Maruti Suzuki’s stock returns zoom; will earnings play catch-up?
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Maruti Suzuki India Ltd’s (MSIL) stock was the top performer among members of BSE Sensex during FY17.
It zoomed 62%, not only surpassing the Sensex return (17%) by close to four times but also leaving other auto counterparts such as Tata Motors Ltd, Bajaj Auto Ltd, Hero MotoCorp Ltd and Mahindra and Mahindra Ltd far behind.
Not just this.
At Rs6,024, it enjoys a one-year forward price-to-earning (PE) multiple of 22.3, which is higher than the five-year mean PE of around 19.
Now, the question is: will earnings play catch-up with the stock’s expanding valuation? There are more reasons to believe so than otherwise.
For Maruti Suzuki, earnings momentum hinges on sales growth, which is expected to be robust for the next two years.
Maruti Suzuki closed FY17 with a 10% sales growth, notwithstanding the capacity constraints and challenges of the currency ban.
New launches lined up, along with higher capacity through its new Gujarat plant, should sustain this momentum.
The six-month waiting period for its new premium vehicles is also expected to reduce in the months ahead.
Further, MSIL’s new vehicles are in the higher end of the affordability spectrum, which implies more bang for the buck. December quarter results support this assumption as in spite of the demonetisation-led cash crunch and drop in sales, the average realization per unit sold was up by 8.5% year-on-year.
Another feather in its cap is that MSIL’s market share has inched up to 47.5% (up by 100 basis points) in spite of increasing competition across segments. Rising demand for utility vehicles, too, is working to its advantage. Sales in this segment more than doubled in FY17 and should make up for sliding sales in the mini segment and also give MSIL’s revenue an edge in the medium term.
Logically, robust production would bring in the benefits of lower cost per unit of vehicle. So, although staff costs and raw material costs, along with marketing expenses, may go up, analysts are confident that they would be stable as a percentage of sales. Operating margin should be sustained around 14.5-15% in the current year. That said, a risk to the profit margins of MSIL comes from any adverse currency movement as it still imports parts and pays royalty to its Japanese partner and shareholder.
The larger and more critical factor to weigh for investors would be the impact of vehicles produced in the new Gujarat plant (a wholly owned subsidiary of Suzuki) on MSIL’s profitability, at least in the initial phase until it reaches full capacity utilization.
Such developments may lead to temporary blips in the stock price.
Yet, the milestone is clear on a two-year horizon. A 10-12% compounded annual growth rate, or CAGR, in sales volume between FY16 and FY19 with a 15-20% growth in earnings is not difficult for MSIL to achieve.
That should appease investors enough to sustain a mean valuation of about 20 times one-year forward earnings.