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Maruti: Running 全wift値y? - Views on News from Equitymaster
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Maruti: Running 全wift値y?
Jan 20, 2006

Introduction to results
Maruti announced its 3QFY06 results earlier today. While the topline grew by 8% YoY, a significant reduction in operating costs enabled the company to report a 30% YoY increase in operating profits. Similarly a substantial reduction in interest expense and also depreciation charges boosted net profits by 41% YoY. As a result the net margins expanded by 260 basis points to 10.9% in 3QFY06. But for a decline in other income, the net profit growth would have been higher.

(Rs m) 3QFY05 3QFY06 Change 9MFY05 9MFY06 Change
Net sales 28,890 31,142 7.8% 81,156 87,812 8.2%
Expenditure 25,317 26,483 4.6% 71,374 76,408 7.1%
Operating profit (EBDITA) 3,573 4,659 30.4% 9,782 11,405 16.6%
EBDITA margin (%) 12.4% 15.0% 12.1% 13.0%
Other income 1,275 1,066 -16.4% 3,071 3,139 2.2%
Interest (net) 75 17 -76.9% 261 170 -34.9%
Depreciation 1,052 681 -35.3% 3,446 2,129 -38.2%
Profit before tax 3,721 5,027 35.1% 9,146 12,245 33.9%
Tax 1,324 1,637 23.6% 3,205 3,964 23.7%
Profit after tax/(loss) 2,397 3,390 41.4% 5,941 8,281 39.4%
Net profit margin (%) 8.3% 10.9% 7.3% 9.4%
No. of shares (m) 289 289 289 289
Diluted earnings per share (Rs)* 37.6
Price to earnings ratio (x) 18.8
(* trailing twelve months)

Company background
Maruti Udyog Ltd (MUL), incorporated in 1981, is the country's largest passenger car manufacturer with a market share of 50% in FY05 of the domestic car market. While Suzuki, Japan holds a 54.2% equity stake in the company. After remaining a near monopoly till 1992, the entry of other multinationals and the emergence of domestic competition have resulted in the company losing market share. However, the company has been able to steady its share in the Indian passenger car segment through aggressive capacity expansion and new product introductions.

What has driven the performance in 3QFY06?
Topline pricing pressure evident: The topline growth of the company lagged the volumes growth (see table below) indicating that company has been facing the heat in terms of increasing competition in the passenger car industry. However, it should be noted that the company has been making concerted efforts at improving its product mix (see adjacent chart) with the launch of 羨lto and the recent 全wift to cushion its margins. Apart from this, the company has changed its accounting policy whereby discounts offered by the company are now adjusted from the sales as compared to the earlier practice of reporting the same as a part of other operating expenses.

We have maintained for some time now that amongst the various automobile segments, the passenger car segment is the most competitive (both in terms of number of players and the number of models). Going forward, we expect the pricing pressure to increase with increasing number of product launches both from domestic as well as international players.

On the volumes front, the woes for 閃-800 have continued as it registered another quarter of volume decline. This is partly due to the cannibalization effect (from 羨lto) and also the ageing nature of the 閃-800 model (launched in 1984). However, the decline in this case in 3QFY06 is much lower when compared to the nine-month period. This was seemingly the effect of some success that Maruti was able to achieve with its 閃800 dedicated schemes like the one for government employees and teachers. However, this decline in demand for 閃-800 has been more than adequately compensated by the increase in sales of cars in the A2 segment. Apart from the continued demand for 羨lto, the recently launched 全wift has aided the growth in this segment.

Segment Models 3QFY05 3QFY06 % change 9MFY05 9MFY06 % change
A1 M800 28,476 23,736 -16.6% 88,347 63,950 -27.6%
C Omni, Versa 16,728 16,264 -2.8% 47,625 48,496 1.8%
A2 Alto, Wagon-R, Zen, Swift 58,502 87,917 50.3% 183,387 242,421 32.2%
A3 Baleno, Esteem 8,910 7,954 -10.7% 20,733 22,889 10.4%
Total passenger cars 112,616 135,871 20.6% 340,092 377,756 11.1%
MUV Gypsy,Vitara 902 1,256 39.2% 2,967 3,007 1.3%
Total sales (Domestic) 113,518 137,127 20.8% 343,059 380,763 11.0%
Exports 14,027 7,886 -43.8% 37,958 26,656 -29.8%
Total 127,545 145,013 13.7% 381,017 407,419 6.9%

Operating expense - an all-round show: As can be seen from the table below, Maruti has been able to control operating expenses under all the heads. On the raw materials front, the company has seemingly benefited from the weakness in steel prices. It should be noted that some of the steel procurement contracts of the company was due for renewal in the month of October/November 2005. To put this in perspective, average domestic steel prices have declined by around 6% YoY during the current quarter. However, it must be noted that improving product mix has capped the benefits arising from lower steel prices. The decline in other expenses should be viewed in light of the efforts of the company to improve its productivity since the last couple of years (known as 祖hallenge 50 program). Similarly, Maruti has also embarked on a new program (called 創ext leap) to bring in further improvement in productivity. Apart from this, as stated earlier, the change in accounting policy also reduced its other operating expenses.

Cost break-up
(Rs m) 3QFY05 3QFY06 %Change 9MFY05 9MFY06 %Change
Raw materials 22,095 23,686 7.2% 61,759 67,803 9.8%
% sales 76.5% 76.1% 76.1% 77.2%
Staff costs 578 584 1.1% 1,439 1,721 19.6%
% sales 2.0% 1.9% 1.8% 2.0%
Other expenses 2,645 2,214 -16.3% 8,177 6,884 -15.8%
% sales 9.2% 7.1% 10.1% 7.8%

Net profit depreciation effect: There has been a substantial increase in bottomline during the quarter and nine-months ending December 2005 for the company primarily on account of a reduction in depreciation charges. Maruti had charged higher depreciation on some of its assets (writing-off them fully) worth Rs 1 bn in FY05, resulting in inflated depreciation in the previous year. Going forward, we expect the depreciation impact to rise on account of higher capital expenditure (total capex plans of Rs 50 bn over the next three years).

The reduction in interest expense of Maruti should be viewed in light of increasing cash generation with growing volume sales. In FY05, Maruti generated Rs 11 bn from operations. Against this, the debt position stood at Rs 3 bn.

What to expect?
At Rs 706, the stock is trading at price to cash flow multiple of 10.9 times our FY08 estimates. The 9mFY06 performance of Maruti is more or less in line with our FY06 estimates (except for depreciation, which declined at a faster rate). Going forward, while we do not have any doubt about the capability of the company to continue its dominance in the passenger car market (we expect Maruti to gain market share in next two years), we believe that the main reason for the phenomenal performance in 9mFY06 is largely due to the depreciation impact. We expect this to even out considering the huge capex plans that the company has drawn for itself. Apart from this, we expect competitive pressures to restrict the topline growth and thereby the operating margins expansion. Having said that any further decline in steel prices could provide cushion to the margins.

Considering the above facts, we believe that the stock is fairly valued at the current juncture. Tata Motors remains our preferred play in the four-wheeler segment.

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