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Racing Ahead

Maruti Suzuki stock has a rising car sales graph on positive pricing position

This article appeared in the December issue of Wealth Insight magazine that takes an in-depth look at the performance of auto major Maruti Suzuki and gauges the outlook for the future.

Profile

Established in 1983, Maruti Suzuki India Limited (MSIL) is India’s largest passenger car manufacturing company and offers 13 models encompassing every segment. Its business end includes facilitation of pre-owned car sales, fleet management and financing. The company has four plants, three located in Palam Gurgaon Road, Gurgaon, Haryana and one located at Manesar Industrial Town, Gurgaon, Haryana. During the fiscal year ended March 31, 2009, MSIL produced and sold over seven million cars, and exported more than 500,000. Its subsidiaries are in the car insurance and financing business. 

Promoters

MSIL began as a collaboration between the Government of India (GoI) and Suzuki Motor Corporation of Japan. The success of the joint venture led Suzuki to raise its equity from 26 per cent to 40 per cent in 1987, and further to 50 per cent in 1992. The GoI held an initial public offering (IPO) of 25 per cent in June, 2003. As of 10 May, 2007, the GoI sold-off its complete shareholding amounting to 18 per cent.  Suzuki now owns 54 per cent of MSIL, followed by foreign institutional investors (FIIs) with 22 per cent. 

Investment Rationale

Volumes to be maintained

Strong momentum in volumes is likely to be maintained due to multiple medium-term drivers. For the November-December, 2009 period, volumes are seen stable at  a month-on-month basis of 83-85,000 units/month. Volume growth in November would be driven by inventory filling due to a pre-planned plant shutdown in December. While exports are expected to remain stable at 10-11,000 units/month, volume buoyancy is expected to be sustained (over the next two months) as inventory will get depleted due to the order backlog for models like Swift, Dzire, and Ritz.

Improving Demand 

Increasing sectoral sales have attracted ICICI Bank back into the car financing segment and that will have a push-on effect too. Current credit sales are at 71 per cent (vs 71% in September, 2008, vs 60% in November, 2008). This coupled with recovery in urban markets, which grew by 8 per cent in 2QFY10 (vs 10% de-growth in 1QFY10 and 8% de-growth in FY09) would support volumes in FY11. Deeper penetration of marketing network into rural areas will also drive growth — contribution of rural market at 16 per cent in 2QFY10 is low and is growing rapidly with a 55 per cent growth in 2QFY10 (vs 38% in 1QFY10 and 25% in FY09). 

Price Hike 

Maruti changes prices once a year in January. But, any changes this time would be driven by: 

a) expected roll-back in excise duty; 

b) increase in costs;

c) change in emission norms. 

Given that MSIL already has three models (Ritz, A-Star and Estilo) with Euro IV compliant engines, it could increase prices on these models in January, 2010. For other models, price changes may take place along with up-gradation of engines in non-Euro IV compliant models which would happen around March-April, 2010. Further, discounts from levels of 2QFY10 at Rs 9,700/unit (Rs 9,500/unit in 1QFY10; Rs 12,000/unit in 2HFY09) has a limited scope to fall further.

Risks & Concerns

Incentive Uncertainty 

Concern is being voiced over the fact that out of 13 European Union (EU) countries having an incentive plan, those in eight are expiring in 2009. They account for 63 per cent of the total EU car sales. 

Concern on Commodities

MSIL is negotiating contracts for steel and other commodities, but it would be forced to pay more as prices have jumped 30-60 per cent from the bottom seen in 4QFY09.

R&D Expenses

Strengthening research & development (R&D) will surely pressurise margins. But MSIL has to wait for 2-3 years to benefit from its true potential. Also, to maintain its lead against the competition, MSIL is unlikely to cut R&D expenses.

Forex Exposures

Given significant exposure to forex (Yen imports of 27% of sales and Euro/USD exports of 15% of sales), unhedged forex exposure poses risk to profitability, especially since it would be exposed to three currencies in FY11, including Yen (imports), USD (exports & imports) and EU (exports).

Valuations

Robust volume outlook would drive stock performance in the medium term. With a better macro environment, there are catalysts in the form of improving product mix and higher operating leverage, which would drive profitability and earnings growth for Maruti Suzuki. The stock is valued at 17.3x FY11E EPS.

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