1. Maruti Suzuki gets ‘Hold’ rating; HSBC expects a strong Q2 preview

Maruti Suzuki gets ‘Hold’ rating; HSBC expects a strong Q2 preview

We expect Maruti to report a strong Q2, reporting margin expansion of 90-100 bps q-o-q. While YEN is adverse, the impact will not be significant and more than offset by operating-leverage, pricing increase and better mix. (i) YEN appreciated in the quarter by 4% on average.

By: | New Delhi | Published: October 15, 2016 6:05 AM

We expect Maruti to report a strong Q2, reporting margin expansion of 90-100 bps q-o-q. While YEN is adverse, the impact will not be significant and more than offset by operating-leverage, pricing increase and better mix. (i) YEN appreciated in the quarter by 4% on average. However, quarter end rates have not moved much. Consequently hit from royalty increase will be limited. Also, increase in Baleno exports will offset the direct import hit. Overall currency impact should not be more than 50-60 bps. (ii) Positively, the company took a price increase in August and also sold 70K more vehicles than Q1. Collectively, pricing increase and higher volumes should add 150-200 bps margins. Mix improved as well in the quarter. (iii) Finally commodities have not moved much in Q2 and should not have a material impact on Q2 margins.

dsfStrong business vs Expensive Valuations: Maruti’s strong competitive positioning in the Indian car industry is well acknowledged. We have also been positive on the business of Maruti. In our recent note we highlighted that Maruti enjoys a ‘virtuous cycle’ of strong product portfolio leading to cross-selling opportunities, which leads to scale benefits and higher resale value. However, the stock is priced to perfection, in our view, for the next 12-24 months. As seen in the table above, the stock factors in ~10% volume growth and 15% earnings CAGR over the next 10 years. Last cycle average PE for Maruti is 16x, and even after adjusting for the lowered cost of equity, the stock leaves little scope for positive surprise.

Valuations and estimates: We have raised our TP to R6,000 (from R5,500) as we factor in a recent reduction in cost of equity by the HSBC global equity strategy team and also better margins by Maruti in the coming years. For FY18/19 we raise our earnings by 3-5% largely led by better than expected recent sales performance.

Q2FY17 Preview

The company sold nearly 418.5K vehicles in the quarter ending September 2016 (Q2FY17), a growth of 18% y-o-y and 20% q-o-q. This is the highest ever quarterly sales for MSIL with nearly 45K units more than the previous peak volumes in Q3FY16 (374K units). The strong volume growth in Q2 is partly helped by early

festive season. Additionally, increased sales contribution from Ciaz, SUV segment and Baleno should further improve mix and offset the impact from higher proportion of mini segment cars in our view. We expect average selling price to increase by 1.5% q-o-q led by mix improvement and price hike taken by the company in the month of August. Overall we expect revenues to grow nearly 32% y-o-y led by volume growth of 18% and 14% improvement in realisations.

Valuation and estimates Maruti’s strong competitive positioning in the Indian car industry is well acknowledged. We have also been positive on the business of Maruti. In our recent note we highlighted Maruti enjoys a ‘virtuous cycle’ of strong product portfolio leading to cross-selling opportunities, which leads to scale benefits and higher resale value.

However, the stock is priced to perfection, in our view, for the next 12-24 months. The stock already factors in 10% volume growth and ~15% earnings CAGR over the next 10 years. Last cycle average PE for Maruti is 16x, and even after adjusting for the lowered cost of equity, the stock leaves little scope for positive surprise. We therefore believe upside to the stock price is likely to be limited.

We value the company using a DCF methodology. The HSBC global strategy team has lowered the cost of equity for India from 9.5% to 9%. Consequently we lower global risk-free rate to 2.5% (from 3%), and maintain a market risk premium of 6.5% and a WACC of 10.3% (from 10.5%). Our DCF analysis factors in a

CAGR of c10% volume growth over the next 10 years accounting for the increasing penetration of passenger vehicles in India. We marginally revise our FY18e earnings to factor in better than expected volume growth in the past two months and recent price hike. Consequently we raise our TP to R6,000 from R5,500 and maintain Hold rating, with c5% upside to our target price from current levels.

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