Mahindra is a classic conglomerate with participation in diverse businesses and multiple end markets. However, we believe the company is well positioned in only one of its main business segments: the farm equipment segment. Even as Mahindra derives more than one third of its operating profits from this segment, the company's positioning in other businesses dilutes overall profitability and constrains its ability to generate sustainable economic profits. Return on invested capital has trailed the company's cost of capital in three of the past six years and we expect a similar trend in the future as well.
Growth in the Indian farm equipment industry has been driven by priority lending status accorded to tractor financing (attracting lower interest rates), a good monsoon season over the years (increasing farm productivity), successful implementation of the National Rural Employment Guarantee Act (leading to fewer available farmworkers), and higher minimum support prices (causing enhanced rural income). However, Mahindra, the market leader for the last 28 years, has outpaced the industry's growth through a combination of organic and inorganic growth. The company's acquisition of a majority stake in one of its competitors, Punjab Tractors Limited, increased Mahindra's already dominant domestic market share from 30% in fiscal 2008 to more than 37% in fiscal 2009. Increased spending on research and development has led to the introduction of newer models in the sub-20 horsepower category and over-50HP category. This, coupled with good replacement demand in the mid 31HP-50HP categories, has further augmented Mahindra's market share to 42% in fiscal 2011. These initiatives have also helped Mahindra fend off competitive pressures from local rivals Tractor and Farm Equipment, or TAFE, and global majors Deere & Company DE and New Holland CNH, and aided operating margin growth from 11% in fiscal 2007 to 15% in fiscal 2011. Even though we do not expect the tractor industry to grow at the historical CAGR of 20%, we believe Mahindra is best positioned in the domestic market. It has a solid reputation, a strong dealership network of more than 1,000 dealers (20% more than the nearest local competitor) and a healthy relationship with end users to benefit from the estimated 10% growth in our forecast.
Mahindra has a niche and limited presence in the Indian automotive industry. It is the leader in the diesel-powered passenger utility vehicle segment, with a market share of 53% in fiscal 2012. Its key models, Bolero and Scorpio, and the new Xylo and XUV 500, have the potential to enable Mahindra to keep its lead in this segment. However, this segment accounts for only about 14% of the total Indian passenger vehicle, or PV, market, thereby affording Mahindra only 8% of the overall domestic PV market. The company's 2011 acquisition of SsangYong Motors, the almost bankrupt South Korean SUV and luxury car manufacturer, was intended to increase the company's geographic footprint and gain further SUV technological expertise. However, we expect continued losses at SsangYong to result in a decline in Mahindra's operating margins in the near term. Among domestic commercial vehicles, or CVs, Mahindra holds second position in the light CV segment. However, we expect increased competition from local rivals Tata Motors TTM and Ashok Leyland ASHOKLEY, as well as global OEMs Daimler Benz AG DAI and GM GM to limit Mahindra's future growth in this segment. At the same time, cyclicality of demand, low switching costs for its customers and high operating leverage in this business pose a serious challenge in the long run to earn excess economic profits.
Mahindra participates in the Indian Information Technology sector through Tech Mahindra, or TML. TML will be fifth in the Indian IT industry after its proposed fiscal 2013 merger with Mahindra Satyam, or MS (the erstwhile Satyam Computers Services). But TML's exposure to a few big customers, leading to constant pricing pressures and MS' legacy issues, constrain our enthusiasm for the company's future growth. Mahindra also has a strong presence in the Indian rural and semi-urban finance market through its subsidiary, Mahindra and Mahindra Financial Services Limited, or MMFSL. Although this business has more than doubled in the last four years and we expect continued strong growth for its products and services, it accounts for only 15% of Mahindra's overall operating income, thereby limiting any significant contribution to Mahindra's future operating profits. The company's other business forays into hospitality, infrastructure, engineering and auto components, steel trading and processing, defense equipment, aerospace and many others altogether account for about 15% of its revenue and less than 10% of its operating profits. Although we expect these businesses to grow in the near term, we do not expect Mahindra to gain any long-term structural advantage from them.
