Strong utility vehicle growth trajectory to drive M&M's FY23 performance

Revival in tractors, improvement in supply, and margin gains are other key triggers for the auto major

Robust demand trends in the utility vehicle (UV) space, improving tractor sales, turnaround in performance of subsidiaries, and better capital allocation are positives for automotive major Mahindra & Mahindra (M&M). Brokerages have revised their earnings expectations upwards and expect the automotive manufacturing corporation to achieve 18-20 per cent growth in revenue and earnings over the next two years.  

The key trigger for the stock will continue to be volume traction in automobiles, even as the tractor segment is witnessing some revival. Although chip shortage continues to be an overriding concern, gradual easing and rising order books have helped the company report a robust 20 per cent volume growth to fewer than 27,000 units on a sequential basis in May. Monthly order books for key sport UV models, such as the XUV700 and the Thar, remain higher than the production levels. 

The roll-out of the new Scorpio-N by end-June could add to its incremental gains. Even as the existing avatar will continue to be sold in rural markets, the new version, with an initial capacity of 5,000 units, is targeted at the urban market.

The company, currently in third place in the UV market in volume and in pole position in value, expects its volume rankings to improve as the semiconductor situation improves.

While the company has been losing market share over the past few years, strong demand and sales outperformance have led to improving share from the third quarter of 2021-22 (FY22). The company gained 300-basis point (bp) market share in the second half of FY22 to 16.5 per cent. 

Given the overall passenger vehicle order book of 170,000 units, higher demand, expectation of production uptick, and volume growth in the near term are expected to be strong. While the company ended FY22 with automobile volume growth of 32 per cent, brokerages expect growth in the current financial year (2022-23, or FY23) to be at over 20-25 per cent to about 570,000 units. 

Although the Street will track the company’s automobile segment market share, the other important driver for M&M core earnings is the tractor business. In addition to surge in commodity prices and supply disruptions, the disappointment in FY22 on the earnings front was largely due to weak showing of the tractor segment. Even as UV volume growth was at 31 per cent last year, tractor volumes remained stagnant, crim­ping its profitability and net profit. 

While the company has reported a fall in tractor volumes in each of the last three quarters, the fall in the March quarter was sharp at over 22 per cent. Given the farm equipment margins are 3-4x those of automobile margins, weaker performance of the segment is negative for the company’s profitability. 

Margins for the farm equipment segment hit a five-year low in the March quarter, according to Motilal Oswal Research. Operating leverage and price hikes restricted the overall margin fall to 320 bps at 11.4 per cent.

While the ban on export of wheat has put a dampener on the sector, the trend over the past few months has been good. In May, the domestic tractor industry registered more than a 35 per cent growth over the year-ago period.

Say Rishi Vora and Eswar Bavineni of Kotak Institutional Equities, “Higher food prices, resulting in better cash flow for farmers, led to higher demand for tractors. With timely arrival of the southwest monsoon and forecast of a normal monsoon, kharif crop is expected to deliver record production, auguring well for tractor demand.”

Tractor market leader M&M reported a volume growth of 48 per cent and is adding to its market share. The company, which expects the tractor industry to grow in single digits in FY23, ended last year with 41 per cent share in the segment and intends to maintain its share at these levels in the future.   

Even as sentiment in the farm equipment sector is better now, the Street expects automobiles to be the mainstay of business.

Say analysts, led by Jinesh Gandhi, of Motilal Oswal Research, “While the outlook for tractors has improved, we expect the automobile business to be the key growth driver over the next few years. Despite deterioration in the (product) mix, annual growth in operating profit and earnings over FY22 through 2023-24 (FY24) is pegged at 26 per cent and 21 per cent, respectively.”

Although the stock is up 49 per cent from its March levels, valuations at 16x its FY24 earnings are at a discount to its five-year average, given the weak tractor cycle. What should help earnings is the turnaround in loss-making subsidiaries and cut in investments for the ventures. While there are multiple positives, investors should await progress on supply disruption, raw material, and demand trends in the tractor business before considering the stock.