Multiple headwinds override valuation comfort in Maruti Suzuki

While earnings estimates are cut, analysts hint at volume and margin recovery

It was a smooth ride for the stock of Maruti Suzuki for a better part of the last three months. India’s largest passenger vehicle maker posted a return of 27 per cent from its lows in December to its highs last month sharply outperforming its peer index, the Nifty Auto, which delivered a third of this return in this period.

Waning impact of the omicron virus, easing semiconductor supply, strong order backlog and margin gains in the December quarter (Q3FY22) contributed to the improved sentiment. However, the gains evapourated with the worsening geopolitical situation putting at risk the narrative of improving profitability. Operating profit margins had recovered 350 basis points in the December quarter on a sequential basis after registering a decline for five consecutive quarters.

While there is little clarity on the geopolitical front, brokerages are divided on the outlook across key parameters of volumes, margins and market share for the automobile major. The immediate concern for most analysts is the ability of the company to cope up with the surge in raw material prices and the impact on margins which were recovering.

Kotak Institutional Equities and ICICI Securities highlight the risk of commodity costs and the impact they could have on the market leader. Basudeb Banerjee and Pratit Vajani of ICICI Securities believe that the surge in aluminium, palladium, plastics on the back of a 30 per cent increase in Brent crude oil price, if sustained till the first half of FY23, would inflate the total cost of ownership by 20 per cent year-on-year.

This will be the second consecutive year that commodity costs would have risen by the same quantum. Even if Maruti increases prices by 10 per cent in CY22 after a similar increase last year, the hit to gross margin could be about 300 basis points while the impact at the operating level would be 350-400 basis points, says ICICI Securities. Gross margins for the last seven quarters were hovering in the 24-30 per cent range while operating profit margins (excluding loss) were in the 4.2-10.3 per cent band.

While ICICI Securities expects the earnings impact of commodity headwinds for FY23/24 to be in the 4-15 per cent range, Kotak Institutional Equities pegs it higher 11-22 per cent. The rationale of the latter is a 3-4 per cent cut in volume estimates on deferment in replacement demand and thus lower operating leverage and a 120-190 basis cut in operating profit margin assumptions due to raw material inflation. Kotak has a sell rating while ICICI Securities has upgraded the stock to buy on valuation comfort.

While most brokerages have highlighted the commodity pressures, Ambit Capital and Jefferies are betting on volume growth at sector level as well market share gains from new launches going ahead. Say Nitin Mangal and Sagar Sahu of Jefferies, “India's PV industry is recovering from its worst downturn in four decades. We believe the industry is on the cusp of a replacement cycle. PVs offer a healthy long-term growth outlook, given low penetration and high aspiration.”

In their base case, analysts at the brokerage expect Maruti to post a 14-25 per cent volume growth in FY23/24 with operating profit margins set to expand to 9.4 per cent-11.8 per cent in FY23/24. They expect its earnings per share (EPS) to rise from an estimated Rs 111 per share in FY22 to Rs 271 in FY23 and Rs 404 in FY24; Kotak’s FY24 EPS number is pegged at Rs 294.

The other positive is the expectations of a turnaround in volumes led by new launches. Maruti is expected to end FY22 with a market share of 44 per cent, down from 50 per cent levels in FY18-20 due to rising competitive intensity, exit from diesel models and chip shortages. Weak volumes and higher input cost inflation led to a fall in operating profit margins by 630 basis points to 6.5 per cent over the last four years. This, according to Karan Kokane of Ambit Capital, is about to change with the worst of the chip shortage now behind and the company planning to launch new sports utility vehicles in FY23/24. While Ambit Capital expects market share to move back to 50 per cent by FY25, rising scale, consistent price hikes amidst input commodity cost stabilisation and better mix would drive about a three times jump in operating profit over FY22-FY24.

What works for the stock are valuations post the 21 per cent correction from highs last month. At the current price, the stock is trading at 17.6 times its FY24 earnings estimates compared to the long term mean of 25 times, points out ICICI Securities. Given the uncertainties related to the commodity movement and the challenges for Maruti to gain back share, investors should await clarity on both fronts before considering the stock.