During the last two years, the auto industry has had a dream run, thanks to the turnaround after the economic slowdown. Going forward, the industry faces headwinds in the form of high input prices, increasing interest rates and an expected moderation in volumes due to base effect and rising prices. On the other hand, there are no signs of weakness in demand, indicating that there may still be steam left before the industry growth peaks out.

A safe bet

In such a scenario, an investment in the M&M stock is a safe bet for those looking for exposure to the auto sector. This investment argument stems from three reasons.

One, the company operates in the utility vehicle (UV) segment, which, going by M&M's own experience in 2008, handles a slowdown relatively better than passenger cars. Two, the company also derives a good portion of its revenues from the sale of tractors, which enjoy superior margins to UVs, providing scope for overall margins to be higher.

Three, in the segments it operates, the company's product mix is such that there are products such as the Bolero, the Yuvraj tractor and a host of LCVs at the lower end to keep the volume momentum ticking, as well as products at the premium end to take care of the margins. Besides, M&M has also lined up launches, which would help bring additional volumes.

After our buy call in July 2010 at Rs 638, the stock touched its 52-week high of Rs 826 in November. Broader market volatility since then has brought down the price to Rs 595. At this price, it trades at a PE of about 13.5 times its trailing 12-month standalone earnings (diluted). We reiterate a buy for investors with a one-to-two year perspective.

For the quarter ended December 2010, net sales grew 35 per cent to Rs 6,074 crore year-on-year, backed by a volume growth of 33 per cent. Adjusted net profits grew 49 per cent to Rs 618 crore. Despite pressures from a spike in raw material costs, the company managed an EBITDA margin of about 15 per cent , similar to third quarter of 2009-10. This is attributable to the combined impact of price increases, cost-reduction and value-engineering efforts.

Entry into premium UVs

With the acquisition of Ssangyong Motors, the company's utility vehicles portfolio received a face-lift. For M&M, this deal has been a sweetener on three fronts. For one, with products such as the Rexton II, New Kyron and Actyon SUVs and the Rodius MPV, Ssangyong gives the UV product line an extension into the premium SUV segment (beyond the Scorpio). This augurs well for the company's realisations and margins over the long-term.

Two, Ssangyong's foothold in the markets of South America, Russia, Eastern and Western Europe, and Africa bodes well for M&M ‘s plans to launch a global SUV this year. This is expected to take over the flagship position of the Scorpio. It expects its global vehicle volumes to contribute to 20 per cent of its total business by 2012.

Another area where the acquisition may come in handy is in the technology for diesel engines. Ssangyong has an engine plant which manufactures gasoline and diesel engines and its SUVs run on diesel engines. M&M can use Ssangyong's technology base to share vehicle platforms and develop more products. Aside of this, considering M&M's over 60 per cent market share in the domestic SUV segment and strong export opportunities, the company may also consider joint sourcing of raw material and local assembly options in India to cut costs.

Back home, the company also plans a compact SUV on the Xylo platform. Besides, it has recently driven into the niche SUV segment with the launch of the ‘Thar'.

Farm equipment hold promise

A normal monsoon and record agricultural output has benefited the company on the farm equipment front. Going forward, the fact that a major portion of demand has shifted to >40 HP tractors from <40 HP tractors bodes well for the company's earnings prospects. This is because, aside of the higher HP Arjun tractors, it has access to tractors of much higher horsepower (up to 125 HP) through their JV in China.

These can also be used for haulage and commercial material handling, beyond agricultural purposes. At the other end, to cater to small and marginal farmers or to those large farmers who need a second tractor, M&M has pioneered the ‘Yuvraj', a 15 HP tractor, which has been received well in the markets.

Given the strong demand, the company is expanding its tractor capacity by 50 per cent from the current two lakh units. Capacity expansion for ‘Yuvraj' is also on the cards. To cash in on the potential for farm mechanisation solutions, M&M has begun selling harvesters and rice transplanters. It has recently signed an agreement with Italy's Maschio-Gespardo for supply of the complete range of tillage equipment.

Hub and spoke model

In its commercial vehicles division, the company has used the hub and spoke model to further growth. Hence, from being a marginal player, M&M has taken competition head on by concentrating on the two ends of the CV segment. At the lower end, M&M brought in the Gio and Maxximo, both sub-one-tonne trucks, and has gained market shares in this fast-growing segment.

The Genio, a 1.25-tonne truck based on the new ‘U' platform, was launched recently. For HCVs (trucks and tippers), M&M is in a joint venture with Navistar of the US. While two trucks have hit the markets, the entire range of heavy duty trucks will come in 2011-12. However, these launches may support volume growth only if freight rates continue to hold and higher interest costs don't turn the CV cycle downwards. That said, this business still being nascent, a downturn may not have a significant impact on the company's profitability.

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