Maruti Suzuki: strong Buy

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The recent move into the alternative fuel segment and the introduction of diesel versions for some models will help the company combat the spike in petrol prices.

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Mr S. Nakanishi, MD…The change to a richer product mix will reward the company in terms of better realisations.

Parvatha Vardhini C

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We recommended a 'buy' on Maruti Suzuki in early February at Rs 904. At that time, the company's strong sales numbers in the backdrop of rising interest rates, its market leadership position in the compact cars segment and improved product mix in the A2 (compact) and A3 (midsize) segment, were expected to translate into good earnings prospects for the company.

These positives notwithstanding, the stock has shed about 20 per cent since our recommendation. The fall (partly due to broader market volatility too) is attributable to three reasons — a moderation in growth in monthly sales numbers since December, fall in net profits in the fourth quarter and apprehensions over a further rise in interest rates and fuel prices. At the current market price of Rs 727, the stock trades at an inexpensive PE of 12 times its trailing 12-month earnings.

Moderation in growth

After clocking a growth of 27 per cent year-on-year in November, the number of vehicles sold grew by singe digits between December and Fenruary. . The company ended the financial year on a sober note with a negative growth of 2.1 per cent in March, when its bread and butter compact segment (Alto, Wagon R, Estilo and Swift) surprised with a 11 per cent fall in sales. This moderation could have been due to increased competition from new cars, such as i10. .

Lacklustre fourth quarter

Lacklustre fourth quarter profits, which fell by 34 per cent to Rs 297.6 crore year-on-year , have bogged down the stock. But a large part of this decline is attributable to the steep rise in depreciation charge (due to a change in policy). Operating profits too fell 17 per cent due to higher expenses on raw material and power and higher royalty payments for new launches. In addition, Maruti also had to provide for a marked-to-market (MTM) loss of Rs 50 crore.

Prospects

For investors with a three-year perspective, the current market price present a good opportunity to consider fresh exposures. Sales numbers in April and May already show a turn-around from the tepid numbers recorded in the four preceding months.

With a strong portfolio in the compact segment, the success of the recently-introduced cars such as Swift, SX4 and Dzire, and the expected launch of the Splash this year and A-Star in 2009, the company's volumes are likely to remain buoyant over the next few years. To cater to the increasing demand, the company is also scaling up capacity at its Manesar and Gurgaon facility.

Besides, the slow shift to the mid-size/upper end of compact segment is already visible (Swift, A-Star, Splash, SX4, Dzire), given the increasing competition for a share in the small car pie. This change to a richer product mix will also reward the company in terms of better realisations. Rising fuel prices, double-digit inflation and the possibility of a further rate hike may pose a challenge to the company in the near to medium term. But the company has so far done well to beat the interest rate blues, averaging a growth of about 12 per cent in the number of vehicles sold in 2007-08.

Launches like the Swift Diesel, SX4 and Estilo during this period coupled with aggressive marketing initiatives seems to have aided growth. With launches lined up this year too and its plan to set up mega display-only showrooms across India to increase visibility, the company is expected to continue with the good run. Also, with fuel efficiency becoming important, the recent move into the alternative fuel segment (Wagon R Duo, LPG Omni , LPG 800) and the introduction of diesel versions of the Swift and Dzire will help the company combat the spike in petrol prices.

Rising input costs

The spiralling cost of raw materials such as steel is a concern. Also, increase in other direct costs such as power and fuel due to ongoing capacity expansion, higher promotion expenses due to competition and royalty payment for launches, are expected to keep margins subdued in the medium term. Last month, Maruti hiked prices on its cars from Rs 1,000-18,000 across all models citing rising input costs. Such an increase along with ongoing localisation efforts for its diesel engine components would certainly help cushion the margins

CALL:  STRONG BUY