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Stock Recommendation | MARUTI SUZUKI INDIA LTD – BUY – Target Price : 8522
Publish date: OCTOBER 15, 2018
Passenger vehicle industry witnessed slowdown in 2QFY19 due to floods in Kerala, delayed festive season and some softening in demand. While in the near term, growth is expected to be slow, medium to long term growth outlook for the industry stays intact.
We believe that slowdown in industry sales to have limited impact on MSIL due to production capacity constraint and market share gains. Domestic passenger vehicle industry grew by ~7% in 1HFY19 (de-grew in 2QFY19). MSIL’s growth during the same period stood at 11%, market share gain of 170bps. In the past nine months, INR has depreciated against JPY by ~12%. Accordingly we expect adverse forex movement to impact MSIL’s EBITDA margin in FY19. In FY20, we expect EBITDA margin to see some improvement on expectation of price hikes, operating leverage and vendor localization at Gujarat plant.
In view of adverse forex movement, we cut our EBITDA estimates by 9% for FY19 and 6.7% for FY20. We also lower PE multiple to 23x (from 25x) due to near term slowdown in demand and margin headwinds. We rate the stock as BUY with revised price target of R8,522 (earlier 10,360). Lower than expected volume growth, commodity cost increase and unfavourable currency movement are key risks to our target price.
Domestic passenger vehicle industry slowed down considerably in 2QFY19, in comparison with growth witnessed in recent quarters. Reasons that led to domestic passenger vehicle industry de-growing YoY in 2QFY19 includes floods in Kerala, delayed festive season and some softening in demand.
Post floods, passenger vehicle demand in Kerala (accounts for 8% of domestic volumes) came down significantly in August and September impacting industry sales to certain extent. We expect the demand in Kerala to recover gradually in coming quarters. Furthermore, the base of 2QFY18 was also on the higher side (volume growth in 2QFY18 grew by 13% vs 8% growth in FY18), thereby impacting growth. Festive season dealer inventory build-up happened in 2QFY18 and this year the same is spread out in 2QFY19 and 3QFY19. Higher fuel prices and increase in interest cost is likely to have dampened consumer sentiment to some extent and that is likely to continue in the near term. On the back of above mentioned factors, growth for the passenger car industry is expected to be slightly lower in 2HFY19 as compared with 1HFY19.
In the past seven years (FY12-FY18), volume CAGR in the domestic passenger vehicle industry has been at 4%, much lower than volume CAGR of 16% reported during FY07-FY12. Over the longer term, favourable domestic story (improving income and consumption levels) coupled with low penetration levels provides a huge upside opportunity for the passenger car players in the domestic market.
We believe that slowdown in industry sales to have limited impact on MSIL due to production capacity constraint and market share gains. Given capacity constraints, MSIL’s production in FY19 is expected to grow by ~10 to 12% and thereby any upside in sales volume growth is restricted. In 1HFY19, MSIL has reported 10% YoY volume growth (11.3% growth in domestic segment) and we expect similar growth for the company going ahead in 2HFY19. Given capacity constraints, MSIL’s focus in the past few years has been on the domestic segment. In a scenario of slowdown in domestic demand, MSIL will likely focus on exports (down by 8% in 1HFY19) to utilize spare capacity.
As against competitors, we believe the impact of demand slowdown will be relatively lower on MSIL (and thereby continue to outperform industry growth) on following reasons – strong product portfolio, customer preference for petrol engine and significant volume share from rural segment.
MSIL has widest range in its product portfolio that covers 85% of the industry (in terms of volumes) and makes them less vulnerable to shift in demand within segments. Further, MSIL has least dependence on its top selling model (~16% in FY18). In the past few years, there has been meaningful shift towards petrol vehicles (from 47% in FY14 to 60% in FY18). Given higher fuels prices and emission concerns related to diesel vehicles, we believe demand to stay in favour of petrol vehicles. MSIL is strong player in the petrol vehicle segment (contributes 70% of company volume. Any further shift in demand to petrol vehicle will be positive for MSIL.
Strong presence in rural areas has helped the company tide competitive pressure and demand slowdown in urban areas. Currently, around one third domestic volumes comes through rural sales. In FY18, the top ten cities showed weak demand, whereas non-urban markets witnessed healthy demand. Management had highlighted in 1QFY19 that rural retail demand is growing by 15%. In our view, MSIL will continue concentrating on further improving rural sales on following counts. Firstly, the future growth of the industry will continue to be driven by non-metro cities and rural areas. Secondly, lower penetration levels in rural areas provide with more growth opportunities as compared with metros and large cities. Thirdly, competitive pressure is low as competition's distribution network is largely limited to bigger cities. Fourthly, expanding footprints in rural India is giving MSIL a first mover advantage.
MSIL has foreign currency exposure to currencies like yen, euro and dollar. MSIL’s direct forex exposure stands at around 10% of its net sales (relates to raw material imports and royalty payment). Taking into account the exposure of its vendors (raw material imports), the indirect exposure stands at around 10% of the company’s net sales. Combined, MSIL’s overall gross forex exposure (mainly JPY) is ~20% of its net sales.
For direct imports, MSIL has 50% cover for USD/JPY exposure and for USD/INR exposure, 50% is covered by way of natural hedge and balance 50% exposure there are no hedges. For royalty, two third payments happen in JPY. MSIL compensates its vendors with a lag of one quarter (takes preceding quarters average rate into consideration).
In the past nine months, INR has depreciated against JPY by ~12%. Accordingly we expect adverse forex movement to impact MSIL’s EBITDA margin in FY19.
In FY20, we expect EBITDA margin to see some improvement on expectation of price hikes to offset commodity prices and adverse forex movements. Almost all MNC in the passenger vehicle segment operating in India have import content higher as compared to MSIL. Thereby, majority companies in the passenger vehicle segment will be facing pressure on margins from INR depreciation. We thereby see a possibility of price increase in the coming months and that should alleviate pressure on margins. In August 2018, MSIL’s announced a price hike owing to increase in commodity cost and adverse foreign exchange rates. Ramp-up at Gujarat plant will provide operating leverage. Further, vendor localization at Gujarat plant is relatively low and is expected to increase over the next few years. Logistics cost will come down with higher vendor localization
In view of adverse forex movement, we cut our EBITDA estimates by 9% for FY19 and 6.7% for FY20. We also lower our other income estimates. Accordingly, we cut our net profit estimates by 11.7% for FY19 and 10.6% for FY20. Due to near term slowdown in demand and margin headwinds, we revise our PE multiple to 23x (from 25x) – in line with past four years average one year forward PE multiple. We rate the stock as BUY with revised price target of Rs8,522 (earlier Rs10,360)
Lower than expected volume growth, commodity cost increase and unfavourable currency movement are key risks to our target price.
Maruti Suzuki India (MSIL), India’s largest passenger car company, is a subsidiary of Suzuki Motor Corporation of Japan. Formed as a government owned company, it entered into a JV with Suzuki Motor Corporation. Over the years the company has been one the most successful player in the Indian car market. Currently the company is the market leader with ~50% market share and on a solid footing with a dense sales and service network. MSIL’s strong network helps them sell their products to virtually every nook and corner of the country. MSIL’s combined annual production capacity is about 1.5mn units in the Gurugram and Manesar facilities. In Gujarat, Suzuki Motor Corporation has set up a facility which it plans to scale-up in the coming years.
BUY - We expect the stock to deliver more than 12% returns over the next 12 months ACCUMULATE - We expect the stock to deliver 5% - 12% returns over the next 12 months REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months SELL - We expect the stock to deliver negative returns over the next 12 months NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. SUBSCRIBE - We advise investor to subscribe to the IPO. RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA - Not Available or Not Applicable. The information is not available for display or is not applicable NM - Not Meaningful. The information is not meaningful and is therefore excluded. NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark. Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
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