With its early-mover advantage in the Indian market, Maruti is a dominant player in the domestic passenger car market with a 50% market share. We rate Maruti shares Buy. Over FY10-12E, we expect the Indian car market to resume growth at the trend rate of 12-15%, driven by low penetration levels, resumption of financing and a decline of 10% in the overall cost of ownership. Maruti is best positioned to benefit from this growth, in our view, given its dominance in the domestic car market. The company?s rising penetration in the diesel car market gives it a more balanced product mix than two years ago, while export initiatives will reduce its dependence on the domestic car market. We estimate earnings and cash earnings CAGRs of 43% and 33%, respectively, over FY09-12E, driven by unit sales CAGR of 17% and margin expansion.
Valuation: Our target price for Maruti of Rs 1,707 is based on 13x Mar FY11e cash earnings (CEPS = PAT + depreciation). At 13x (earlier 13.5x) we value MSIL at 30% over its historical average of 10x. We have cut it from 13.5x to 13x as market multiples have also declined commensurately over the last four months and we think that MSIL?s relative premium to the broader Sensex should continue with recent past levels. We estimate cash earnings CAGR of 33% over FY09-FY12E, which should support valuations, in our view. On our target multiple, Maruti would trade at FY11E P/E of around 17x (broad market is 15.5-16x). We prefer price/cash earnings as a valuation metric for the automobile sector, given the industry?s high capital intensity (both in terms of capacity and product development).
Risks: We rate Maruti Low Risk. This is below the Medium Risk suggested by our quantitative risk-rating system, which tracks 260-day historical share price volatility, but warranted by improving macro trends for the auto sector, in our view. Upside risks that could prevent the stock from reaching our target price include, greater than forecast increase in volumes and realisations and decline in competitive intensity. Downside risks include, sales of passenger vehicles are sensitive to economic variables with an
appreciable rise in interest rates potentially hitting volume growth across the auto sector, revised emission and safety norms could bring cost pressures, competitive pressures in the Indian market continue to increase, which could impact margins over the longer term and higher than forecast increase in commodity costs.
Con call takeaways: The company has increased its dealership network by almost 18% (from last year?s 680 to 802 this year) and, as per our discussions with the management this number could grow to c1,000 dealers in next two years. Management is optimistic that, with this wide network, it could grow rural demand by almost 100% in FY11. The cost pressures have been building up on the commodity front. This is reflected in the ~170 bps increase in the material cost/sales ratio. However, management has said that almost half of it is due to the cost incurred in the shift from BS-III to BS-IV emission norms engines. Maruti now has all of its vehicles conforming to the BS-IV norms except the Maruti 800 and Gypsy, which are manufactured on contract basis.
Q4FY10 results disappointed mainly on the back of below-expectations Ebitda margins, which could be attributed to higher material costs. This Ebitda margin contraction resulted in PAT coming in below expectations.Though the results were below expectations, we maintain our buy on the stock. Given recent underperformance of the stock, we believe that the volume surprises in 1Q and 2Q are yet to be reflected in the stock price.