We view demonetisation as a two-quarter bump in India’s nascent car recovery theme; cut FY17e EPS by 8%. MSIL trades at 15.9x FY19e P/E. Demand for its new models remains strong; we would use any weakness in the Nov/Dec sales print to buy.
Wealth Destruction vs Disruption, take a more conservative stance
From not having enough capacity, the street now fears that MSIL may not have enough demand. The demonetisation move has led to wealth disruption and wealth destruction. We think the disruption hit is in the price but it is difficult to estimate the demand destruction/delay impact; thus in this note we take a conservative view on MSIL’s volumes and highlight EPS across different scenarios. We expect the next 3 months to see sharp declines in sales. MSIL’s domestic car sales are up 11% FYTD17 and our 1.5% FY17 growth implies an 11% decline for the rest of the year.
FY18 Outlook — 6% growth in run rate vs FYTD17
Build average of 125k domestic sales in FY18e, ie 6% higher than the FYTD17 run rate, and this leads to domestic sales of 1.5 million units, or 13% y-o-y growth. We think this is feasible as: (i) models like Baleno and Breeza have 4 months orderbook; (ii) MSIL plans to launch Ignis in Jan 2017; and (iii) MSIL intends to launch more hybrid and AMT variants. JPY has depreciated against INR by 4.5% in past month and this is favourable for MSIL. We believe Yen weakness will help MSIL offset some of the pressures arising from commodity costs and expect an 11.3% FY18 Ebit margin vs 11.5% in FY17. We cut earnings by 8%/6%/7% for FY17/18/19e. We now value the stock at 19x FY19e vs 20x earlier, which is supported by our DCF valuation.
Valuations, in line with median in FY19
MSIL now trades at 19.8x 1-year forward P/E, a 24% premium to its 12-year median. We maintain our underlying assumption that a gradual recovery in the Indian car market will continue and thus multiples will remain at a premium. The two-year forward P/E is at median multiples and as visibility on recovery improves we expect multiples to re-rate. Permanent derailing of nascent car recovery remains key downside risk.
If we build in a three-month impact on sales the FY18 run-rate looks similar to the April-September 2016 run rate: It is difficult to assess the demand destruction post demonetisation so we take a conservative view and expect a 125k average run rate in FY18; this implies growth of 13% on a y-o-y basis. Exports should pick up for MSIL driven by a good response to Baleno. Lower sales expected for FY17-19 pull down our earnings estimates.
EPS and PT cut
We cut our EPS estimates by 8%, 6% & 7% in FY17e, FY18e & FY19e, respectively. The cuts are primarily driven by volume cuts. Our PT (linked to our base case) is cut 11% — the cut in our PT is more than the cuts in EPS as we lower the target multiple to 19x vs 20x previously to factor in the uncertainty prevailing after the government’s move. The target multiple remains at a premium to the 12-year average median multiple of 16x; however, as we believe the Indian PV cycle is just picking up and given Maruti is gaining market share it should continue to outperform peers, show handsome bottomline growth and command premium multiples.