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Not quite the time to get one
The country’s largest passenger car maker has taken a knock over yen worries, but its stock is still not a screaming 'buy' 

Jitendra Kumar Gupta

When an auto major has an advertising and marketing budget of 800 crore, the biggest in the industry, creating a buzz around its vehicles is a given. That’s what the country’s largest passenger car maker Maruti Suzuki has often done by spending the maximum on TV commercials and shows at over 450 crore. Just last November it became the first company in India to produce an entire TV serial, Chalti ka Naam Gaadi, scripted around its flagship model, the Alto 800. Three years ago it had produced a Hindi film titled Mere Dad ki Maruti. The Japanese car maker has pushed the envelope not just with advertising, but more so within its bouquet of offerings.

Ambrish Mishra, Director, institutional research, JM Financial Today, with close to 16 models across seven different categories, Maruti reigns supreme with a market share of 47%. It has plans to launch 15 new models by 2020 and double its sales network to 4,000 over the same period. In fact, its performance, too, has matched its ad blitzkrieg, with sales and PAT growing at CAGR of 10% and 15% over the past five years.

In fact, in FY16, while its peers struggled, Maruti’s sales grew 16% to over 56,000 crore, profit jumped 23% to over 4,500 crore, led by benign input prices and robust volume growth. Not surprising that when the FY16 results were announced three months back, chairman RC Bhargava mentioned: “In most ways, this year’s result is the best we have ever had. We are setting a challenge of repeating a double-digit growth in FY17, in spite of all difficulties. It is not going to be an easy year.”

Prophetic words indeed, for things did turn nasty. The volatility in the yen following the UK’s exit from the Eurozone and the company’s first double-digit decline in monthly sales in June, following a fire outbreak at one of its supplier’s plant and a maintenance shutdown, are a case in point. Domestic sales slipped 10% in June, while exports took the brunt, plummeting 45%. Since the year began, the stock has come off its high of over 4,600. It plunged to 4,084 on June 16 after the yen hit its strongest level in almost two years. Though the stock has since bounced back, the jury is still out if the worst is over.

Kapil Singh Analyst, Nomura Securities IndiaCurrency blues
For Maruti, yen has always been a cause of worry. The concern around the currency is primarily because every 1% rise against the greenback hits Maruti’s earnings by about 1.5-2%. Currently, the company’s direct and indirect imports stand at 17%. Plus, the 6% royalty it pays to parent Suzuki in yen, means it is perpetually exposed to the yen-dollar curve. The trajectory of the curve is becoming a point of worry again. The yen has gained more than 19% this year to trade near 100 to a dollar and is up more than 5% since the UK voted to leave the Eurozone.

But are the concerns around the currency overblown? Even if one does a scenario analysis making a case for a 5% and 10% appreciation in yen from the current levels to 97-92 levels, respectively, it is possible that in the worst case (10% increase) Maruti’s share price might correct by another 20%. A correction of that kind will take its share price to 3,332 against the current market price of 4,415. At 3,300, the PE multiple will drop to 14x, which was last seen in FY12. 

But, historically, over the past 16 years, the yen has breached 100 to a dollar only once. In FY12, when the yen gained 11% against the dollar, Maruti’s share price tumbled a massive 30% to 950 around October 2011. Ambrish Mishra, director of institutional research at JM Financial, is not too worried. “In FY12 the exposure to yen was almost 28%, but today it is 23%. Besides, Maruti does not take the entire hit on its book, as a part of the cost is also passed on to its vendors. So effectively, if at all the yen goes up, to that extent Maruti will be less impacted.” 

Analysts also point out that Maruti has been following a safe hedging policy where it hedges its forex exposure for the first month fully, two-third in the second month and one-third in the third month. That apart, the company is gradually looking for more and more domestic suppliers and working on a rupee-based royalty payment. For instance, Brezza is supposed to be the first model for which the royalty will be calculated in rupee terms. The company hopes to do it gradually for other models and new launches.

Jigar Shah, CEO, Maybank Kim Eng Securities, too, believes the measures will pay off. “Maruti will have some exports to Japan earning yen and part of it will mitigate the royalty being paid to the parent in yen. Also, if at all there is some yen volatility impact it will not be seen immediately. I do not think investors should panic and jump the ship.”

Staging a comeback
The other reason why analysts are bullish is Maruti’s stellar performance in recent years. From a low of 35% market share in Q3FY12, Maruti has snapped back at competition with new launches and has cornered over 47% share of the passenger car market. Despite competitive pressure particularly in the entry level segment, customers continue to flock towards Maruti.

In a recent conference call, allaying analyst concerns over increased competition in the small car segment, RS Kalsi, head-supply chain at Maruti, pointed out: “Look at the service network that Maruti Suzuki has…we have more than 3,150 workshops across the country. This difference is seen by the buyer only after he has used the vehicle for six months and then he is on the lookout for workshops, parts, servicing facilities. So, that is where we have a competitive edge over others.”

Companies such as Renault and Tata Motors have launched Kwid (2.56 lakh-3.53 lakh) and Tiago (3.4 lakh-5.8 lakh), respectively, in an already crowded space where Maruti was competing with Hyundai’s Eon and M&M’s KUV100. However, Ajay Seth, head of marketing and sales, Maruti, mentioned in the conference call, that, fifth year in a row, the company’s market share had improved over the previous year. “It stood at 46.8%, the highest in seven years. The company’s product related initiatives contributed significantly to higher sales and market share,” he said.

Analysts, too, are buying the line. “One key concern with Maruti was the perception that it is primarily a “first-time buyer’s choice”, but less of an aspirational brand. But with new launches such as Ciaz, Baleno, S-Cross and Vitara Brezza, it has started to attract the attention of “upgrade” buyers as well,” mentions Yogesh Aggarwal, analyst at HSBC Securities, in a report.

Maruti has slowly and gradually moved into the segments where it did not have a presence. For instance the launch of Brezza in a completely new segment of sub-compact sports utility vehicles, followed by Baleno in the premium hatchback segment and S-Cross in the crossover segment helped it gain market share. The spate of rollouts is an outcome of Maruti ‘s higher R&D spend, which has gone up from 173 crore or 0.6% of sales in FY10 to 657 crore or 1.22% of sales in FY15.

“Earlier, Maruti used to launch one product a year, now they are launching close to two-three new products every year,” adds Kapil Singh who tracks the sector at Nomura Securities.

Starting with Ertiga in 2013, Maruti has seen great success with its new launches. Today, the contribution of premium models in its portfolio has grown to almost 33% against 13% in FY13 (See: Moving up the curve).

How it helps
The big rub-off from the launches is that Maruti has gained market share in segments where it did not have a presence or was a weaker competitor. For instance in mid-size cars such as Ciaz, it had mere 2.7% market share in FY13 and today it stands at 25.2%. Similarly, in the compact segment, where models such as Vitara Brezza are placed, its market share has moved up from 34% in FY13 to 42% in FY16. In fact in Q4FY16, the company reported 4% growth in overall volumes to 360,402 cars, largely because of S-Cross and Baleno. In FY16, when the industry grew merely 8%, Maruti was able to grow its volume by 11%.

In line with its premium positioning, the company has launched a new dealer network named as NEXA, which are exclusive showrooms for its high-end models. Till date, it has opened around 127 such showrooms.

“Not just the volumes, but their premiumisation strategy over the past few years is really working in terms of helping them improve margins, which will continue to reflect in the coming years,” adds Singh of Nomura, who has a “buy” rating on the stock with a target price of 4,560.

The contribution of cars, which have an average realisation of less than 4 lakh, has dropped from 52% in FY13 to 44% in FY16. Similarly, contribution of cars, which have realisation in excess of 8 lakh, has moved up from mere 1% in FY13 to 6%. For instance, compared with its existing products such as Swift, which is selling at around 7 lakh and DZire, which costs around 8 lakh, the newly launched Vitara Brezza is selling at over 10 lakh, Baleno around 9 lakh and S-Cross at 12 lakh. This obviously is helping in better realisation, which has moved from around 364,000 a car in Q1FY13 to 425,000 a car. 

This is despite higher discounts that have been offered to deal with the lull period. Discounts, as a percent of realisation, jumped from 3% in FY13 to 5% in FY15. But owing to supply constraints, the company is once again cutting back on discounts. For the first time in Q4FY16, it reduced average discount to 17,600 or 4% of realisation compared with 22,000 or 5.5% of realisation in the previous quarter.

Priming for growth
The big challenge for Maruti now is to keep up with demand. It is already producing at full capacity of 1.4 million units at its Manesar plant. To maintain a growth rate of 10%, Maruti will need to produce close to 1.57 million cars in the current fiscal. To roll out the additional number of vehicles, the company is looking at de-bottlenecking existing plants as its new plant in Gujarat will go on stream only next year. The new facility will boost Maruti’s production capacity by 750,000 units annually. 

“Today, the volume growth is constrained by supply, but that will not be the case in FY18. Demand, particularly in the entry level segment, will start picking up in the second half of FY17. Besides, the 7th Pay Commission implementation alone can add 5-6% to industry growth. And, if Maruti is able to push through supply with the Gujarat plant coming on stream by January 2017 and debottlenecking, it is possible to achieve volume growth of about 12-15% over the next two years,” feels Singh of Nomura.
(See: Northward bound)

When the 6th Pay Commission hike, covering 55 lakh government employees, was implemented in 2008, Maruti reported over 13% growth in volume. Importantly, when the arrears (60%) were paid by the government in FY10, that year, too, Maruti’s sales were up 28%. The robust performance was aided by a good monsoon.

Expecting an encore this fiscal, analysts are looking at the onset of monsoon and implementation of 7th Pay Commission as the two big triggers. Rural sales (accounting for 35% of revenue) were down last fiscal following a bout of poor monsoon for the second consecutive year. This year the Met Department has forecasted rains at 106% of the long period average. In 2007 when monsoon turned out to be at 105% of the long-term average, Maruti’s volume grew 20%.

The management, on its part, is gearing up to cater to the demand surge from the hinterland. “Last year, we added about 20,000 villages to our network of 144,200 villages. This year, we will be reaching about 160,000 villages. So, till the time revival in rural demand takes place, our intent would be to enhance Maruti’s reach,” mentioned Kalsi in the conference call.

RS Kalsi, Head, supply chain, Maruti

On the exports front (8% of sales), the company is trying to offset a drop in volume. Last November, Sri Lanka, which was its largest destination for exports, hiked the import duty on 1000cc vehicles from 50% to 70%, thus impacting demand for models such as Wagon R. The country also raised import duty on vans from 85% to 150%. The impact of this was seen in Q4FY16, when exports tumbled 9% to 27,009 units and it has continued in Q1FY17 as well. The company is looking to compensate the fall with exports of 50,000 units of Baleno, 47% of total exports, to Japan and Europe. The move is also fetching higher realisation as against Baleno’s domestic price of 7-8 lakh per car, it was launched at 13 lakh in the UK. The impact was evident in Q4FY16, when realisation was up 28% on a QoQ basis. 

All priced in
From the beginning of the year, as the yen continued to head north, analysts lowered their FY17 earnings per share estimates from 240 in January 2016 to around 200 a share. As a result, the valuation premium, too, shrank. The one-year forward multiple dropped from 24 times to 22 times. Investors, for now, do not expect the yen-dollar range to move beyond 100 and are focusing on its annual free cash flow of close to 9,000 crore and its return on equity of close to 60%. Analysts expect Maruti’s cash reserves to remain at elevated levels of close to 18,000 crore as the planned capacity expansion will be primarily funded by its parent Suzuki Motor Co. The expectation is that Maruti will use the money to invest in strengthening its reach and brand.

But for all the positives, there seems to be no room for further appreciation as at the current level of 4,392, the stock has already breached the one-year consensus target price of 4,351. Besides, based on the trailing five-year average of P/E 24x, the stock is not exactly a steal at 29x. Even if the Yen stays within the 100 band, a reversal of benign commodity prices could also throw up a nasty surprise, not to mention any delay in commissioning the new plant. Against such a backdrop, investors would be better off steering clear.

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