Maruti Suzuki India Ltd beat the Street’s estimates comfortably on both revenue and operating profit margin for the March quarter. But curiously enough, analysts are unlikely to change earnings estimates; if anything, the results were a reminder about the headwinds the company faces.
Take Maruti Suzuki’s capacity constraints for instance—the company ended the year with sales of 1.43 million cars, just short of its capacity of 1.55 million cars. According to an analyst at a domestic institutional brokerage firm, even though the company’s annual report puts the capacity at 1.55 million cars, the management has alluded to a lower effective capacity of 1.4 million cars. As such, Maruti Suzuki is bursting at the seams already as far as production goes.
Analysts at Religare Capital Markets Ltd said in a 23 March note to clients, “We expect Maruti to hit a capacity roadblock in FY17 despite efforts at debottlenecking its stated manufacturing capacity of 1.55 million units. The Gujarat plant is expected to add 250,000 units of capacity only in FY18. Production constraints would limit volume growth to an 11% (compound annual growth rate) over FY16-FY18.”
Besides, it looks like the commodity cycle has bottomed out and there may well be pressure on margins because of higher commodity prices. In fiscal year 2015-16, raw material costs fell by as much as 320 basis points (bps) as a percentage of sales because of low commodity prices. And finally, the rupee has depreciated against the yen in recent months, which could also put pressure on margins, as yen-denominated expenses amount to around 22% of revenues. Thus far, the company has escaped the full impact of the appreciating yen thanks to its hedges, although if forex rates persist at current levels, margins will start getting impacted soon. A basis point is 0.01%.
The March quarter results, nevertheless, were fairly decent. Revenue grew by 12.5% year-on-year, far higher than the 3.9% growth in volumes, thanks to a better product mix and lower discounts. Sequentially, the average discount per vehicle fell by Rs.4,000, according to an analyst. The company has done away with discounts for some its newly launched diesel vehicles. Note also that the company raised vehicle prices in January; these two factors have helped realizations and profitability.
The appreciating yen didn’t hurt margins as much because of hedges, although royalty payments pertaining to the December quarter were marked-to-market based on current forex rates, resulting in a 40 bps hit on margins. Despite this, overall margins rose by 100 bps on a quarter-on-quarter basis. For perspective, analysts at Kotak Institutional Equities estimated margins to be flat sequentially.
Investors were evidently excited about the company’s performance both on the revenue front as well as margins. Maruti Suzuki’s shares rose 3.5% on the National Stock Exchange of India Ltd on Tuesday. But as a result, the company’s price-earnings multiple has risen to as high as 25 times FY16 earnings. While it’s true that its performance has been above par both in terms of revenue and profit growth, the future looks a tad uncertain, and investors should start questioning the Maruti Suzuki’s premium valuations.