Policy uncertainity overhangs for M&M

Expectations of an increase in duties on diesel-powered passenger vehicles and slowing tractor sales have hurt market sentiments, but a benign Budget could boost the stock

The difference in relative returns of Mahindra & Mahindra (M&M) and other key auto scrips, (such as Tata Motors and Maruti Suzuki), in recent months reflects the market’s worry about the possibility of higher taxes being imposed on diesel-powered passenger vehicles in the forthcoming Union Budget.

Shares in M&M, which get over 60 per cent of its standalone volumes from this segment, have gained four per cent in 2012, while Tata Motors and Maruti’s scrips have gained 54 and 38 per cent, respectively. Though the market is discounting some tax hikes, any major increase in taxes is likely to hurt passenger vehicle volume growth and M&M’s standalone performance in 2012-13, given volumes in the tractor business are also estimated to slow down. At Rs 712 (a price-to-earnings ratio of 12 times, based on 2012-13 earnings per share estimates), analysts believe the stock is fairly valued reflecting these concerns. However, any adverse outcome in the Budget may prolong its underperformance.

A party spoiler
Regarding the policy direction, any differentiation in diesel prices for passenger and commercial vehicles appears hard to execute logistically and is, therefore, unlikely, believes Umesh Karne, analyst at Brics Securities. Conversely, an increase in the excise duty, a surcharge on diesel-powered vehicles or the recent suggestion of a one-time tax of Rs 80,000 if carried out could impact demand, he feels. This would be in addition to the expected two per cent excise duty increase for the sector at large, in the final leg of removing incentives given earlier as part of a stimulus package.

The excise duty on large cars, sport and multi-utility vehicles is 22 per cent, with an additional ad valorem of about Rs 15,000, says Surjit Arora of Prabhudas Lilladher, and if that increases by 5-10 per cent, it would hurt demand, with a major impact on M&M.

Arora sees a Rs 25,000-30,000 one-time tax on diesel cars/utility vehicles, which would be a four-five per cent increase. This would be passed on to customers because of the thin margins on these products. Hence, there would be no impact on earnings before interest, taxes, depreciation, and amortisation margins. However, current consensus estimates peg volume growth at 15 per cent, which could then dip to 10-12 per cent. Arora sees the fuel price differential to stay the same, but with the price increase, the total break-even cost could increase to 1.7-1.8 years, from 1-1.5 years at present, thereby dampening demand.

Diesel-powered vehicles command a premium over petrol variants, but diesel passenger vehicle sales have increased significantly, given the fuel price differential of about 36 per cent and better fuel efficiency of diesel engines. This tax, therefore, is a key factor affecting future volume growth estimates, belying the improving macro-economic outlook, expected to pick up in the second half of 2012-13. Some analysts like Karne though, don’t believe a one-time tax will be levied, which if comes true could significantly boost the stock

Tractors, slowing growth
Meanwhile, M&M also reported slowing tractor sales, influenced by seasonal trends, which could extend into the March 2012 quarter, as well. The management, too, expects tractor sales to slow down to 8-10 per cent year-on-year in 2012-13, after strong growth in the last couple of years. However, auto volumes were high, receiving an added boost from strong sales of ‘XUV 500’ sales. The 8,000 bookings in December and 25,000 applications in the second round (closed in January) boosted volume estimates.

Karne expects the overall auto segment volume to grow 12-14 per cent in 2012-13. Arora believes robust demand in spite of price hikes (two per cent in October 2011 and again in January for tractors and automobiles, with a 3.5 per cent hike for XUV 500) suggests strong pricing power for M&M. So, it is unlikely to feel the competitive intensity sharply in the utility vehicle segment, though both Ford and Hyundai plan to launch compact sports utility vehicles. But Maruti could pose some threat to M&M, which has four products in the Rs 8-15 lakh price range.

However, the change in the product mix is expected to have some impact on operating profit margins, as tractors enjoy higher margin than auto. Consensus forward earnings estimates reflect a combination of this margin impact with expected growth outlook and have been revised four per cent lower after results.

Outlook
Other than domestic policy, the other risk is with regard to SsangYong Motor, its Korean acquisition, says Karne, based on slowing volumes in Korea and global concerns stemming from Europe. He points out the $465-million investment is still seeing a Rs 600-700-crore annualised loss and won’t break even this year as per the management guidance. Therefore, a lot depends on improving volumes in emerging markets like China and entry into Russia and India.

Overall, most analysts believe these concerns are already reflecting in the price. A possible near-term trigger could come from a reversal of the Maharashtra state VAT notification on M&M’s Chakan plant, being sought by the company.