We upgrade our rating to Buy from Underperform, and raise PO (price objective) to Rs 1,720 (23% upside potential) from Rs 1,369. Our estimates are 8%-18% ahead of street over FY12-13E, and a non-consensus call driven by: (i) revision in standalone profit forecasts by 9-19% over next two years, due to increased sales visibility given the recent launch successes and easing of capacity constraints, and (ii) rising contribution from subsidiaries and associates (about 8%), now part of PO.

Contrary to consensus view, we expect Maruti to maintain the market share on the back of (i) Alto K-10, Eeco , and stronger demand for the Swift Dzire upgraded K-series engines, despite competition, (ii) introduction of CNG vehicles on popular models, and (ii) likely entry into the premium segment next year. The management has also scaled up expansion plans by about 25% vs earlier target. We, therefore, raise our estimate of domestic growth to 21% CAGR (compound annual growth rate) over FY10-13E, from 13%.

We believe 8.9% Ebitda (earnings before interest, taxes,depreciation and amortisation) margin in Q1 FY11 was near trough. Notwithstanding the currency-related impact in H2, we maintain assumptions over FY12-13E, due to (i) operating leverage on stronger volumes, (ii) favourable sales mix (i.e. local, model shift) and (ii) better price realisations.

We expect the stock to revert to premium rating on (i) strong sales-led profit growth of 24% CAGR, which we believe will lead to consensus upgrades, and (ii) being a proxy to passenger vehicles, the only listed pure-play in the fastest growing segment.

Our upward revision to rating is driven by: (i) increased sales visibility after (a) recent launch successes, such as of Alto K-10, Eeco, (b) scaled-up expansion plans that lower apprehension over capacity constraints; (ii) likely margin expansion due to operating leverage, better mix and realisations; and (iii) stock underperformance leading to attractive valuations.

Standalone profit estimate has been lowered by around 1% this year on margin pressures due to currency fluctuations. We, however, raise forecasts by 9.4% in FY12E and 19.4% in FY13E, despite pruning margins by 20-50 bps (basis points).

We sharply raise assumptions of car volumes, mainly driven by a revision in domestic sales growth to 25% in FY11E and 20% in FY12E (earlier 18% and 12%, respectively). Export growth has been slightly lowered to reflect global trends.

Our profit estimates are ahead of the street by 8% in FY12E and 18% in FY13E, which is due to stronger volume assumptions. We expect consensus upgrades on expected volume surprise.

We believe the earnings trajectory has bottomed in Q1. We expect strong volumes to more than offset the restrictive impact of margins due to currency and cost-competitive pressures.

Maruti has financial interests in several auto-related ventures, including Suzuki Powertrain India (30% ownership), which supplies diesel engines to fast-growing models such as Swift, Dzire Ritz, well as transmission components to drive localisation of the parent. Following operational turnaround last year, we expect business scale-up to further benefit these entities. Over the next three years, we estimate 7.4% net profit contribution from subsidiaries, joint ventures and associates. As a result, our forecasts are now based on consolidated operations.

Buy for 23% potential upside: Historically, Maruti stock has tracked sales and earnings growth, rather than the market share. Multiples expand during periods of strong sales on expectation that profits will follow.

On a one-year forward basis, the stock trades close to its P/E (price-to-earnings) average of about 14x (times). We expect reversion to premium valuations on the back of: strong sales performance, with stable-to-improving market share trends Vs consensus expectation of loss; and proxy to autos in India.

We have assessed potential for the Indian passenger vehicles market using different methods and come to a similar conclusion. Over the next five years, we forecast car demand to register 19-20% annual growth, and sales to increase from 1.9 million last year to 4.6 million by 2015.

Per-capita income method: Income elasticity drives higher car ownership when per capita income crosses the inflection point of around $3,000, adjusted for purchasing power parity. For instance, China?s vehicle ownership (per million person) grew 30.4% annually during 2002-2007 (1,265 to 4,767) when per capita income grew from $2,900 to $5,400.

In India, IMF data suggests $3,000 threshold to be crossed in 2010 and at $4,800 by 2015. Based on income elasticity rates of China, we forecast India?s vehicle ownership (per m person) to grow by 19.7% and car demand to register 21.3% annual growth over the next five years, and sales at 5 m for 2015 from 1.9m.

Competition will be overcome: Maruti faces new competition, in small cars (minis/compact hatchbacks) and entry level sedans (collectively 77% of sales). Although most launches have fared well, only Ford Figo is a surprise success. Influx of models, however, has resulted in strong YTD (year-to- date) growth of 34% in the Indian passenger vehicle market.

Over the past year, Maruti?s market share is down just 78 bps (to 47%), whereas Tata Motors and Hyundai have collectively lost 126 bps (basis points). We believe this is a fair refection of likely future trends. Contrary to the consensus view of structural decline, we expect Maruti will be able to protect its domestic market share over the next three years. It has a comprehensive plan to raise production capabilities and enrich the product portfolio.

Capacity constraints to ease: Maruti?s capacity of 1.2m i.e., 100,000units/ month is being fully utilised on a doubleshift basis. The company has announced plans to raise production capacity by 10% from H2 through debottlenecking; and start another unit in Manesar, for 250,000 units (+15%).

Stronger balance sheet: Maruti has consistently enjoyed a debt-free status and funded all capex and investment via internal generation. We expect the company to remain FCF (free cash flow) positive during our forecast period and cash surplus to rise to Rs 100 bn by end-FY12E (25% of market capitalisaton).

Our PO of Rs 1,720 is based on sum of core business at 15x FY12E P/E at Rs 1,375/share and cash and equivalents at Rs 345/sh. At this PO, the stock would trade at 16x FY12E P/E, a 20% premium to historical average.