Margins to remain in mid 15% range for FY 16E, increase in FY 17E on operating leverage

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1 January 29, 2016 Buy Maruti Suzuki (MSIL) Industry: Auto and Auto Components Industry View: Positive Result Update Prune estimates on margin dip, maintain BUY on good volume growth Q3 numbers hurt by slurry of unexpected costs Maruti Suzuki India Ltd (MSIL) s Q3FY16 numbers came in well below street expectations. The top-line grew by 20% yoy at Rs148 bn. Volumes in the quarter grew by 15.6% yoy and 6% qoq to 3.74 lakh units. Net realizations improved by 5.9% yoy and 2.7% qoq as the quarter saw high priced new launches. EBITDA grew by 31% yoy while EBITDA margins decreased from 16.7% to 14.7% qoq. RM to sales went up to 69.9% up from 68.6% qoq due to decretion of inventory levels at 4,000 units from an average of 25,000 units. Employee costs increased to 3.42% from 3.08% qoq on higher bonus expenses which led to an impact of 15 bps on margins. Other expenses were at 14.1% due to Rs 700 mn additional costs linked with maintenance of the ageing Gurgaon plant which the company carries out biannually (June and December). Also the launch costs associated with Baleno and S-Cross led to higher advertising expenses. Furthermore, discounts associated with S-Cross (~Rs 2 lakh per vehicle) also led to margin dip. Other income remained low due to low scrap sale rate, while depreciation and amortization sequentially grew by 8% and 15% yoy to Rs 7.2 bn on the back of new launches. Tax rate in the quarter went up to 29.9%. In line with weak operational outperformance adjusted PAT dropped by 17% qoq at Rs10.19 bn, but grew by 17% yoy. MSIL volumes to spur on new launches though small cars are facing competition Currently the demand for passenger vehicles has been picking up. MSIL has posted a 13.9% domestic growth in Q3FY16. With MSIL s wide distribution network, robust aftersales support, wide portfolio of affordable products and recent good launches, MSIL has reported strong domestic numbers. Demand has shifted more towards petrol vehicles with the gap between diesel and petrol getting narrower day by day (68% petrol v/s 32% diesel). With new products such as Ciaz, S-Cross and Baleno, MSIL has been able to grow its overall PV market share though competition has stiffened. In the hatchback small car segment, the launch of Renault Kwid is gving very tough competition to the likes of Alto (growth of just 0.5% YTD). With Ciaz continuing a strong show in the third quarter of its launch, we expect this car to be the front runner in sedan segment for MSIL alongside Dzire. We are optimistic about the volume growth here on considering the warm response for Ciaz, new launch of Swift variant, Celerio strength, and the recent launch of Baleno which is attracting demand of units per month. Since the launch of Baleno happened in Q3, the complete full year volumes numbers of it will be seen only in FY17, which we believe to take MSIL s volumes to an altogether new level. We estimate 8% of sales to come from Baleno in FY17 (1,20,000 units). The forthcoming Auto Expo will witness MSIL showcasing two new models. The first one to be launched is Vitarra Brezza SUV to compete with Hyundai Creta, Mahindra TUV 3oo, Renault Duster and Ford Ecosport while the second launch is of Ignis, which will be pitted in against the likes of Mahindra KUV 100. The launches will follow in Q4 or Q1FY17. Stock Data Current Market Price (Rs) 4,040 Target Price (Rs) 4,486 Potential upside (%) 11 Reuters Bloomberg What s Changed MRTI.BO MSIL IN 12 month PriceTarget (Rs) From 4,891 to 4,486 FY2016E EPS (Rs) From 180 to 160 FY2017E EPS (Rs) From 222 to 214 Key Data Market Cap (Rs bn) 1, Week Range (Rs) 4,789 / 3,362 Avg Daily Trading Value last 6 mts(rs.mn) 3,393 Promotors (%) FII Holding (%) DII Holding (%) Public & Others Holding (%) 6.29 Fiscal YE YE Mar FY14 FY15 FY16E FY17E Total sales (Rs bn) EBITDA margins(%) PAT margins(%) EPS P/E P/BV EV/EBITDA ROE% ROCE% Dividend yield % Relative Price Performance Jan-15 May-15 Sep-15 Jan-16 Maruti Suzuki One Year Indexed S&P Bse Sensex (%) 1 Month 3 Months 12 Months Absolute (12) (9) 10 BSE Relative (6) 1 27 Ashwin Patil [email protected] Disclaimer: The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true and is for general guidance only. 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2 Financial Highlights Maruti Suzuki India Ltd. If the monsoon this year is in line with expectations then the rural markets (>30% of total volumes) also may yield a good traction for MSIL. Considering the growth that the company has posted in 9M FY16 at 13.9%, we believe that with the recent launches, the company can easily post a growth of 13.1% in FY16E and 14.9% in FY17E on an additional boost from the newer launches. On the exports front, we expect growth to continue from geographies like Angola, Peru, Chile, Indonesia, Algeria etc. MSIL has also started exporting Baleno to markets like Japan which will provide a fillip to exports. We expect exports to grow at 6%/8% in FY16E/17E. Margins to remain in mid 15% range for FY 16E, increase in FY 17E on operating leverage Q3 EBITDA margins were badly hit by some unforeseen costs related with inventory decretion, employee bonus costs and maintenance costs at Gurgaon plant. However, higher discounting and new launch expenses were factored in the street estimates. Commodity costs benefits were seen in the quarter to the extent of 50 bps only but going forward these benefits will be limited. The increase in the opening of Nexa outlets (200 by end of FY17 from 100 currently) along with higher foreign import content in Baleno as well as the upcoming launches of Brezza and Ignis may continue to impact margins in Q4 and in FY17E. Almost 21% of the RM costs are Yen denominated (6% royalty and 16% indirect imports at vendor end). However, the concerns over appreciating Yen v/s Rupee are mitigated in Q4 as the company has taken hedges against it. Also, with increase in Baleno exports to Japan the company will be awarded with a natural hedge. However, the indirect imports will be impacted to the extent of GBP denominated imports as the company has unhedged exposure against GBP on the vendor side. New launches may provide us with a tradeoff between volume growth and marketing expenses escalation which may impact margins either ways. We also believe that prudent costs saving through internal processes and operating leverage coming in through new launches and volume growth also coming from Seventh Pay Commission implementation will provide margin boost. Considering the pros and cons, we have reduced FY16E margins to 15.5% from 16% and FY17E margins to 16.4% from 16.8% earlier. Rs mn Q3 FY16 Q2 FY16 % qoq Q3 FY15 % yoy Total income 150, , , Raw material costs 103,277 93, , Employee costs 5,045 4, , Other expenses 20,796 19, , EBITDA 21,701 22,694 (4.4) 16, EBITDA margins % 14.7% 16.7% (200 bps) 13.6% 110 bps Depreciation & Amortization 7,221 6, , Interest expenses (18.7) Other income 315 1,371 (77.0) 1,290 (75.6) PBT 14,551 17,193 (15.4) 11, Tax 4,358 4,937 (11.7) 2, Adjusted PAT 10,193 12,256 (16.8) 8, Exceptional items - - N/A 700 N/A Reported PAT (Rs) 10,193 12,256 (16.8) 8, LKP Research 2

3 Outlook and Valuation Maruti Suzuki India MSIL s volume performance has been very strong in 9M FY16 and the company has witnessed a quick gain in its market share too. With expectations of economic revival coming in FY17 along with interest rates and fuel costs going down along with recent launches of Baleno, S-Cross and Ciaz and upcoming launches of Brezza and Ignis from MSIL s stable will continue with a strong volume growth. Implementation of Seventh Pay Commission, improvement in GDP in line with falling oil prices and possible implementation of GST in FY17 will help the cause. MSIL being a proxy to the recovery in economy, we believe policy reforms and a populous upcoming budget may spur demand for cars. However, margin headwinds may lead to eating up of some gains coming from volume surge. Competition coming from Renault Kwid may impact Alto volumes, while Baleno and the upcoming launches which are expected to have high import content will be vulnerable to currency movement in Yen beyond Q4FY16 (where the Yen exposure is hedged). However, Baleno exports to Japan may provide a natural hedge in FY17 which is positive and would take care of much of the Yen exposure, though movement in GBP and $ exposures in indirect imports may impact margins. New launches of Brezza and Ignis may lead to increase advertising expenses. Lower commodity benefits may not restrict RM costs from moving higher but according to us the decretion of inventory levels seen in Q3 is a temporary phenomenon and will get adjusted in the ensuing quarters thus helping margins to improve from the lows seen in Q3. Higher capex and maintenance costs at the ageing Gurgaon plant may lead to higher depreciation costs, but expectations of higher other income and lower tax rate (24%) due to changes in accounting standards from FY17 may lift the bottomline. Expectations of higher exports with Baleno and newer launches to country like Japan may too help the profitability. In line with strong volume performance we have increased the volume outlook slightly but have cut the margin outlook to a higher extent than the volume upgradation. As a net-net effect, we have cut the target price by 8%, but from current levels, we still have an upside of 10% for a lower target price of 4,486. Maintain BUY. Per unit parameters (Rs.) Q4 FY14 Q1 FY15 Q2 FY15 Q3 FY15 Q4 FY15 Q1 FY16 Q2 FY16 Q3 FY16 Net Realisation/unit 363, , , , , , , ,666 Material Cost/unit 273, , , , , , , ,007 Employee cost per unit 12,344 11,788 11,489 11,578 14,658 13,567 11,830 13,483 EBITDA/unit 38,400 44,285 47,246 51,329 62,423 66,479 64,227 57,996 PAT/unit 24,626 25,414 26,795 26,927 37,041 37,293 34,685 27,241 LKP Research 3

4 Maruti Suzuki India Ltd. Financial Income statement YE Mar (Rs.mn) FY14 FY15 FY16E FY17E Total Revenues 436, , , ,668 Raw Material Cost 313, , , ,155 Employee Cost 13,681 16,066 20,061 22,095 Other Exp 59,221 66,431 81,903 96,764 EBITDA 50,151 67,130 90, ,655 EBITDA Margin(%) Other Income 8,229 8,316 5,000 6,000 Depreciation 20,844 24,703 27,713 29,834 EBIT 37,536 50,742 68,062 86,821 EBIT Margin(%) Interest PBT 35,777 48,682 67,062 86,021 PBT Margin(%) Tax 8,755 11,570 18,777 21,505 PAT 27,022 37,112 48,284 64,516 PAT Margins (%) Minority interest Exceptional items Adj PAT 27,022 37,112 48,284 64,516 Adj PAT Margins (%) Key Ratios YE Mar (Rs mn) FY14 FY15 FY16E FY17E Per Share Data (Rs) Adj. EPS CEPS BVPS DPS Growth Ratios(%) Total revenues EBITDA PAT EPS Growth Valuation Ratios (X) PE P/CEPS P/BV EV/Sales EV/EBITDA Operating Ratios (Days) Inventory days Recievable Days Payables day Net Debt/Equity (x) Profitability Ratios (%) ROCE ROE Dividend payout Dividend yield Source: Company, LKP Research Balance sheet YE Mar (Rs. mn) FY14 FY15 FY16E FY17E Equity and Liabilities Equity Share Capital 1,510 1,510 1,510 1,510 Reserves & Surplus 208, , , ,452 Total Networth 209, , , ,962 Total debt 4,604 1, Net Deferred Tax 5,866 4,810 3,810 2,810 Other long term liabilities 2,386 1, Long term provisions 1,980 2,926 3,426 3,926 Current Liab & Prov Short term borrowings 12, Other current liabilities 13,382 18,658 20,658 22,658 Trade payables 48,975 55,614 68,921 79,717 Total provisions 6,777 13,604 15,604 17,604 Total Equity & Liabilities 305, , , ,879 Assets Net block 106, , , ,123 Capital WIP 26,214 18,828 20,000 22,000 Intangible Assets 1,827 2,923 4,000 5,000 Non current Investments 13,048 98, , ,176 Other non current assets Total fixed assets Current investments 88,131 29,964 41,964 53,964 Cash and Bank 6, , Inventories 17,059 26,150 28,500 35,000 Trade receivables 14,137 10,698 11,220 11,123 Loan, Advances & others 12,511 11,728 18,136 22,330 Other current assets 3,779 3,256 3,510 4,060 Total current Assets 141,914 81, , ,588 Total Assets 305, , , ,879 Cash Flow YE Mar (Rs mn) FY14 FY15 FY16E FY17E PBT 36,585 48,682 67,062 86,021 Depreciation 20,844 24,703 27,713 29,834 Interest (510) 974 1, Chng in working capital 7,561 8,356 (4,081) (8,351) Tax paid (8,320) (10,407) (18,777) (21,505) Other operating activities (7,125) (8,202) (4,989) (6,000) Cash flow from operations (a) 49,035 64,106 67,928 80,798 Capital expenditure (34,984) (32,468) (51,172) (67,000) Chng in investments (25,893) (20,271) (5,000) (5,000) Other investing activities 11,948 7,740 1,864 1,000 (Inc)/dec inintangible assets 0 0 (1,077) (1,000) (Inc)/dec in other non curr. assets 9,457 5,682 2,941 2,000 Cash flow from investing (b) (48,929) (44,999) (54,308) (71,000) Free cash flow (a+b) ,107 13,620 9,798 Equity raised/(repaid) Inc/dec in borrowings 12, (500) (300) Dividend paid (incl. tax) (2,828) (4,241) (9,280) (11,600) Other financing activities (10,078) (15,734) (1,000) (800) Cash flow from financing (c) (659) (19,621) (10,780) (12,700) Net chng in cash (a+b+c) (553) (514) 2,840 (2,902) Closing cash & cash equiv , LKP Research 4

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