We recently met with Maruti management and came back quite positive on the near-term outlook with expectations of a strong Q2 as margins improve from Q1 levels on better product mix (higher ASP and lower discounts) and operating leverage (higher volumes). Management reiterated its view that it will be difficult to cross 1.55 million units at its Haryana plant and hence it is likely to be severely capacity constrained for FY19. The second and third lines in Gujarat will come in only in early-CY19 and by end-CY19. Management shared that the margin improvement at Gujarat plant will be a function of (i) powertrain manufacturing at Gujarat which will start with second line, (ii) vendors moving to Gujarat which is gradually happening, (iii) full utilisation of the plant; which will keep varying as they keep adding lines; first line will reach full utilisation in Q4FY18. MSIL will continue to focus on investment in network expansion, R&D and new products to further improve competitive advantage. Fundamentally, MSIL is very well placed as it is executing well and passing through a very benign competitive phase, however valuations at 30x FY19E appear stretched.
Capacity constraints to continue till FY20E
Management highlighted that production capacity in FY18E is likely to be at 1.75m, followed by 1.85m in FY19E. Recent average monthly volumes of ~165k in July/August were supported by June GST transition as well as higher number of working days in August. Festival holidays in October and maintenance shutdown in December will average out some of the higher production/sales achieved in 1H. Given the ramp up periods involved, capacity is likely to be 2mn in FY20E. Exports’ focus is likely to remain low given that the company will probably be constrained to meet domestic demand if growth continues at similar rate of past 18 months.
Gujarat plant margin drag may continue for some time
Management shared that there are three aspects to reduction of margin drag from Gujarat plant. First is on account of engines and powertrain manufacturing, which is currently being supplied from Maruti’s plants in Haryana. In early CY19, once the second line starts, drive trains will also get manufactured at Gujarat. Second is related to supply of components, where vendors have started setting up capacities around Gujarat plant, and the benefits will come through over the next 12 months. Third is related to overall volumes, where the plant is expected to reach full capacity by end-FY18E.
Shift in product mix augurs well for Q2 margins
We highlight that product mix has been favourable in the past two months with entry segment’s share down 400 bp vs 2Q17. The new models (New Dzire, Baleno and Brezza) have waiting periods and hence there are no discounts being offered to customers. This in turn leads us to believe that margins are likely to trend up on a q-o-q basis.
Investment to continue on network expansion, R&D centre
Maruti had indicated earlier that it plans to invest in large warehouses to improve availability of its products in various markets. Warehouses have already been set up in Bangalore, Nagpur and Gujarat plants. After the success with Nexa, Maruti is now looking at revamping its main outlets under the brand Arena with main focuson digitisation along with better interiors. Management shared that in addition to creation of facilities at Rohtak (test track, other infrastructure facilities), the company is focusing on improving its capabilities in terms of design of cars.
The target is to come up with new models for the Indian market every year starting from 2019. This should help them provide more options to consumers. Also, as the share of locally designed models rise, Maruti will also benefit from lower royalty payouts.