Maruti Suzuki: No brake on momentum

Near-term concerns of a firm yen and cost pressures may cap upsides, but the company’s longer-term prospects remain good, making it a value pick.

It’s only in uncommon circumstances that prices of bellwether stocks touch attractive levels. That’s what has happened to Maruti Suzuki’s stock. Ever since the macro environment changed, with interest rates and raw material prices looking up, the market sentiment has turned weak. Maruti, too, has seen its margins coming under pressure, leading to underperformance of its stock. The Japan crisis only accentuated worries, resulting in Maruti’s stock touching a 21-month low of Rs 1,171 last week.

While bargain hunting has pushed the stock up 12 per cent since then, compared to an 8 per cent rise in Sensex, the question is whether this rise is sustainable? It may be difficult for the stock to keep rising from current levels in the near term, given the cost pressures, but the downside, too, seems limited. The stock is currently trading at 8.5 times enterprise value to Ebitda multiple and a 9.1 times cash EPS, based on 2011-12 forecasts (discount of 18 per cent to past-five-year averages), wherein analysts believe valuations are attractive for value investors to buy from a year’s perspective.

NEAR-TERM CONCERNS
As crisis struck Japan, causing the yen to appreciate, Maruti’s stock dipped on concerns of the company’s payouts increasing, as 9-10 per cent of the components in its vehicles are imported from Japan. This year (nine months to December 2010), margins are already down, due to the rising yen, forex volatility and higher input costs. Also, Maruti is expected to pay a royalty of Rs 15,695 for every vehicle it sells in 2011-12. The royalty payout would change by Rs 157 per vehicle for every 1 per cent appreciation in the Japanese yen.

STABLE GROWTH
In Rs crore	9MTH FY11	% chg y-o-y	FY11E	FY12E
Sales	26,394	26.8	35,876	41,654
Ebitda (%)	11.4	-349 bps

10.4 10.7 Net profit1,629-11.52,3692,789 EPS (Rs)56.4-11.581.996 E: Estimated                                                     Source: CapitaLine Plus, Bloomberg

Although Maruti (and other car makers) has raised prices recently, with another increase expected in April, margins are likely to remain under pressure in March quarter and for 1-2 more quarters, feel analysts.

VOLUMES HEALTHY
Until recently, each time a leading global auto major announced its India plans, auto analysts rushed to downgrade Maruti’s stock. No matter what the company claimed, analysts maintained that competition would erode the company’s leadership in the passenger car market (53.2 per cent market share).

Manufacturers like Toyota and Honda, who entered the Indian market more than a decade ago, are now preparing to tap compact car segment, which accounts for three-fourths of the market, by launching their first compact cars targeting the mass market. On the other hand, new entrants like Volkswagen and Nissan have already launched compact cars. However, despite rising competition, Maruti has sustained a good growth rate of 24.5 per cent in 2010-11 (year-to-date), reflecting that it is capable of withstanding competitive pressures. In February alone, the company posted stable 15.5 per cent volume growth year-on-year and 1.7 per cent month-on-month to 111,645 units — its third highest monthly volumes ever. This came as a positive surprise for analysts, as they had been writing the company’s market-share obituary for a while now.

Fundamentally, the company is likely to enjoy a leadership position in the Indian car market for the foreseeable future. According to last month’s report by Daiwa Securities, Maruti may not be the only company to lose market share as a result of rising competition. Analysts at Daiwa believe Hyundai Motor India, General Motors India and Tata Motors (not rated) are equally at risk, though they believe the combined share of Maruti, Hyundai Motor and Tata Motors would still exceed 75 per cent by 2014-15, compared with around 85 per cent currently. According to analyst forecasts, Maruti’s market share will decline, albeit marginally, by 3.1 per cent by 2014-15.

GEARING FOR HIGHER SALES
One of the biggest issues that the company has addressed is debottlenecking production. It has improved productivity and production efficiencies by 30 per cent, without making any extra capital expenditure. By next month, the company will have a run rate of 1.4 million cars a year. By the first half of 2011-12, additional capacity of 250,000 cars will come up in Manesar and another 250,000 by 2012-13. Apart from expanding capacity to capture incremental demand, the company has been launching new products/variants as well, with more to come.

“Maruti’s planned launches over the next 12 months look competitive to us, and we expect them to improve going forward,” noted Daiwa Securities’ analysts. Overall, analysts expect the pressure on margins of automakers to start receding in 1-2 quarters, and demand to pick up, as interest rates soften in the second half of 2011 calendar year. They project the company’s sales to grow 16 per cent, and net profit to rise 18 per cent during 2012-13. At Rs 1,263.55, the stock trades at 13.1 times the 2011-12 estimated EPS.