M&M: Clouds on the horizon

A weak monsoon could hurt the company's profitable tractor business.

With news that at least half-a-dozen states have had poor rainfall, the Mahindra and Mahindra (M&M) stock fell 9 per cent on Monday. The stock had rallied smartly with the rest of the market over the past couple of months to a high of 943 early last week. Since then, it has lost nearly 20 per cent. Should the monsoon turn out to be much weaker than normal, it would undoubtedly hit sales of tractors, which accounted for nearly half the company’s sales in the June 2009 quarter.

Even if a fair share of tractors is now used for non-agricultural purposes, industry watchers point out that the demand will certainly drop, hurting the company’s sales volumes. At the end of July, M&M was believed to be holding tractor inventories of around three weeks, which is normal.

Tractors are a highly profitable business for M&M. In fact, it was better-than-expected profitability of the farm equipment segment, which posted an EBIT (earnings before interest and tax) margin of nearly 17 per cent, that resulted in strong earnings for the auto major in the June 2009 quarter.

The farm segment included number for Punjab Tractors (PTL), which was merged with M&M in August last year and, therefore, the results are not comparable with those for the June 2008 quarter. Nevertheless, the strong volumes pushed up revenues while lower prices of key inputs such as steel, aluminium and plastics helped bring down the raw material bill.

The PTL merger should continue to yield synergies but the 14.4 per cent operating profit margin that M&M managed in the June 2009 quarter could slip to around 12 per cent in 2009-10 given that raw material prices are inching up and because there could be some pressure on the top line in the coming quarters.

Also, while the Xylo has turned out to be a popular model and will drive UV volumes in the current year, it’s also true that the elections helped create some extra business for M&M in the last quarter. All in all, the impact of the monsoon will be crucial for the company. At the current price of Rs 758, the stock trades at around 12.5 times estimated 2009-10 consolidated earnings and is not cheap.