Maruti Suzuki Indias (MSIL) Q1 results were in line with margins of 11.7% (consensus: 11.6%, Nomura: 12%). Despite record-high discounts of R21,000 a car (5.7% of ASP), MSIL was able to deliver these margins because of its cost-reduction efforts. After many months of slowdown, the company saw ~13% volume growth in urban markets in June 2014. In our view, the cycle is clearly beginning to turn now and discounts can pull back by 100-200 bps over the next year. Along with the expected revival in the passenger vehicles (PV) industry, MSIL also embarks on a structural change.
With the new R&D centre starting in India, the rollout of products would be much faster. Over the next 12-18 months, we are likely to see the best-ever phase of model launches with products like Ciaz, new LCV & SX4 Cross and the new MUV. It will also enable MSIL to leverage new technology better, e.g. AMT and the smaller 800cc diesel engine being scaled up in other models. Royalty expenses can also start coming down as MSIL gets credit for R&D expenses in India.
The localisation drive would also cut earnings volatility more significantly than earlier. Imports are down to 16% of net sales from a peak of 24% (in part helped by the Japanese yens movement). As imports come down further and match exports, earnings visibility should be even better. MSILs FCF (free cash flow) generation could further improve significantly if shareholders approve the Gujarat deal.
Expect strong recovery in industry volumes over the next 2-3 yearsWe note that the period between FY11 and FY14 was one of the toughest for the Indian passenger car industry in the last 20 years. PV volumes remained flattish during this period, reflecting a tough job environment owing to weaker industrial growth and a steep increase in the cost of ownership. Industrial growth has been quite weak over the last three years, but this has likely bottomed out, in our view. There are already some signs of recovery over the last couple of monthsIIP growth was about 4% in April-May. Historically, there has been a strong correlation between industrial growth and growth in car industrial volumes. With a revival in industrial growth, we expect strong recovery in PV industry volumes over the next 2-3 years. We expect 12% volume growth for the PV industry in FY15 and 15% in FY16/17.
Strong market share performance across all segmentsMSILs market share performance has remained strong over the past year. Its market share in the domestic PV segment was 43.6% in FY14 compared with 41.2% in FY13. This has further improved to ~45% in Q1FY15. As per our discussions with the company, rural markets have been strong growth driver for MSIL there was about 20% volume growth in FY14 and 26% in Q1FY15. As per MSIL management, rural sales now account for more than 30% of the companys domestic volumes, which is quite significant, in our view. As per the company, there has been a strong recovery in entry-segment cars in Q1FY15 as first-time buyer mix has risen to 43% from 39% q-o-q. This is quite positive for MSIL as it has a very high market share of about 70% in this segment. In the hatchback and premium hatchback segments, MSIL has been able to improve its market share led by the continued strong performance of Wagon R and Swift models. Furthermore, we note that despite the launch of Honda Amaze, Maruti has been able to gain some market share in the Sedan segment in FY14. Other smaller OEMs such as Nissan, Volkswagen, and Tata Motors have lost market share to Honda in the Sedan segment.
New model launches to help sustain market shareAt the Tokyo Motor Show held in November 2013, Suzuki highlighted its plan for strong new launches in India over the next five years. As per Suzuki, it will launch 14 new models in India during FY14-18F, which will include small cars as well as more SUV models.
In February 2014, MSIL launched Celerio with the new automated manual transmission (AMT) technologythis has received a strong response from customers with a waiting period of 4-5 months. The company is looking to increase the capacity of the AMT variant over the next year and launch this technology in existing models as well. Over the next 2-3 years, Maruti will embark on its strongest-ever new model launch cycle, there will be 6-7 new launches and most of these will be in new segments like compact SUVs, crossovers, higher-end sedans and LCVs. The new model pipeline gives strong growth visibility and will help MSIL sustain its high market share in India.
Over the last two years, competitive intensity in the PV segment has come down the HHI index for the industry has increased to 2,364 in FY14 from 2,134 in FY12 (higher number indicates greater concentration and less competition). We have noted a considerable decline in the new launch pipeline by competitors over the last 1-2 years as compared with a slew of new launches in the FY10-11 period.
On the contrary, in the two-wheeler segment, competitive intensity continued to increase over the last 2-3 years, led by the aggressive expansion plans of Honda Motorcycles (HMSI).
Given a strong product cycle, we raise our volume growth estimates to 13% for FY14 and 18% for FY16F (up from 11.5% and 14.3%). We also raise our target multiple to 17x to capture above structural changes in business profile.
Catalysts: Strong volume growth from July onwards, new models, falling discounts and shareholders approval of the Gujarat plant deal.
Valuation: Target price of R3,025 based on 17x FY16-17F average consolidated EPS of R178.