Investors ignored Mahindra and Mahindra Ltd’s (M&M’s)double-digit revenue growth in the December quarter, and focused instead on the disappointment on the margin front. The stock closed 2.6% lower at ₹683 on Friday. Coming on the heels of a sharp 31% decline from the high scaled in August, M&M’s current stock price discounts its one-year forward earnings estimates 12 times. This is lower than the 17-18 times valuation seen last April.
Why has the stock got such a drubbing? After all, 11.2% revenue growth of M&M along with subsidiary Mahindra Vehicle Manufacturers Ltd, is commendable given the challenging domestic scenario. Both its segments, automotive and farm equipment, clocked 11-12% sales growth each.
The Street is concerned about weakening profitability amid slowing growth. At the analysts’ call, management lowered FY19 growth estimates for the farm equipment segment to about 10% from the earlier 12-14%, and for auto segment to 4-6% from 7-8%.
The company will bet on its new launches such as the XUV300 in the auto segment, where its utility vehicle sales have been slipping. Investor expectations on sales growth are likely to contract further in FY20 due to uncertainty on BS-VI emission norms. Further, the peaking tractor cycle that has been robust the past 12 months could hurt volumes.
Another issue is the pressure on margins. The December quarter Ebitda (earnings before interest, tax, depreciation and amortization) margin at 13.2% was below expectation and 150 basis points lower from a year ago. Both segments failed the Street’s forecast on this count. Profitability of the farm equipment segment contracted 130 basis points to 19.2%, while that of the auto segment fell by 260 basis points to 5.8%, the lowest seen in five years.
Management indicated a softer trend in raw material costs. This has been a sore point in the last two quarters. Most auto firms were unable to pass on the impact of high input costs and adverse forex movements in a falling sales environment. In fact, discounts to keep up market share and clear the inventory also dented profits too.
The moot question is whether softer material costs will shore up M&M’s falling profitability in the coming quarters. There is a tone of caution for the auto segment due to rising competition and cost of compliance with technological changes. The monsoon, which influences farm equipment sales, is uncertain. Also, operating leverage in the auto segment coming from new models may be partially offset by flat tractor volume. This comprises nearly two-thirds of consolidated profit.
December quarter’s Ebitda of ₹1,703 crore was nearly 15% lower than what analysts had pencilled in and flat compared to a year back. However, higher other income was a shot in the arm. Along with the write-back of tax provisions, net profit jumped 60% year-on-year.
But investors are cautious. According to Mitul Shah, vice president (research) at Reliance Securities Ltd, “We expect Mahindra to face margin pressure on account of turbulence in the rural economy, intensifying competition in utility vehicles and a slow-down in tractors.” That said, valuations of the M&M stock have come down.