Mahindra & Mahindra's Q2FY20 results (Outperformer) - Margins surprise; subsidiary losses a concern

Q2FY20 result highlights

• Operating performance ahead: M&M+MVML adjusted PAT of Rs 13.5bn (-24% yoy) was 20% above our expectation. The variance was largely due to higher gross margins and a sharp jump in other income.
• Margins surprise: M&M+MVML’s revenues at Rs109.4 bn were down 15% yoy due to a volume decline of 16%. EBITDA margins at 14.1% (down 40bps yoy, flat qoq) beat expectations (12.8%). The margin beat was largely on account of an improvement in gross margins (34%, up 188bps qoq) – largely due to lower commodity costs, improved product mix and price hikes. The improved gross margins were however partially negated by operating deleverage (other expenses/employee costs rose by 114bps/66bps qoq). While EBIT margins of the tractor business at 19% (flat qoq) were resilient, the automobile business margins at 5.8% (down 70bps qoq, 200bps yoy) were visibly weaker due to negative operating leverage. PAT at Rs13.5bn (-24% yoy) benefitted from higher other income/lower tax rate. Notably, the consolidated automotive EBIT reported a loss of Rs3.7bn that is ~Rs7.6bn lower than the M&M+MVML automobile EBIT. The difference reflects higher losses at Ssangyong.
• Concall highlights: (a)The management guided for a ~7% decline in tractor volumes in FY20 (previously 0 to-5%). While the company expects tractor volumes to remain muted in the near term due to unseasonal rains, it expects volumes to pick up in Feb- March 2020 (high water reservoirs a positive) (b) Despite a strong festival season (retail growth of 14% from festival to festival), the company expects a volume decline of ~5% in H2 for the industry PVs (13% decline in passenger cars likely to offset a growth in the UV segment). (c) The automobile losses at Ssangyong are likely to remain high in Q3 as well – however, the company hopes to reduce the losses from Q4FY20.

Key positives: Strong gross margins; higher other income

Key negatives: Increased losses in automobile subsidiaries

Impact on earnings: We raise our FY20/21 EPS estimates by ~4.2%/3.7% on a lower tax rate.

Valuations & view

The recent improvement in demand during the festival was encouraging and additionally, the monsoons should benefit tractor demand in Q4. However, the continuing losses at the foreign subsidiaries remain a concern. Also, the impact of BSVI could throw up some challenges for the LCV/pickup portfolio. Nonetheless, we believe that on the whole, reasonable valuations (ex-subsidiaries ~9xFY21E EPS) make for a favourable risk reward return. Maintain outperformer with a SOTP based of Rs642.