Stock corner: Maintain ‘buy’ on M&M with target price of Rs 676

M&M continues to surprise on profitability

Mahindra & Mahindra’s (M&M) Q2FY20 Ebitda at Rs. 1,540 crore (down 16.7%) came 7% ahead of consensus driven by better product mix, price increase and tight leash on cost. Key positive surprises were: 23% jump in PV festive retail sales — higher than industry; sustained market share gain in PV — up 60 bps q-o-q to 7.8%; inventory under control; and benign outlook on tractors & UVs. However, key negative surprises were: Significant jump in losses of subsidiary; and uncertainty on diesel portfolio’s orderly BS VI transition.

Though we are enthused by the sharpened margin focus, reduction in losses of subsidiary remains key monitorable. Hence, we remove the company from our BRAVEHEART series. Maintain ‘buy’ with March 2021E SOTP-based TP of Rs. 676.

M&M continues to surprise on profitability. While price hike and better product mix benefitted revenue, commodity cost benefit led to positive gross margin surprise. Tight leash on cost (evident from y-o-y decline in fixed cost) led to a 7% Ebitda beat. Effective customer-acquisition cost led to lower-than-expected incentive during festive sales (up Rs. 1,000-1,500/vehicle y-o-y). By segment, despite an 8% y-o-y dip in volumes, the FES segment posted 19.3% (down only 90 bps y-o-y) Ebit margin driven by strong focus on cost control. However, the Ebit margin in the automotive business slid about 210 bps y-o-y to 5.8% due to higher depreciation and volume 21% decline.

M&M is currently battling various headwinds: a) near-term uncertain demand outlook; and 2) perception challenge on its ability to ensure a smooth transition to BS VI. Given its state of preparedness, we expect the BS VI transition to be smooth. However, demand concerns persist.

At the current stock level, we believe the street is overly pessimistic about M&M’s ability to smoothly transition to BS VI. We maintain ‘buy/SO’. The stock is trading at FY20/21E PER of 15.2x/16.4x.