Neutral rating on Maruti Suzuki; Headwinds to cap stock performance

By: | Published: March 14, 2016 12:12 AM

Volume growth for FY17e is likely to come in lower than earlier estimated due to the infra cess announced in the Budget

With Maruti’s share price having corrected by 20%+ YTD (year-to-date), investors are considering buying into the fall. We highlight that near-term headwinds are likely to weigh on stock price performance as volume growth for FY17e (estimates) is likely to come in lower than earlier estimated due to the infra cess announced in the Budget, particularly at a time when demand recovery is tepid. Further, currency related volatility/elevated discounts remain an overhang on profitability.
* Should investors buy into the correction? Though Maruti’s valuations have corrected post the recent stock price fall, we believe that near-term headwinds will cap the price performance as: (i) industry growth estimates for FY17 are likely to come in lower than earlier forecasts due to the duty increases in the recent Budget. As recovery remains tepid, the increase in duties will impact growth rates, in our view. We believe that domestic passenger car industry will likely grow at 10-12% in FY17e vs. our earlier estimates of 12-14%. (ii) Currency related headwinds/elevated discounts are a near-term overhang for margins.
* Growth estimates: We are lowering our FY16/17 volume estimates for Maruti to factor in the weaker sales in Q4 on account of the supply disruptions as well as the impact of price hikes post the levy of the infra cess in the budget. We are now building in volume growth of 10%/12% in FY16-17e. Consequently, we are lowering our EPS estimates by 2%/6% to factor in the same.
* Valuations and view: We set a revised Sept 16 price target of R3,880 to factor in the lower estimates. We value the stock at 18x forward PE (which is at a 10% premium to its average historical PE). Key upside risks to our rating and price target include a sharp pick-up in industry growth. Key downside risks include an encouraging response to new model launches by competitors and a weaker INR.
* Should investors buy into the correction? Though Maruti’s valuations have corrected post the recent stock price fall, we believe that near-term headwinds will cap the price performance as: (i) industry growth estimates for FY17e are likely to come in lower than earlier forecasts due to the duty increases in the recent budget. As the recovery remains tepid, the increase in duties will impact growth rates, in our view. We believe that domestic passenger car industry will likely grow at 10-12% in FY17e vs. our earlier estimates of 12-14%. (ii) Currency related headwinds/elevated discounts are a near-term overhang for margins.
* Infra cess levied in the budget: The government announced a 1-4% levy as an infra cess on passenger cars (including on petrol, diesel, CNG and LPG vehicles). The cess though has not been levied on three-wheelers, electric vehicles, hybrid vehicles, and vehicles registered as taxis. Maruti has raised its product prices to reflect the same.
Maruti derives ~14% of sales from above 4m cars – models include the Ciaz, the Ertiga, S Cross, etc. The diesel variants of the Ertiga and the Ciaz are mild hybrids and hence will be exempt from the cess. The Ciaz and the Ertiga is ~9% of volumes (of which diesel hybrid will be 50%).

We believe margins have peaked in FY16e and are expected to decline over FY17-18e.

Price Target: We are lowering our volume estimates for Maruti in FY16/17e to factor in the weaker sales in Q4 on account of the supply disruptions as well as the impact of price hikes post the levy of the infra cess in the Budget. We are now building in volume growth of 10% / 12% in FY16-17e. Consequently, we are lowering our EPS estimates by 2%/6% to factor in the same.

We set a revised September 16 price target of R3,880 to factor in the lower estimates. We value the stock at 18x forward P/E.

Key upside risks to our rating and price target include a sharp pick-up in industry growth. Key downside risks include an encouraging response to new model launches by competitors and a weaker INR.

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