Volume, margin worries for M&M

Anand Mahindra, chairman of Mahindra & Mahindra


Mahindra and Mahindra (M&M) stock is down 14 per cent since the announcement of the demonetisation move. Some of the Street’s fears came true when M&M announced a 34 per cent dip in utility vehicle (UV) sales and 21 per cent fall in tractor sales for November. While UV sales were down on weak consumer sentiment and inventory correction after the festive season, it's the sharp fall in tractor sales (which were growing at 60 per cent) that's worrying, say analysts. Unlike other auto players, M&M’s portfolio is skewed towards rural consumption. Analysts at Morgan Stanley say that since tractors are a rural play and M&M’s UV portfolio has a large mix of rural sales, the weakness could be an indication of rural liquidity stress. The company has underperformed its passenger vehicle peers given the exposure to products with higher average selling prices and rural markets, say analysts at Quant Capital.
What could add to the difficulty are reports of lower Rabi sowing. With 50 per cent of Rabi sowing completed, the activity is 4.5 per cent higher than last year. However, analysts say the number looks positive given that last year, sowing was impacted by lower reservoir levels. Edelweiss analysts say the current levels as on November 25 are 7.5 per cent below normal and has, in fact, deteriorated compared to the week ended November 18 when the sowing levels were 4.5 per cent below normal. While the government is taking steps such as accepting old notes for agri-input purchases and improving cash supply to rural areas, cash crunch could persist till at least January 2017, they add.
While M&M’s passenger vehicle sales on a year-to-date basis are up 5.5 per cent, analysts have started lowering their FY17 volume forecasts. Quant Capital has cut its volume and revenue forecasts for FY17 by four per cent each, while net profit has been revised downwards by six per cent. What could aggravate the situation on the volume and demand fronts are increasing commodity prices. While the prices of natural rubber, lead and steel are up 12-16 per cent in November compared to the prices in October (aluminium is flat), all the four are up 20-81 per cent compared to the year-ago period. Higher commodity prices at this time will add to the high cost base given lower volumes.
The stock is available at 15 times FY18 estimate. This is at a 25 per cent discount to its 5-year average multiple of 20 times, indicating the part of the pain is already priced in. The current valuations also make it the cheapest stock in the large cap auto space with only Tata Motors at just under 10 times less expensive than this.