Maruti Suzuki: will capacity challenges put brakes on valuations?
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Last week, Maruti Suzuki India Ltd’s stock almost scaled its peak decadal valuation. At Rs5,602, the one-year forward price-to-earnings multiple of 24.9 times was only a tad lower than the 25.4 times scaled a year back. Since FY06, the stock has steadily been rerated by investors on the back of strong sales performance and the firm’s consistent market leadership. Monday, of course, saw the share fall by 0.6%, but it still did better than the broad market’s 1.3% dip.
There appears little scope for a further rerating in the near term as capacity constraints are set to hold back sales growth—a key catalyst for the increase in its valuation. Maruti’s plants are working at full capacity. With the festival season around the corner, sales growth may be limited by the fact that there is a six- eight month wait for its car models.
The firm’s Gujarat plant will give it additional capacity but it will manage to line up vehicles for sale only in early 2017.
A report by CLSA explains that if rural demand and the effect of higher salaries following the 7th pay panel report pan out into greater demand for smaller cars, the firm may lose out to competition. Maruti’s market share in this segment, where it has reigned supreme for several years, may slip, even as new entrants take advantage of rising demand. Robust demand for its small cars has meant that it accounts for nearly half the car market.
So far in FY17, sales in this segment have gone downhill against the year-ago numbers. Analysts are, therefore, anticipating that Maruti’s full-year growth may be in single digits, in sync with industry growth. This could keep the stock range-bound for some time.
What could offset the dullness in its sales growth is if its margins expand. The new models yield higher realizations and do not offer discount. Therefore, the average discount per vehicle, which was high in the last few quarters, could come down to lift profit margins. However, in the June quarter, operating profit grew by a thin 2% year-on-year, missing the Street’s expectation. Operating margin had weakened by 140 basis points year-on-year too.
Meanwhile, efforts towards higher localization of parts in new models may help ease the effect of any adverse currency movement. A report by Karvy Stock Broking explains this: “The company aims to mitigate currency risk by increasing Baleno exports to Japan, paying royalties in Indian rupees (instead of Japanese Yen) and reducing import content, which brings down its net Yen exposure to less than 10% of sales (from 20-25%).”
However, most of the positives arising from strong response to its new vehicles with higher realization on sales and lower import content of parts are already priced into its current valuation. Also, the extent to which higher depreciation charges will impact profit margins and the final net profit, when the Gujarat plant goes on stream, will have a bearing on the valuation too.
Given this scenario, the next catalyst for the stock could most likely come when robust sales volume growth makes a comeback, which looks set to take off only in FY18.