Sell rating to Maruti Suzuki shares: Ambit Capital

Updated: February 3, 2015 1:23 PM

Declining diesel mix and competitive pressures to tell on future margins

Maruti Suzuki’s Q3 results, after adjusting for one-offs, were marginally ahead of our expectations. The higher-than-expected realisation in Q3 makes us upgrade our Ebitda margin estimates by 18-20 basis points for FY15-17e. Overall, we upgrade our net earnings estimates for FY15e/16e/17e by 4% each. Whilst we expect Maruti to benefit from the cyclical passenger vehicle (PV) demand recovery in FY16, increasing competitive intensity would restrict further market share gains.

The yen depreciation relative to INR would help Ebitda margin improve from 12.0% in H1FY15 to 13.7% in H2FY15 and further to 14.2% in FY16/FY17; however, the declining diesel mix and high discounts are likely to disappoint most consensus margin upgrades (average 15-15.5% for FY16/FY17).

The upgrade to our net earnings estimates coupled with the roll forward of the DCF (discounted cash flow)—based TP (target price) date to Feb 2016 (from Jan 2016) lead to an increase in our SOTP (sum-of-the-parts)-based TP to R3,100 (R3,000 earlier). The stock is trading at 17.9x FY17 earnings vs the historical average of 15.0x. We retain Sell.

Results overview: Maruti Suzuki’s Q3 revenues increased by 15% y-o-y and 2% q-o-q. The revenue performance for the quarter was 2% higher than our expectations. Raw material costs as a percentage of sales declined by 114 bps quarter-on-quarter and 143 bps year-on-year (due to the favourable currency impact).

Maruti-Suzuki

Gross margin was 77bps higher than our expectations. During the quarter, the company made a one-time provision amounting to R700m for excise duty demand on sales tax subsidy which was included in ‘other expenses’. Adjusting for this, the ‘other expenses’ increased 19% y-o-y and were 6% higher than our expectations. The gross margin outperformance was partially negated by ‘other expenses’ (by 51bps), resulting in Ebitda margin at 13.2%. Absolute Ebitda was 4% ahead of our expectations. The Ebitda outperformance was offset by the lower-than-expected ‘other income,’ resulting in in-line PBT and PAT.

Takeaways from the conference call

Demand/volumes: In the domestic market, MSIL recorded a volume growth of 10% y-o-y in Q3 driven by: (i) decline in petrol prices, (ii) benefit of lower excise duties, (iii) higher sales promotion activities, and (iv) launch of new models/refreshers during the quarter (Ciaz, new Swift and Alto K10 with automated manual technology. Whilst rural sales growth remains healthy, demand in the urban markets has witnessed double-digit year-on-year growth in 9M(month)FY15.

Within the petrol segment, Maruti volumes rose 17% y-o-y vs industry growth of 20%. However, in the diesel category, whilst industry volumes declined 13% y-o-y, Maruti’s volumes declined only 5%. With near-term volumes being impacted by the roll back of lower excise duty rates, the company expects FY15 domestic volumes to grow at 10% y-o-y, implying only 2% y-o-y growth for Q4 (vs 13% y-o-y in 9MFY15). The PV industry is yet to witness a broad-based recovery in demand and sales would need to be supported by providing incentives.

The company expects export volume growth of 18% y-o-y for FY15 (vs 23% y-o-y in 9MFY15).

Costs/margin: The blended discount/vehicle remained constant q-o-q (R21k/vehicle). Maruti expects discounts to remain high until a sustained broad-based recovery in demand is seen. The yen’s depreciation against the USD is likely to have a positive impact on the indirect imports in the coming quarters’ margin.

Capex: The capex for FY15 would be R35 bn, which would be spent towards product development, marketing infrastructure and maintenance capex.

Where do we go from here?

Maruti’s Q3 results marginally exceeded our expectations on average realisation per vehicle (by 2%). This prompts us to raise our average net realisation per vehicle estimate by around 1.4% over FY15-17. This results in about an 18-20bps upgrade to our Ebitda margin estimates for FY15-17e. Overall, we upgrade our absolute Ebitda estimate for FY15/ 16/17 by 3% and net earnings by 4% each.

However, despite the marginal upgrades, we retain Sell rating due to the following reasons:

Further market share gains may be limited: We expect PV demand to bounce back in FY16 and deliver 15% CAGR over FY15-17e on the back of rising consumer sentiment and moderating fuel costs and interest rates. Maruti has gained 370bps y-o-y market share (to 45%) in April-Dec 2014. But new launches from competitors and Maruti’s incremental focus towards utility vehicles and the premium segment could restrict further market share gains.

Margin performance may disappoint consensus upgrades: We expect a recovery in demand (operating leverage benefits and discount moderation) and depreciation in yen relative to INR to help Ebitda margin improve from 12.0% in H1FY15 to 14.2% in FY16/FY17. However, the declining mix of higher-margin diesel models and competitive pressures are likely to disappoint most consensus margin upgrades (15-15.5%).

By Ambit Capital

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