Maruti Suzuki: Buy

Investors with a two-three year perspective can consider fresh exposures to the Maruti Suzuki stock at the current price of Rs 1,012. The stock, which now trades at around 16 times trailing 12-month earnings, is among the least expensive from the index basket and has cooled off considerably from its 52-week-high of Rs 1,252 recorded a month ago.

The company’s strong sales numbers in a backdrop of higher interest rates, its market leadership position in the compact car segment, capacity expansions and improved product mix in the A2 (compact) and A3 (mid-size) segments are the key positives that lend visibility to its earnings prospects. Any further dips in the stock price related to the broader markets can also be used to step up exposure.
Strong growth

The company has reported a 30 per cent growth in net sales for the first half of 2007-08, backed by a 19 per cent growth in volumes and 9 per cent growth in realisations. Growth was driven by a 22 per cent expansion in the A2 segment (Alto, Wagon R, Zen Estilo, Swift) and a robust 68 per cent increase in the A3 segment (Esteem, SX4). Overall, the company’s market share in the passenger car segment increased by 2.1 per cent and stood at 54.8 per cent for the first half of the year.

The improved product mix in both these segments, helped by new launches such as the Swift Diesel and the SX4, coupled with aggressive marketing initiatives targeted at different consumer segments, such as ‘Wheels of India’ for State Government employees, ‘First Class Offer’ for Railway employees, ‘Power Deal’ for NTPC staff and ‘Smile India’ campaign by the company, have boosted sales growth.
Margins

Increase in raw material costs, higher promotion and marketing expenses, lower initial margins on new, higher-end launches such as the Swift diesel and SX4 and higher import content for the Swift diesel have led to subdued margins in the recent quarter.

Operating margin slipped by 0.80 percentage points to 13.1 per cent on a year-on-year basis. However, this has been offset by higher volume growth. Net profits grew by 27 per cent, year-on-year, despite the slippage in margins.

To increase localisation of its diesel engine components, the company recently entered into a joint venture with Magneti Marelli, a subsidiary of the Fiat group, to produce electronic control units for diesel engines. Production is expected to begin in end 2008.
Capacity expansions

The demand for the Swift, Swift Diesel and the SX4, currently being manufactured at the Manesar facility, has already exceeded supply. The plant, which has a capacity to manufacture one lakh units per annum, is presently working at 120 per cent capacity. The company is scaling up capacity to 2,00,000 units by FY09 and 3,00,000 units by FY10. It is also making further investments in the existing plant at Gurgaon for capacity expansion and for setting up a new engine shop. The company has already spent Rs 600 crore in the first half on capex and will incur a capex of Rs 2,000 crore by the end of this fiscal.
Product Launches

The changes in Maruti’s product portfolio over the last year or two has made it the only player to be present across all price points, starting from Rs 2 lakh (Maruti 800) to around Rs 5 lakh (Swift). Besides the Swift and SX4 among the new launches, the fuel-efficient LPG version of the Wagon R called the ‘Wagon R Duo’, has also met with a positive response.

Going forward, the company is expected to launch a new compact segment car ‘A Star’ in the second half of FY09. The ‘A Star’ will primarily be an export model and will be launched in India in the ‘premium compact’ segment with a price range of Rs 3.5-5 lakh. 50,000 units of A Star will be contract-manufactured for Nissan while another 50,000 is expected to be sold in the domestic market. About 1,00,000 units will be exported to Europe under the Suzuki label.

This, coupled with the sedan version of the Swift and a new-look Zen Estilo, is also expected to contribute to volume growth in the next two years.
Expanding Export market

Exports, which were primarily to Europe, were discontinued in FY06. While the ‘A Star’ is being developed to cater to the European export market, the company has used the interim period to scale up export of models such as the 800, Alto and Zen to other countries such as Indonesia, Chile, Egypt and Sri Lanka. This strategy seems to have paid off with Maruti obtaining a 51 per cent growth in exports in the first half year over the same period last year. From I lakh units of the ‘A star’ initially, the company expects to double its exports to Europe in 2010.
The ‘Rs 1 lakh car’ effect

Though the stock has been dogged by concerns about a dent in market share from the planned Rs1 lakh car, Maruti appears well-placed to counter a competitive threat. The only model that can be affected by the Rs 1 lakh car is the Maruti 800, which currently contributes under 10 per cent to volumes. The 800 itself could be used as the platform to develop a car that will compete with the car from the Tatas. This platform will give the company pricing power to take on a cheaper car as additional fixed costs may be limited.
Concerns

The prevailing capacity constraints for Swift and SX4 could dampen sales volumes. New launches in the same segment, such as the Spark from General Motors and i10 from Hyundai, coupled with any new launches/re-launches from the Tata-Fiat stable, could pose stiff competition. Besides, small cars to be launched by Honda and Toyota in 2011 at the premium end of the compact segment may also eat into Maruti’s market share in the coming years. Possible increases in raw material prices and increased interest and depreciation costs due to ongoing capacity expansion could exert pressure on margins over the next two years.