Maruti Suzuki India Ltd remains the best pick in the Indian auto sector, as the company has successfully weathered fierce competition to increase its market share in the past seven years. Last year, MSIL gained ground in the passenger car segment, aided by strong rural penetration. A leadership position in dealer network and reach (1,651 dealers in 1,300 cities, which is three times the touch points of the nearest competitor), low product maintenance and high resale value make Maruti vehicles the best products to own in Indian conditions. The stock can deliver 20-25 per cent returns over the next two years as volume and margin gains continue to aid a re-rating.
RECOVERY ON THE CARDS
While the economic slump has been prolonged, a recovery is on the cards as the GDP is set to improve (our economist estimates FY16 growth of 7.3 per cent vs FY14's 4.7 per cent), inflation has started tapering down and interest rates are heading south. Trends suggest a strong rebound in volumes and FY16/FY17 will be a more decisive year for four-wheeler growth.
RURAL DEMAND
MSIL added 25,000 villages to its network in FY15 and is looking to add another 25,000 villages in FY16. The rural segment continues to grow in double digits (15 per cent in Q1FY16) and the urban segment, too, has picked up. The company has 1,651 dealerships and a presence in 1,300 cities. A balanced portfolio of about 70 per cent petrol and 30 per cent diesel car sales has helped it counter competition amid the diesel prices deregulation.
MARKET SHARE
MSIL has improved its market share in the passenger car segment to 45 per cent in FY15 from 38.4 per cert in FY12 despite fierce competition and an extremely tough demand environment. Launches such as the S-Cross (August), a premium hatchback and a compact SUV (XA- Alpha) in FY16 will enable the company to face competition from the likes of Honda Jazz, Hyundai Elite i20, Hyundai Creta, Renault Duster and Ford EcoSport.
MARGIN UPTICK AND GROWTH
Enhanced focus on localisation and cost reduction has resulted in decade-high margins in Q1FY16. We estimate 16-16.3 per cent EBITDA margins in the next two years against 11 per cent averaged over FY10-FY15. A weak yen would further augment margins. (PAT sensitivity at 2.5 per cent on a 1 per cent change in the yen/rupee). We expect the company to post a revenue growth of 16 per cent, EBITDA growth of 23 per cent, and profit growth of 27 per cent over FY15- FY18, driven by margin expansion and volume pick-up after the prolonged slump.
FORAY INTO PREMIUM SEGMENT
Built on a brand-new platform, the S-Cross is a premium offering from MSIL and will come only in a diesel variant, with 1.3litre (five trims) and 1.6litre (three trims) engines. The vehicle will compete with Renault Duster and Hyundai Creta, and also some compact sedans such as Hyundai Verna and Honda City. MSIL’s Ciaz could face some cannibalisation. With the success of Ciaz (which sells around 4,800 units a month), S-Cross could be a game-changer for MSIL in building the company’s premium credentials.
RETURN RATIOS AND CASH BALANCE
MSIL’s return ratios are expected to improve to 20 per cent in FY17 from 14 per cent in FY14 on the strength of higher utilisation, improved profits and lower capex in coming years. Cash generation might grow meaningfully from the current $42 billion due to moderation in capex and strong profit growth ahead. This could result in valuation upgrades as a recovery sets in.
VALUATIONS
MSIL continues to trade at premium valuations mainly due to strong volumes and profitability. The stock can give 20-25 per cent returns over the next two years as volume growth momentum picks up with new model launches and as margins expand on the back of currency benefits, high operating leverage and cost rationalisation (lower commodity costs).
KEY RISKS
* Lower than expected volume growth
* Appreciation of the Japanese yen will hit the margins
Jhaveri is director (institutional research) at Religare Capital Markets.
