Maruti Suzuki: Changing fortunes


After a difficult 2011 where labour issues compounded the impact of slowing demand hurting topline and sudden sharp rupee depreciation added to existing cost pressures on profitability, Maruti Suzuki is expected to see a significant improvement in the year ahead. Sales in February suggested that volumes were normalising led by robust compact car segment (includes Swift and Swift Dzire) sales. New launches, more diesel variants and falling interest rates are expected to fuel latent demand which should boost sales in the next two years starting from the second half of FY13, according to Spark Capital Research.

The key concern for the auto sector stems from lack of clarity regarding fuel price hikes in the Union Budget and a possible one-time tax on diesel powered passenger vehicles which could range between Rs 20,000-25,000, according to Surjit Arora, analyst at Prabhudas Lilladher. While a hike in fuel prices could hurt overall demand, analysts believe that the quantum of the expected special diesel vehicle tax would have higher impact on the diesel vehicle sales, making them even more expensive relative to petrol vehicles. Currently, the price premium for diesel cars varies between Rs 80,000-1,00,000 within a similar size segment. However, diesel car sales have boomed because of relatively lower overall cost of ownership given lower cost of fuel (Rs 46 per litre on average versus Rs 72-72 per litre for petrol) as well as higher fuel efficiencies of 17-18 km per litre for diesel engines against 14-15 km per litre for petrol. It takes a little over a year to offset the difference, believes Arora and a price hike would extend that time (by at least about 3-6 months, which is not significant). With diesel car sales being largely incremental to volumes for Maruti, the impact of a one-time tax on diesel is unlikely to be major with overall demand sentiment being a crucial factor.

“Potential policy decisions (special tax on diesel vehicles and increase in fuel prices) may remain an overhang on the stock in the near-term. However, we see these changes having little impact on Maruti’s earnings”, says Joseph George, analyst, IIFL Research in a March 1 note.

The improving volume and earnings outlook has seen the stock rise 32% in the last three months including a 5% rise post release of February sales numbers. At Rs 1,310 levels, it trades at a fair valuation of 16 times consensus one-year forward earnings. While Maruti remains a top pick of analysts in the sector, given the stock’s rise, investors with a 1-2 year perspective could consider it on corrections.

Neutral to policy outcome

Maruti is positioned at the crossroads while the sector awaits policy decisions. The potential fallout of a one-time tax on diesel vehicles is a shift in sales favouring the relatively cheaper petrol-based vehicles, which could boost Maruti’s prospects. IIFL Research sees a potential shift from the cheapest diesel cars to Maruti’s petrol offerings if this scenario plays out reversing the earlier transition to entry level diesel cars like Chevrolet Beat and Tata Indica.

Even if status quo is maintained, there are gains for Maruti. Continued robust demand for diesel vehicles will allow Maruti’s diesel line up to boost volumes which could be another growth lever, according to Spark Capital Research. The company has already seen strong demand for the diesel variants of Swift and Dzire, with both running long waiting periods (between 2-6 months). It is expanding diesel car production capacities with engines sourced from Fiat (in a three year deal starting January 2012 which should increase availability of diesel engines by 65% with expanded Suzuki Powertrain capacity) and is expected to introduce diesel variants on other platforms to milk the evident opportunity.

A hike in fuel prices may however impact demand, but IIFL Research posits that this may not be significant coming as it does after almost 10 months of relatively steady prices. The impact of the expected 2% increase in excise duties to 12% on demand will also be interesting to watch. A similar step in February 2010 was passed through on average and still saw car sales jump nearly 30%, albeit in a strong economic environment. The impact of a pass through is expected to be limited in the small car segment.

Help from a strong rupee

The increased production is expected to drive operating leverage and boost margins as will better realisation from higher diesel car sales and stable to lower input costs with higher local vendor sourcing. With Yen-based input costs equating to about 23% of revenue, the rupee’s 6% appreciation against the Japanese yen in the last three months will also ease margin pressures. Maruti had seen a 100 basis point sequential impact on Ebitda margins from the sharp rupee depreciation in December 2011 quarter, which included lag effect (by a quarter) on indirect imports by vendors, direct imports and royalty payouts.

A 1% appreciation of the Rupee versus the Yen boosts Ebitda margins by 20 basis points, according to IIFL Research which expects margins to move closer to the historical 10% levels in FY13 and a net EPS upside of 2.5% at current exchange rates after adjusting for lower export realisations. However, Spark Research flags the volatile currency environment as a key risk. The company has hedged its Yen and Euro direct forex exposure (in March 2012 quarter) but its indirect (through vendor) Yen exposure and USD exposure is not hedged. Its FY13 forex exposure is also unhedged, according to Motilal Oswal Research. Thus, any sizeable depreciation in the Rupee versus Yen could play spoilsport.