Mahindra & Mahindra BUY

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1 27 June 2018 India Automobiles Company Update Mahindra & Mahindra BUY Farm Equipment Segment Day : The Upside of Rise On 26 Jun 18, we attended M&M s Farm Equipment Segment (FES) day, highlighting the upside to Mahindra Rise strategy, which would be driven by an increase in a) the domestic tractor market share, b) revenue share from global operations, and c) revenue from the farm machinery category. The company intends to increase its domestic tractor market share from 43% to 50%, supported by the new affordable Trakstar brand, mechanisation of the horticulture segment and growth in the high horsepower (hp) segment. The company views its current global market share of <2%, favourably and as an opportunity to increase its revenue from global operations from 37% currently to 50% in the next 2-3 years, supported by its operations in the Americas, Japan and Turkey. Low penetration of farm equipment in India is likely to boost sales of M&M s harvesters and rice transplanters, which are developed using technological support from its global subsidiaries. Driven by these strategies, costsaving measures (Kuber), total productive maintenance (TPM), Poka-Yoke and virtual reality as well as cost synergies across subsidiaries, the company has guided for improvement in margins and maximisation of ROCE. Domestic Strategy: Globally, the level of farm mechanisation is well above that of India (40%). While total industry sales for tractors in FY18 stood at c.6.5 million, the peak tractor requirement could be c.16.2 million, indicating 2.5x potential in annual tractor sales. Given the long-term trend of mechanisation in India and M&M s market leadership in tractors (43%, FY18), it is targeting 50% market share, supported by: a) the introduction of an affordable brand Trakstar by Growmax which is priced c.5-10% lower than existing aggressive brands; b) targeting small farmers with lower hp tractors such as JIVO (20-30hp); c) targeting the horticulture segment, which has c.50% lower mechanisation than food grains and is likely to post a 6-8% CAGR during FY18-FY23, significantly higher than the c.2.5% CAGR for food grains; and d) targeting sales in the higher hp segment (>60hp) as demand is likely to increase with the increasing use of farm implements. Furthermore, management highlighted that the tractor industry is expected to grow 8-10% in FY19. Global Strategy: While M&M is the largest tractor selling brand in volume terms its share is <2% in the global farm equipment market (valued at USD 160bn). With visible headroom for growth, the company intends to achieve 50% of FES revenue from its global operations (vs. the current share of 37%) in the next 2-3 years. This global strategy is driven by potential upside to its businesses in the Americas, Japan and Turkey. Farm Machinery Strategy: In India, farm machinery (c. USD 1bn) is only c.0.2x of that of the tractor industry (c.usd 5.7bn). However, of the USD 160bn global farm equipment market, c.usd 100bn caters to the non-tractor segment, indicating significant potential for the farm machinery segment. As a result, M&M is targeting USD 1bn in global revenue from this segment (vs. USD 340mn currently), supported by the increasing cost of agriculture labour and farm mechanisation. Farm machinery strategy in India will be driven by: Vivek Kumar vivek.kumar@jmfl.com Tel: (91 22) Vaikam Kumar S vaikam.kumar@jmfl.com Tel: (91 22) Jayesh Chandra Gupta jayesh.gupta@jmfl.com Tel: (91 22) Recommendation and Price Target Current Reco. BUY Previous Reco. BUY Current Price Target (12M) 960 Upside/(Downside) 7.5% Previous Price Target 840 Change 14.3% Key Data MM IN Current Market Price Market cap (bn) INR893 INR1,109.7/US$16.2 Free Float 81% Shares in issue (mn) 1,189.9 Diluted share (mn) 1, mon avg daily val (mn) INR2,246.4/US$ week range 934/612 Sensex/Nifty 35,217/10,671 INR/US$ 68.6 Price Performance % 1M 6M 12M Absolute Relative* * To the BSE Sensex Thank you for your ongoing support in the Asiamoney Annual Brokers Poll. Click here to see the JM Financial team. Financial Summary Net Sales 408, , , , ,554 Sales Growth (%) EBITDA 46,202 45,146 62,240 75,191 88,602 EBITDA Margin (%) Adjusted Net Profit 31,361 30,949 39,224 47,896 56,171 Diluted EPS (INR) Diluted EPS Growth (%) ROIC (%) ROE (%) P/E (x) P/B (x) EV/EBITDA (x) Dividend Yield (%) Source: Company data, JM Financial. Note: Valuations as of 27/Jun/2018 JM Financial Research is also available on: Bloomberg - JMFR <GO>, Thomson Publisher & Reuters S&P Capital IQ and FactSet Please see Appendix I at the end of this report for Important Disclosures and Disclaimers and Research Analyst Certification. JM Financial Institutional Securities Limited

2 - a) Rice value chain Rice transplanters can plant rice seedlings c.25x faster than human hands. However, the current penetration of rice transplanters is only 0.2 units/1,000 hectares of cultivation. As a result, only 2,000 rice transplanters are sold annually in India vs. sales of c.110,000 annually in China. Additionally, M&M is likely to benefit from rice transplanter and harvester technology received from its global subsidiary - Mitsubishi Agricultural Machinery, based in Japan. - b) Harvesters - Current penetration of Harvester is only 0.5 units/1,000 hectares of cultivation, significantly lower than tractor penetration (20 units/1,000 hectares of cultivation). M&M is also likely to benefit from harvester technology from its Swedenbased associate Sampo Rosenlew. Financial Strategy: The company is expected to increase its revenue, driven by domestic tractor sales, domestic sales of farm machinery and global sales of farm equipment. Furthermore, management highlighted that it has accrued significant cost benefits from its internal cost savings project Kuber, continuous improvement techniques such as total productive maintenance, error prevention techniques such as Poka-Yoke and employee training through virtual reality. As the result, management is confident about maximising margins. Currently, the PBIT margin of the consolidated M&M FES is 13.9%, comparable with global competitors, despite a -1.3% PBIT margin at its global subsidiaries. Further, management guided for improvement of the PBIT margin of global subsidiaries from -1.3% current to +5.0% over the next 3-5 years, driven by cost synergies across subsidiaries. Details of global strategy: In the Americas, M&M aspires to increase its revenue from USD 600mn currently to USD 1bn, driven by: - a) USA: This is the third largest tractor market in the world. Mahindra USA intends to benefit from its #3 position in the < 80hp segment, which caters to family farms. The company is also likely to benefit from the introduction of the hp tractor, range of diesel retriever UTVs and expansion of its dealer network. - b) Mexico: Mahindra Mexico, which sold its first tractor in Aug 17 is benefiting from the country s average farm size, which is comparable to India. This is leading to sales of JIVO (20-30hp). Furthermore, the company plans to introduce high-hp tractors (40-95hp) and gain from the popularity of its 5-yr warranty. - c) Brazil: Mahindra Brazil plans to obtain subsidy benefit from the localisation of its tractor and harvester portfolio. Its focus area is the hp segment, which caters to the orchid and vineyard market. In Japan, which is the third largest agri-machinery market in Asia and largest exporter of tractors in the world, M&M along with Mitsubishi Agricultural Machinery (MAM) is leveraging cost savings by sourcing components from India, while targeting USD 1bn in revenue through the sale of light-weight tractor (both domestic and export- especially SE Asia) and rice value chain equipment. In Turkey, M&M with its three companies: Erkunt tractors, Erkunt foundaries and Hisarlar aspires to achieve USD 0.5bn in revenues driven by: a) the #3 position of Erkunt tractors (aspires to improve it to #2), b) the USD 1.3bn market size of farm mechanisation in Turkey, which is likely to benefit Hisarlar (#1 position in soil tillage implements), and c) export opportunities from Turkey to the Middle East. JM Financial Institutional Securities Limited Page 2

3 Exhibit 1. Tractor market share, FY18 Exhibit 2. Level of farm mechanisation, 2017 John Deere, 9% Escorts, 11% Others, 6% MM, 43% Sonalika, 12% TAFE, 19% Source: JM Financial Source: JM Financial Exhibit 3. Trakstar: Likely to help improve market share Exhibit 4. Rice transplanter of M&M Source: Company presentation Source: Company presentation Exhibit 5. FES: Global footprint Source: Company presentation, *Gross without eliminations incl. exports from India, #For Global subsidiaries JM Financial Institutional Securities Limited Page 3

4 Financial Tables (Standalone) Income Statement Net Sales 408, , , , ,554 Sales Growth 7.3% 7.8% 10.5% 16.8% 16.1% Other Operating Income Total Revenue 408, , , , ,554 Cost of Goods Sold/Op. Exp 295, , , , ,994 Personnel Cost 23,487 27,144 28,409 31,744 35,582 Other Expenses 43,902 47,433 54,860 58,018 67,377 EBITDA 46,202 45,146 62,240 75,191 88,602 EBITDA Margin 11.3% 10.2% 12.8% 13.2% 13.4% EBITDA Growth 23.9% -2.3% 37.9% 20.8% 17.8% Depn. & Amort. 10,681 15,264 14,794 14,919 17,336 EBIT 35,521 29,882 47,446 60,272 71,266 Other Income 8,499 13,455 10,364 11,192 12,192 Finance Cost 1,861 1,596 1,122 2,050 2,050 PBT before Excep. & Forex 42,160 41,741 56,687 69,414 81,407 Excep. & Forex Inc./Loss(-) PBT 42,160 41,741 56,687 69,414 81,407 Taxes 10,799 10,792 17,464 21,518 25,236 Extraordinary Inc./Loss(-) 687 5,485 4, Assoc. Profit/Min. Int.(-) Reported Net Profit 32,049 36,434 43,560 47,896 56,171 Adjusted Net Profit 31,361 30,949 39,224 47,896 56,171 Net Margin 7.7% 7.0% 8.1% 8.4% 8.5% Diluted Share Cap. (mn) 1, , , , ,189.9 Diluted EPS (INR) Diluted EPS Growth 14.7% -1.3% 26.7% 22.1% 17.3% Total Dividend + Tax 7,112 7,717 8,330 8,330 8,330 Dividend Per Share (INR) Cash Flow Statement Profit before Tax 42,160 41,741 56,687 69,414 81,407 Depn. & Amort. 10,681 15,264 14,794 14,919 17,336 Net Interest Exp. / Inc. (-) 1,861 1,596 1,122 2,050 2,050 Inc (-) / Dec in WCap. 23,309-6,117 11,106-2,673-6,897 Others 687 5,485 4, Taxes Paid -10,799-10,792-17,464-21,518-25,236 Operating Cash Flow 67,899 47,176 70,582 62,192 68,660 Capex -21,181-21,797-26,561-23,174-24,564 Free Cash Flow 46,718 25,379 44,021 39,019 44,096 Inc (-) / Dec in Investments -4,093-43,610-26,746-20,000-20,000 Others -1,861-1,596-1,122-2,050-2,050 Investing Cash Flow -27,134-67,003-54,429-45,224-46,614 Inc / Dec (-) in Capital 6 5 2, Dividend + Tax thereon -7,112-7,717-8,330-8,330-8,330 Inc / Dec (-) in Loans -7,768 9, ,000 3,000 Others -20,145 12, Financing Cash Flow -35,019 13,831-4,091-6,301-6,181 Inc / Dec (-) in Cash 5,747-5,995 12,063 10,667 15,864 Opening Cash Balance 542,092 22,870 16,875 28,937 39,605 Closing Cash Balance 547,839 16,875 28,937 39,605 55,469 Balance Sheet Shareholders Fund 224, , , , ,016 Share Capital 2,963 2,968 5,950 5,950 5,950 Reserves & Surplus 221, , , , ,067 Preference Share Capital Minority Interest Total Loans 18,436 27,729 28,644 31,644 34,644 Def. Tax Liab. / Assets (-) 4,601 1,948 5,418 6,112 6,926 Total - Equity & Liab. 247, , , , ,586 Net Fixed Assets 91,581 98, , , ,364 Gross Fixed Assets 145, , , , ,735 Intangible Assets Less: Depn. & Amort. 69,622 84,886 99, , ,935 Capital WIP 15,622 20,404 31,287 13,174 14,564 Investments 135, , , , ,830 Current Assets 127, , , , ,201 Inventories 26,879 27,580 27,017 37,401 43,434 Sundry Debtors 25,116 29,388 31,730 38,959 45,243 Cash & Bank Balances 22,870 16,875 28,937 39,605 55,469 Loans & Advances 53,074 48,642 70,773 56,880 66,055 Other Current Assets Current Liab. & Prov. 107, , , , ,809 Current Liabilities 66,780 68,811 86,034 91, ,556 Provisions & Others 40,948 33,340 51,132 46,253 46,253 Net Current Assets 20,213 20,334 21,291 34,631 57,392 Total Assets 247, , , , ,586 Dupont Analysis Net Margin 7.7% 7.0% 8.1% 8.4% 8.5% Asset Turnover (x) Leverage Factor (x) RoE 14.3% 12.6% 13.7% 14.9% 15.4% Key Ratios BV/Share (INR) ROIC 0.0% 24.1% 33.4% 40.8% 43.2% ROE 14.3% 12.6% 13.7% 14.9% 15.4% Net Debt/Equity (x) P/E (x) P/B (x) EV/EBITDA (x) EV/Sales (x) Debtor days Inventory days Creditor days JM Financial Institutional Securities Limited Page 4

5 History of Earnings Estimate and Target Price Date Recommendation Target Price % Chg. Recommendation History 10-Aug-15 Buy Nov-15 Buy Dec-15 Buy Feb-16 Buy Mar-16 Buy Apr-16 Buy May-16 Buy Nov-16 Buy Feb-17 Buy May-17 Buy Aug-17 Buy Nov-17 Buy Apr-18 Buy May-18 Buy JM Financial Institutional Securities Limited Page 5

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