debt/equity (x) 0.1 0.1 0.1 0.1 M&M Total vol (nos) 7,77,953.0 7,21,174.3 8,99,495.9 9,80,836.8 Net debt/equity (x) 0 (0.1) (0.2) (0.3) % Growth (17.2) (7.3) 24.7 9.0 Interest coverage (x) 32.0 13.1 17.9 20.3 EBITDA/vehicle 81,631.7 96,322.7 86,728.7 88,352.1 Valuation Drivers Valuation Metrics Year to March FY20A FY21E FY22E FY23E Year to March FY20A FY21E FY22E FY23E EPS growth (%) (19.7) (3.0) 16.5 13.1 Diluted P/E (x) 20.9 21.6 18.5 16.4 RoE (%) 10.2 11.6 12.2 12.3 Price/BV (x) 2.6 2.4 2.1 1.9 EBITDA growth (%) (15.7) 9.4 12.3 11.1 EV/EBITDA (x) 14.8 13.0 11.0 9.4 Payout ratio (%) 12.9 11.4 10.3 9.5 Dividend yield (%) 0.5 0.5 0.6 0.6 Source: Company and Edelweiss estimates 2 Edelweiss Research is also available on www.edelweissresearch.com, Bloomberg - EDEL, Thomson Reuters, and Factset Edelweiss Securities Limited MAHINDRA & MAHINDRA M&M versus MSIL – Rising valuation gap Currently, M&M trades at a significant discount to MSIL.