Volume gains to offset margin pressures for Maruti Suzuki

Long waiting periods for more profitable new models and operating leverage will help the company offset higher raw material costs

The Maruti Suzuki stock has gained about 4 per cent over the past seven days on strong sales in May, expectations of higher growth in 2018-19, and plans to launch electric vehicles by 2020.

While there are headwinds such as higher raw material cost and a weak rupee, which make imports costlier, analysts say these will be offset by the operating leverage (higher volumes) and reduction in discounts as the demand in the sector improves, and a richer product mix. First, comes volume growth, both for Maruti Suzuki and the sector. After reporting single-digit growth for the past few months, the demand for major players in May has been strong on the back of launches as well as capacity improvement at Maruti Suzuki, India’s largest carmaker.

Maruti Suzuki reported 25 per cent growth, its highest in a decade, led by models that have a waiting period such as the Baleno, Brezza, Dzire and Swift, all of which have been launched over the past couple of years.  These account for half the company’s current monthly production of 119,000 vehicles. Analysts say rising discretionary consumption, revival in rural growth and spending, as well as its expanding distribution network will help the company post double-digit growth in the current financial year. 

The company is also firming up plans to roll out its first electric vehicle by 2020 with an electric version of the WagonR, which will be largely manufactured with inputs sourced from the country. 

What will help Maruti Suzuki, according to analysts such as Bharat Gianani of Sharekhan, is its tie-up with Toyota and the latter’s expertise in new technology, especially in the area of electric and hybrid vehicles. Toyota is among the largest passenger vehicle manufacturers in the world, operating in almost all geographies, and has a vast technological pool, which can be tapped by Maruti, he adds.

Among key triggers for the stock is the increase in production volumes, given the robust demand and waiting periods. The company, which is looking to outpace industry growth in 2018-19, expects to increase production in the first phase at its Gujarat plant from 157,000 units in FY18 to 250,000 in the current fiscal year. The second phase of the Gujarat plant is expected to start operations by January next year. Analysts expect order bookings, which stand at 110,000, to go down as volumes ramp up and despatches improve. The street will also keep an eye on margin improvement, given the rising raw material prices as well as the weak rupee. Operating profit margins in the March quarter were down 150 basis points over the December quarter to 14.2 per cent primarily due to commodity inflation, adverse currency impact, employee costs and other expenses. 

A weaker rupee against the Japanese yen increases expenditure for the company as about 18 per cent of the cost is yen-denominated. While some of the costs are one-off, commodity prices continue to be an issue. However, analysts at Axis Capital say that there are multiple levers for the company to offset this.

“Although rising commodity prices and weaker rupee pose headwinds to margins, we believe margins will improve due to scale benefits, internal cost controls, a richer product mix and reduction in discounts going ahead.” 

In addition to these, analysts say higher localisation in the Gujarat plant and lower royalty under the new agreement with the parent should also boost the margins over the next couple of years.  Gianani of Sharekhan says the levers for Maruti Suzuki include price hikes, reduction in discounts, given the higher proportion of new model sales, and a lower royalty outflow. 

Margins are expected to improve by 100-150 basis points over the next two years from the 2017-18 levels of 15 per cent. Most analysts have a buy call as the stock is trading at about 22 times its FY2020 earnings, which is at a discount to its long-term historical average multiples in an upcycle of 25 times.