Further re-rating of M&M depends on UV, capital allocation outcome

Share price jump reflected in current valuation

The Mahindra & Mahindra (M&M) stock has gained 48 per cent since mid-May, outperforming the BSE Auto Index, which was up 33 per cent during the same period. The outperformance was due to expectations of higher growth for tractors, better-than-expected operating performance in the March quarter, and improving capital allocation policies. 

The immediate trigger for the stock has been volume uptick in the tractor business. For June, the company posted 12 per cent increase in domestic tractor sales. The segment is the only one to have posted growth, compared to a sharp decline in other auto segments. The growth was led by strong cash flows in rural markets on the back of a robust rabi crop and multiple government initiatives. 

With the monsoon making rapid progress and kharif sowing gaining pace, tractor sales are expected to remain strong in the coming months. Given the rising sales graph, analysts believe the earlier expectations of 10 per cent decline in 2020-21 may have to be revised and the sector could see similar volumes, compared to the previous year. 

 

 

With 45 per cent share in the tractor market, the overall growth in the sector is expected to help the market leader. Higher growth will increase the contribution of tractors to volume, revenue, and margins of M&M. 

While M&M’s high rural exposure (65 per cent of volumes, including rural utility vehicle portfolio) should work to its advantage, the surge in stock prices captures the upside from the same. 

Analysts at Motilal Oswal Financial Services say any positive surprise in the sport utility vehicle business, positive evolution of the Ford India joint venture or correction of capital allocation by the new chief executive officer should act as rerating triggers. The improvement in return ratios would depend on its ability to cut its losses or exit from the loss-making international businesses such as SsangYong.
                                                   

While a rural-heavy portfolio is a positive, given the target prices of around Rs 600, there is little upside from the current levels. After gaining 7 per cent on Monday, the stock gave up about 2 per cent of the gains on Tuesday. With most gains priced in and few near-term triggers, the upsides from the current levels are limited.