Question mark on full utilisation of diesel engine capacity

Maruti is the top pick for us in the sector. However, we highlight the risk of lower diesel car sales on Maruti?s profitability. We estimate diesel cars account for 45-50% of Maruti?s total gross profits, more than twice the contribution of petrol cars. We have so far factored in full utilisation of diesel engine capacity in FY14e (estimates) but believe that there are increasing risks to that assumption.

Increasing risks to dieselisation: It has been our view for some time now that the furious increase in dieselisation seen in the last few months is not sustainable. We are even more convinced now, as the government has put the fear of constant increase in diesel fuel price in the minds of the consumer ? this is likely to change the perceived cost of ownership even if the government doesn?t end up sticking to its path.

Maruti?s has executed well in diesels but assumptions at risk: Maruti has executed phenomenally well in the diesel segment, despite the group not having its own diesel engine technology. Its share in the diesel passenger vehicle market is at an all-time high (25%). Maruti?s diesel models dominate the price segments they operate in. We forecast diesel car sales of 400k in FY13e and 470k in FY14e, inherently assuming Maruti sells almost all diesel cars it can produce? an assumption we make because demand still outstrips supply as of now but an assumption that is increasingly at risk.

Why is that a problem? Maruti?s share in petrol market (55%) is much higher than its share of diesel market and thus a shift in demand back to petrol will likely help Maruti gain share. Moreover, pricing pressure in petrol car segment might ease with improving demand. While this may hold true in the longer-term, the transition period may not be as simple in an environment of depressed demand. Loss of diesel demand need not necessarily translate to gains for petrol market or may not necessarily be accompanied with better pricing power.

In our view, Maruti?s diesel cars generate gross contribution 3-4x (times) that of petrol cars. We estimate diesel cars will account for 34% of volumes, 44% of total net sales and nearly 50% of total gross contribution in FY13e and thus a fall in diesel demand will likely hurt in the short-term. At current profitability, 1% lower sales of diesel vehicles will impact EPS (earnings per share) by 1.3% while 1% higher sales of petrol vehicles will boost EPS by 0.7%.

Valuation/risks: Our core thesis on Maruti remains intact. Competitive pressures in the space Maruti operates in is likely to ease significantly and the company is well set to regain some of the lost market share. With currency headwind turning into a tailwind, margins will likely bounce back. At 13.7x FY14e, we maintain the rating with target price of R189.

Jefferies

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