Tractor headwinds may offset M&M's strong utility vehicle segment show

Upsides may be limited given the sharp rerating for the stock since March

The stock of automotive (auto) major Mahindra & Mahindra (M&M) was down over 2 per cent in trade on Friday after the billion-dollar global enterprise headquartered in Mumbai posted a muted performance in the April-June quarter (first quarter, or Q1) of 2022-23 (FY23).

While there are multiple positives, especially from an auto-segment perspective, it is offset by demand and margin concerns in the farm equipment/tractor business. This could keep the stock, which has gained 79 per cent from the lows in March, under pressure in the near term.

Although the company reported its highest quarterly revenue for the two segments, revenues, which were up 67 per cent over the year-ago quarter at Rs 19,613 crore, were lower than Street estimates. A major chunk of growth was driven by overall volumes rising 47 per cent, with price hikes accounting for the rest of the sales increase.

Aided by strong demand and bookings for its utility vehicle (UV) portfolio and a low base in the year-ago quarter, overall volume growth was led by a 77 per cent uptick in the auto segment.

While bookings for the XUV300, the XUV700, the Thar, and the Scorpio crossed the 140,000-mark, demand has been strong for the XUV700 model, which accounted for half of overall bookings. The new launch (ScorpioN), too, has seen a surge in bookings.

While the UV portfolio’s rural sales will get impacted, given slowdown concerns, the demand shift to urban, especially for the ScorpioN, is a positive for the company. Earlier more than half of all Scorpio sales were in the rural segment, which is now under a quarter of sales for the product.

UV volumes have been on an uptrend for the past five quarters, with a quarterly run rate of 75,000 units and the market share steady at 16.3 per cent in Q1.

Sales in July, too, have been strong at 33 per cent on the back of good customer response to new launches and a healthy order book.

The company has lined up 13 new products in the sport utility vehicle (SUV) segment, with eight new electric vehicles by 2027 accounting for a fifth of its volume. While current bookings should reflect on sales in the months to come, the volume run rate needs to be tracked, given that the company does not have a large assembly of new internal combustion engine-based SUVs lined up over the next one year, except for a refresh of the Scorpio Classic and pick-ups.

A positive outcome of rising volumes in the auto business is an improvement in segment margins. Auto segment margins saw a 402-basis point (bp) increase to 5.7 per cent in Q1. Margins in the segment have been stuck in the mid-single-digit range for a while now; the last time it came close to the double-digit mark was over four years ago.

There are few triggers that could change this, say Mitul Shah and Sheryl Fernandes of Reliance Securities. “We believe that a better product mix, with the success of the XUV700 and strong bookings of the new Scorpio, easing production constraints, regular price hikes, and likely commodity softening ahead will support M&M’s margin expansion,” they say.

While the auto segment is firing on all cylinders, there is uncertainty on demand outlook in the tractor segment. Tractor volumes were up 19 per cent year-on-year in Q1. Margins for the segment fell 428 basis points to 16 per cent due to raw material cost inflation and an adverse model mix.

There has been a reversal in demand over the past few months, points out IIFL Research. After growing 41-47 per cent in April and May due to a low base and higher cashflow, volumes have declined in June and July on a normalised base by about 15 per cent.

The ban on wheat exports and the late arrival of the monsoon and uneven rainfall distribution pattern have weighed on sentiment. In addition, farmer cashflow, lower government spending on agriculture and the rural segment are other factors that may derail growth.

Brokerages expect August volumes to be muted before recovering on the back of demand in the festival season. Most tractor companies expect FY23 growth to be in the low- to mid-single digit band.

Axis Securities expects a low single-digit decline for the industry, but a flat trend for market leader M&M. The company gained a 90-bp market share to 42.7 per cent in the June quarter.

Given that M&M and its peers are focusing on improving their market share over maintaining margins, brokerages expect profitability in the segment to be under pressure.

Given that tractor margins are almost 3x the auto-segment margins, a weakness in this business will keep a lid on overall margins for M&M.

Motilal Oswal Research points out that the stock has got substantially rerated over the past two quarters due to strong performance in the SUV segment, cyclical recovery in light commercial vehicles, and higher tractor volumes prior to June. However, it is now trading in line with its five-year average, compared to the earlier 30 per cent discount.

Given the sharp rerating, investors should await triggers on segment margins of both businesses and volume recovery in tractors before considering the stock.