Source: The Hitavada      Date: 26 Mar 2017 09:25:40

BEST bet on rural recovery: M&M is the best play among key auto OEMs on the rural market recovery, with highest revenue contribution from rural markets. For M&M, rural market contributes ~56 % to revenues, 77 % to S/A PAT and ~75 % to SOTP. We expect rural markets to fully recover from impact of demonetisation from 1QFY18 onwards.

Tractors back on track after demonetisation impact: After initial impact of demonetisation, M&M’s tractor volumes are back on track and have grown at ~22.5 % in FY17YTD. Despite such strong recovery in volumes, M&M’s FY17 tractor volumes at ~259k will be lower than previous peak of FY14 (at ~267k). We estimate ~12.5 % CAGR in tractor volume growth over FY17-19E (implies ~4.2 % CAGR over FY14-19E).

Passenger UVs: Worst is behind us as rural recovery to enable market share recovery..: With impact of demonetisation gradually fading and lull in competitive launches in UVs, we expect M&M’s UV business to be back on growth path driven by a) rural recovery, b) launch of petrol variants in existing models, c) 1 new product launch each in FY18 (MPV U321) and FY19 (Compact SUV S221 based on highly successfully Ssangyong 's Tivoli). We estimate modest ~2 % CAGR in passenger UV volumes for M&M over FY17-19E.

whereas M&M’s stronghold of pick-ups should see strong recovery: M&M’s Pick-up UVs contribute ~43 % of M&M’s UV volumes. Pick-up segment has been gaining share at the expense of LCVs (Tata ACE) in the <3.5ton segment. The share of Pick-ups in overall LCV (<3.5 ton) segment increased from 33 % in FY11 to 64% in 9MFY17, as it offered overall very strong package vis-a-vis SCVs. M&M market share has remained stable at 66 % (but off from peak of 73 % in FY15) in Pick-ups and at 51 % (+4pp since FY15) in LCVs (<3.5Ton) in 9MFY17. We believe worst is behind in the pick-up segment and volumes should grow for M&M at ~14 % CAGR over FY17-19E.

EBITDA margins to remain stable: M&M has several levers to support margins viz a) mix (higher tractor share and pick-ups), b) positive operating leverage (15 % revenue CAGR v/s 2 % CAGR in FY14-17E) and c) partial pass-through of commodity price inflation to off-set impact of merger of 2W business on S/A margins. We expect EBITDA margins to remain stable at ~13.6 % over FY17-19E, translating into ~15 % CAGR in EBITDA over FY17-19E and ~13 % CAGR in S/A EPS (higher tax rate, as not yet factoring in 2W biz merger and related tax shield).

Valuation and View: Recovery in rural markets improves visibility of recovery in volumes in both core businesses. After a gap of four years, both the businesses - Tractors and UVs - would be delivering double-digit growth over FY17-19E. M&M is one of the cheapest large cap auto stock with valuations of 17x/14.2x FY18/19E consol EPS and 15.2x/12.8x on core PE basis (adj for value in subs after 20 % Hold-co discount). Maintain Buy with TP of ~INR1,546 (FY19 SOTP based).