M&M: Pick up in tractor sales to boost profitability

The M&M stock has key triggers going for it. Recent government policies should aid its tractor sales while the upcoming launch of compact utility vehicles is expected to help plug product gaps.

The government had last week announced steps to improve agricultural productivity by allotting Rs 50,000 crore for irrigation and reforming the national agricultural market.

The initiatives, according to analysts at J P Morgan, will improve agri incomes and benefit tractor segment sales over the medium term. The measures are expected to reduce volatility in tractor growth rates, which have been erratic over the last few years, falling by about 12% in FY15, with sales coming at just under 600,000 units in FY15.

While the monsoon situation is much better than last year when there was a severe deficit, this is yet to reflect on the sales of tractors, which fell 13% year-on-year.

However, analysts say that they seem to have bottomed out and pace of volume slowdown has decreased with April and May, registering a volume decline of about 18% year-on-year.

Any uptick in recovery should help M&M, which is the top player in the tractor market, with a market share of nearly 42%. The company has been losing share in the market, with June quarter volume decline of 18% as compared to the industry sales fall of 16%. In fact it is the higher contribution from tractors which should help the company report a 120 basis points improvement in margins on a sequential basis.

Why tractors are important to M&M is because they contribute about 45% to the company’s standalone or core earnings before interest and tax. Deutsche Bank analysts estimate that a 5% increase in tractor volumes helps boost earnings per share by 4%. The tractor segment which is highly profitable had reported an Ebit margin of 15% (overall margins 11%) despite a 14% fall in volumes in FY15.

The Street will also keep an eye out for updates on the three new UV platforms that the company expects to unveil this year. The new launches especially in the compact SUV segments is important given that the segment in addition to premium hatch backs and entry level sedans have seen double digit growth in FY15 as compared to a muted passenger car market. The company's prospects could improve if some of the launches are able to get traction.

Analysts peg the sum of parts target price at Rs 1,440. Of this, 71% of the value comes from the auto segment which comprises key sub segments of farm equipment and utility vehicles.