Maruti signals the turn of the profit cycle

Maruti signals the turn of the profit cycle

The December quarter performance of Maruti Suzuki India Ltd (MSIL) signals a reversal of the business cycle. Rising costs and falling profitability are in stark contrast to the uptrend seen a year ago.

Operating profit margin (OPM) of the country’s largest car maker plummeted 580 basis points (bps) year-on-year (y-o-y) and 100 bps quarter-on-quarter (q-o-q) to 9.7% for the December quarter. A year ago, OPM had expanded y-o-y by a huge 890 bps to 15.5%, on the heels of improving business fundamentals after the 2008-09 slowdown. One basis point is one-hundredth of a percentage point.

Also See Losing Ground (PDF)

The variable costs that weighed down on profitability in December had worked in favour of MSIL a year ago. In December, its raw material costs rose 410 bps y-o-y and 110 bps q-o-q to account for 80.3% of sales—in line with expectations as prices of key materials used to make cars such as steel, aluminium, plastics and rubber have all surged in the last six months. Further, currency fluctuations cut both ways—the Japanese yen appreciation made imports more expensive while appreciation of the euro lowered export realizations.

Increase in royalty from 3.7% to 5.2% of sales also weighed down on profit. Similarly, staff costs increased 75 bps y-o-y to 2.5% this quarter, while it was contained in the year-ago period.

Rollback to December 2009—the business cycle was exactly the reverse, with an uptrend in profitability. Savings in raw material costs, a favourable currency and higher exports to Europe along with lower staff expenses all culminated in the expansion in OPM.

One can see the contrast even in the product mix. During the December quarter, higher sales volumes came mainly from the lower profit-margin smaller car segment. Discounts were offered to counter competition. Average realizations were marginally lower compared with a year back and the September quarter. But,?during December 2009,?the?average?realizations?per vehicle had jumped 10% y-o-y as a result of a surge in demand.

The only bright spot in December was the 27.5% growth in revenue to Rs9,276.7 crore. This was driven by robust demand, which led to a 28% y-o-y and 5% q-o-q growth in volumes, after it sold 330,000 cars during the quarter. In fact, MSIL’s capacity will touch 1.4 million cars by April.

MSIL took a 3-5% price hike in early January. But one wonders if this could offset future cost pressures and currency movements. MSIL has hedged the euro but not the yen, which accounts for 23% of sales by way of raw materials and 5.2% of royalty payments.

“One can see headwinds, too—rising interest rate and fuel price can temper demand for cars," says Surjit Arora, analyst, Prabhudas Lilladher Pvt. Ltd. It’s a reversal of a benign interest rate and commodity price scenario seen a year to 15 months ago. In fact, macroeconomists have been cautioning against a business cycle moderation driven by “demand-push" inflationary and cost pressures.

For the December quarter, reported net profit contracted 18% y-o-y and 2% q-o-q to Rs565 crore.

Earnings downgrades are now commonplace in the auto sector and the outlook for MSIL is no different.

Since January, MSIL shares have lost ground and underperformed the BSE Sensex and Auto index. At Rs1,233 the stock seems to have priced in the earnings growth of about 14-15% estimated for fiscal 2012, leaving little room for appreciation.

Graphic by Ahmed Raza Khan/Mint

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