Maruti: The heat is on

Withdrawal of discounts on Suzuki components to cost Maruti dear

Cost pressures have finally caught up with Maruti Udyog. The company reported a flat year-on-year trend in operating margin for the June quarter.

In comparison, last year, when most auto companies struggled with high raw material costs, Maruti had reported a 260 basis points improvement in margin.

But considering that volumes had declined by 1.4 per cent last quarter, it's commendable that the company has maintained margins.

Analysts had expected the company's profitability to fall marginally owing to a drop in margins and because of cost pressures.

Thus far, Maruti has contained its costs well - raw material expenses fell 60 basis points last quarter.

Also, while things have been bleak on the volume front, average price realisation has risen by 7.5 per cent year-on-year, thanks to a better product mix and because of price increases taken.

As a result, both net sales and operating profit increased by about 6 per cent. Growth in net profit was much higher at 32.5 per cent thanks to a 34.4 per cent drop in depreciation. Maruti's depreciation has been declining since the December 2004 quarter mainly because of a decrease in written-down value of its fixed assets.

What's more important is that the rise in operating profit was just 6 per cent. To ensure profit growth improves from current levels, it's pertinent that volume growth returns. Volumes were hit last quarter only because of a drastic drop in sales of Maruti 800.

With the company having cut prices of the Maruti 800 by about 7-8 per cent last month, its volumes are expected to inch up from current levels of 6500 units a month.

This, coupled with sales of the newly introduced 'Swift' should help reverse the trend in volume growth. On the cost front, however, the company could take a hit owing to the withdrawal of discounts offered by Suzuki on components imported from it by Maruti.

True, with an increase proportion of localisation and since the peak import duty has decreased, the impact would be reduced. But these factors may not fully offset the hit.

But even if there are negative surprises on the volumes and cost front going forward, the fact that Maruti trades at less than 13 times estimated FY06 earnings means that the impact on its stock price would not be much.

Apollo Tyres

Given the speed at which rubber prices have been rising, the thing to look out for in June results of tyre firms was how well they've managed the increase in costs of this key input. By that yardstick, Apollo Tyres hasn't done too badly, managing to post a rise of 7.2 per cent in its profit before tax.

The key cost, consumption of raw materials, as anticipated, rose 14.6 per cent to Rs 356.6 crore last quarter and even as a percentage of net sales, it rose 140 basis points to 62.78 per cent.

However, with the company retaining about half of the reduction in excise duties announced in the Union budget, the hit on profitability wasn't worse.

The budget had reduced excise duties on tyres from 24 to 16 per cent. As a result, excise duties paid by the company fell 23.6 per cent in the last quarter and it helped net sales expand 12 per cent to Rs 568 crore.

Tyre companies also partially offset higher input prices by raising product prices by about three per cent a couple of months earlier.

A larger turnover helped operating profit rise 10.6 per cent to Rs 53.1 crore last quarter, but input costs led operating profit mar-gins to shrink slightly to 9.34 per cent.

Going forward, with rubber prices showing no signs of easing, margins of tyre companies are not expected to improve in the short run.

These concerns led the stock to fall about 1.8 per cent in contrast to the buoyancy witnessed on the street on Friday.

Siemens

Siemens reported a drop in growth rate last quarter compared to the previous two quarters. Operating income grew 33.6 per cent to Rs 612.6 crore in the June quarter, which is the third quarter for the company.

In comparison, operating income had increased 56.7 per cent in the first six months of the fiscal. Even profit growth fell to 18.1 per cent at the pre-tax level, compared with a 62.4 per cent in the six months ended March 2005.

Operating margin fell by 216 basis points last quarter, again in contrast with the 170 basis points gain reported in the first six months.

Interestingly, the drop in margin was not on account of rising raw material cost.

These expenses actually fell by 250 basis points as a percentage of operating income. Steel prices have been easing over the last few months and it appears to have helped the company manage this cost better.

Margin fell because of a 430 basis points jump in 'other' costs, which is surprising because these expenses had been reduced by over 300 basis points in the first half of the company's financial year.

While revenue growth has dipped from earlier levels, it should continue to be in strong double-digits, given the company's strong order book.

Nevertheless, it's the company's ability to manage costs that will be the key to improving margins and driving earnings growth.

With contributions from Mobis Philipose and Amriteshwar Mathur.