Maruti Suzuki: Buy

Maruti Suzuki has had a tough time so far in 2011-12. A cyclical slowdown hitting the auto industry, production hiccups from repeated strikes in its plants, increased competition in the compact car segment and foreign exchange losses from a depreciating rupee against the yen have all impacted the company's earnings during this period.

However, with the production losses behind it and demand for passenger cars showing signs of revival, Maruti is poised to witness better times.

An easing of capacity constraints for diesel vehicles and launches such as the compact Dzire and Ertiga are also expected to aid volume growth. Hence, long-term investors with a perspective of one-to-two years can buy the stock. At the current market price of Rs 1,234, the stock trades at a price-to-earnings ratio of about 14.5 times its estimated earnings for FY13.

Volumes slow

High inflation, interest rates and rising fuel prices have hit auto industry growth in 2011-12. While the year-on-year volume growth for April- December 2011 has moderated to 12.5 per cent for the industry (from 26 per cent last year), the passenger cars segment is among the worst affected with a two per cent drop in volumes.

Maruti,a major player in this segment has performed worse than the industry with its domestic volumes showing a 17.5 per cent fall this year. The fall could have been contained to 6 per cent, if not for the production loss of about 81,100 units due to labour unrest.

The company has also lost out to competition. Several launches such as the Etios, Liva, the refurbished Jazz, Brio and the Eon have eaten into the market share of Maruti.

From about 49 per cent market share in the passenger cars segment in April- September 2010, Maruti's market share has dropped to about 42 per cent in the same period this year.

A second reason for the market share loss has been the company's inability to meet the rise in demand for diesel vehicles as a result of the widening gap between petrol and diesel prices.

In models such as the Swift, Dzire, Ritz and SX4, the demand for the diesel variant accounts for 85 per cent of the total. Production losses in addition to capacity constraints for diesel engines dampened sales in these models.

Boost from diesel vehicles

However, a few factors indicate that the company is on a stronger wicket now. First, with inflation beginning to moderate and rate cuts expected sooner than later, the car industry could see a revival in growth. Already, for the first time since May 2011, Maruti's monthly domestic sales volumes have expanded in January 2012. Over January 2011, volumes have grown by about 1 per cent.

Second, the company is now in a position to reduce wait times and meet the demand for its diesel vehicles. While efforts are on to source an additional 5000 diesel engines per month from its affiliate Suzuki Powertrain, Maruti has recently tied-up with Fiat for sourcing one lakh engines per annum for the next three years.

The company is also contemplating setting up of a new diesel plant at Gurgaon with an initial capacity of 1.5 lakh units by the second half of FY13. A ramp up of production at the second line in Manesar too will improve availability of the Swift and Dzire and help cut down on the current four-five month waiting period.

Diversification into UVs to help

Third, launches will also boost volume growth. To take on competition in the small car segment, Maruti has recently rolled out a shorter version of its entry-level sedan, the Dzire.

With this launch, the company would not only be in a position to attract new customers but will also be able to re-direct some of the demand from the Dzire sedan and reduce waiting times there. Moreover, from a medium to long-term perspective, Maruti is working on shedding its ‘small car maker' image. The launch of the Kizashi last year was one such attempt. The Ertiga, a compact MPV (multi-purpose vehicle), which will hit the roads shortly, is another.

The company has also showcased a concept of its compact SUV (sports utility vehicle) codenamed XA Alpha at the Auto Expo this year. Moreover, diversification into the utility vehicles segment will help shield against a slowdown in the cars segment.

In April-December 2011, for example, while car volumes de-grew by 2 per cent, utility vehicles witnessed a 13 per cent volume growth.

Financials to stabilise

For the nine months ended December 2011, net sales dropped by 10.5 per cent to Rs 23655 crore while net profits fell 39 per cent to Rs 995 crore. From about 11.5 per cent in April-December 2010, EBITDA margins contracted to 9 per cent this year.

Besides reduced volumes, what has also affected the numbers is a steep depreciation of the rupee against the yen during this period.

This has not only made import of raw materials and components costlier but has also ballooned the company's royalty expenses/provisions.

Going forward, better volumes, improved realisations from recent price hikes and favourable exchange rates should bring stability to the financials.

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