Operating leverage likely to boost margins; rise in first-time buyers a positive; upgraded to ‘Buy’ with TP up to Rs 7,500 from Rs 6,100
As the economy normalises and hopefully starts to grow positively in FY22, upgrade demand may augment industry growth as well.
As discussed in a July note, we expect significant pent-up demand from the lockdown months to lead to a strong festive season. Importantly, the first-time buyer ratio continues to rise, especially in Tier 2 and 3 cities, which would imply that a demand revival should be sustainable. This bodes well for Maruti, as its share of cars priced at less than Rs 1 m is 60% vs the overall market at 50%. As the economy normalises and hopefully starts to grow positively in FY22, upgrade demand may augment industry growth as well.
Regionally, the North and Central of India have been doing well since the easing of the lockdown measures, and in the past few weeks, the South and West have started to perform better as well.
As volumes normalise, operating leverage will likely remain the biggest tailwind for margins: Utilisation trends for Maruti show that some of its fixed costs, like employee costs, are much higher than historical averages and, hence, may come down notwithstanding the volume outlook. Royalty costs may come down as well, but these are not material in the context of the equivalent rise expected in its R&D spend.
The absence of a diesel portfolio is set to be a margin headwind in the near term. We are not worried about down-trading of demand as it should be more than offset by lower discounts.
Value vs volume market share remains our medium-term concern: The past few years have all been about Maruti’s dominance. While the market wasn’t growing, Maruti expanded its market share. It now seems the problem has reversed a bit for the foreseeable future. While the PV industry looks to be recovering swiftly, Maruti’s “value market share” appears a concern. MSIL has a volume market share of more than 50% but a value share of c40%, on our estimates.
If the Kia Sonet is a success, which is quite likely, Renault launches a successful sub-4-metre SUV and Tata holds on to its 8-9% market share, Maruti would likely find it tough to even hold onto its current value market share.
Upgrade to Buy and lift TP to Rs 7,500: MSIL is trading on 25x/21x FY22/FY23 EPS. While this appears expensive on an absolute basis, the premium is in line with that for the past five years relative to the market. Our outlook for a rise in first-time buyers and mean reversion in demand in the coming years drive our upgrade.