Maruti: Favourable product mix more important than before

Its Q4 show points to an intense competitive landscape that possibly prevents it from hiking prices

Sales volumes defied note-ban blues, but results point to the increased competitive landscape for Maruti Suzuki, something possibly holding off full-fledged prices hikes that are needed to pass on cost increases. Consider the metrics: Even after revenues grew 20 per cent year-on-year in March quarter (Q4) to Rs 18,005 crore, topping expectations, net profit grew 15.8 per cent to Rs 1,709 crore, lower than Bloomberg consensus estimate of Rs 1,771 crore, and the slowest net profit growth in FY17. 

A large part of the pressure may be down to operating profit margin or profitability taking a hit in Q4 due to rising costs of inputs such as steel, aluminium, rubber, and costlier yen compared to the rupee. So, even as Maruti reduced other costs or improved scale, it did not arrest the fall in profitability. While a few analysts believe the dip in profitability was expected as commodity prices were increasing since September 2016 quarter, a decline of 120 basis points in operating profit (Ebitda) margin to 14.2 per cent from a year ago caught a few by surprise. They had hoped that premium products such as Vitara Brezza, Ignis, and Baleno, which continue to enjoy six-eight months waiting period and earn higher margins, would support profitability. Although start-up expenses of its new Gujarat plant stood at Rs 120 crore going by estimates, the cost of raw materials as a percentage of sales stood at 69.6 per cent in Q4, 69.2 per cent in the previous quarter and 66.1 per cent in the year-ago period, estimates Emkay Global.

In FY18, the Gujarat plant could also weigh on profitability, because the plant has a production capacity of 250,000 units per year, but given the management expects only 150,000 units, it is likely to operate at 60 per cent. 

Overall, investors have to tone down their expectations on operating profit margin. “FY18 margin may be lower than those in FY16 and FY17 because of all the cost pressures ahead. But, the pressure should not be significant given the car maker’s ability to implement a price hike whenever necessary. Ongoing cost-control measures should also aid margin,” says Arun Agarwal of Kotak Securities. 

Analysts, however, add that if foreign exchange (forex) fluctuation gets more pronounced, profitability could come under more pressure. Currently, the forex part doesn’t look fully factored in Street estimates. Nonetheless, analysts believe as long as Maruti maintains its operating profit margin in the historical band of 11-12 per cent, investors will have nothing to worry. They believe a higher sales contribution by premium products is necessary and will aid profitability. 

“However, slower growth means stock valuations Maruti has been commanding in the past two to three years may get readjusted,” says an analyst. Nonetheless, he says the stock may not go out of favour given its strong positioning as a consumption stock. Maruti's ability to hold over 47 per cent market share in the passenger vehicles segment also supports the investment rationale. And, as demand improves, some of these concerns will evaporate. For now, in the light of the 20 per cent gains this year, investors may use price correction for fresh exposure in the stock.