India’s largest tractor and utility vehicle (UV) manufacturer Mahindra and Mahindra (M&M) has not disappointed investors even in the tough quarter gone by. M&M has posted a good set of numbers for the June quarter where it gained the highest ever market share in farm equipment segment (FES) and maintained an overall operating margin (excluding GST impact).

Strong leadership in FES, revival riding on rural growth, a slew of new launches and reasonable valuation make it a stock worth accumulating for long-term investors.

Quarter in a snapshot

Without the GST impact, net revenue witnessed a growth of 6.8 percent (YoY) and achieved the highest ever net revenues of Rs 11,238 crore of (M&M and MVML). This was attributed to 2.7 percent volume growth, driven by 13 percent growth in tractors that partially got offset by a decline of 3.8 percent in autos. The average realization was up 2.6 percent.

Excluding GST impact, EBITDA remained stable at around 14.2 percent and with the GST impact it came to around 13.1 percent. GST impact was Rs 144 crore for the quarter.

Net margin fell to 7.7 percent from 8.3 percent a year ago on the back of 3.5 percent increase in the tax rate. The higher tax rate is attributed to the reduction in R&D weighted deduction from the earlier 200 percent to 150 percent and the withdrawal of investment allowance U/S 32AC.

FES – Highest market share

M&M is the market leader in tractors and has been gaining market share. In the domestic market, M&M gained 2 percent (YoY) market share in the FES segment and reached its highest ever market share of 45.8 percent in the quarter ended June 2017. This was attributed to the new launches that took place in the last two years. In terms of exports, FES witnessed significant 14 percent export volume growth. These contributed to the highest ever revenue and profit for the segment (excluding GST impact).

The management pegs tractor industry growth at 10-12 percent for the current fiscal year and believes that M&M would be able to do better than the industry growth on the back of its large exposure in rural and semi-urban areas and revival in rural income.

Auto – GST temporary dampener but good for long-term

Though GST led destocking was the dampener for volumes, M&M could ride well and weather the disruption. GST, however, will augur well for auto volumes in long-term.

On the volume front, domestic volumes were higher by 1.2 percent whereas exports witnessed a significant decline of 56 percent, mainly because of the headwinds faced in the foreign markets. The company achieved its highest ever market share of 52.2 percent in LCV<3.5 ton. HVCs' market share also witnessed an uptick reaching 4.8 percent on the back of good response to the Blazo series.

Portfolio revamp?

M&M has a portfolio of very successful products such as Scorpio and XUV500 in UV segment. Though the company has lost some of its market share in the segment to the competition, it has planned new product launches: U321 and S201 are expected to be launched in FY18 and FY19, respectively.

Undemanding valuation

The underperformance of the stock has rendered the valuation extremely undemanding. If we follow a Sum of the Parts valuation (SOTP) and exclude the value of the subsidiaries, the core automobile business trades at close to 13 times FY19 projected earnings. Albeit the lacklustre performance, this is at a steep discount to peer groups that typically trade at multiples of 19-20 times. We believe that there is headroom to catch up riding on rural recovery and product innovation.

Long term value investors should use the weakness to accumulate M&M.