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Maruti: Taking the ‘Next Leap’! - Views on News from Equitymaster
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Maruti: Taking the ‘Next Leap’!
Apr 26, 2006

Performance Summary
Maruti has announced decent results for the fourth quarter and fiscal ended March 2006. For FY06, while topline has grown by 10% YoY, net profit growth has outpaced the same. This has been on the back of expansion in operating margins and lower interest and depreciation expenses. Performance for the fourth quarter has also been similar.

Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 30,452 32,770 7.6% 109,624 120,522 9.9%
Expenditure 26,297 27,909 6.1% 95,561 104,256 9.1%
Operating profit 4,155 4,862 17.0% 14,063 16,266 15.7%
EBIDTA margin (%) 13.6% 14.8%   12.8% 13.5%  
Other income 969 1,153 18.9% 3,915 4,292 9.6%
Interest 100 34 -65.7% 360 204 -43.4%
Depreciation 1,122 726 -35.3% 4,568 2,854 -37.5%
Profit before tax 3,902 5,255 34.6% 13,049 17,500 34.1%
Tax 1,308 1,645 25.8% 4,513 5,609 24.3%
Profit after tax/(loss) 2,595 3,609 39.1% 8,536 11,891 39.3%
Net profit margin (%) 8.5% 11.0%   7.8% 9.9%  
No. of shares (m) 288.9 288.9 288.9 288.9 288.9  
Diluted earnings per share (Rs) 35.9 50.0   29.5 41.2  
P/E (x)         22.5  

COMPANY BACKGROUND
Maruti Udyog Ltd (MUL), incorporated in 1981, is India's largest passenger car manufacturer with a market share of around 50% (FY05) of the domestic car market. 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 on a consistent basis. However, of late, 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 PERFROMANCE IN 4QFY06?
Benefits of improving product mix: The pricing pressure on the company is evident from the fact that despite improving product mix, the topline growth is almost in line with the volume growth (see table below). Apart from this, the company has changed its accounting policy whereby discounts offered 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 ‘M-800’ have continued, albeit the decline has not been as severe as it was in the previous three quarters. It appears that the efforts of the company to promote aggressively its ‘M800’ dedicated schemes like the one for government employees and teachers have started yielding results. However, this decline in demand for ‘M-800’ has been more than adequately compensated by the increase in sales of cars in the A2 segment. Apart from this, the continued demand for ‘Alto’, and ‘Swift’ has aided the growth in this segment. The performance on the exports front has however been disappointing. This is mainly due to capacity constraints faced by the company. Maruti has clarified that its first priority is domestic market.

Segmental performance
Segment Models 4QFY05 4QFY06 Change FY05 FY06 Change
A1 M800 27,915 25,273 -9.5% 116,262 89,223 -23.3%
C Omni, Versa 17,394 17,870 2.7% 65,019 66,366 2.1%
A2 Alto, Wagon-R, Zen 79,369 92,715 16.8% 262,756 335,136 27.5%
A3 Baleno, Esteem 8,904 9,050 1.6% 29,637 31,939 7.8%
Total passenger cars   133,582 144,908 8.5% 473,674 522,664 10.3%
MUV Gypsy,Vitara 2,237 1,367 -38.9% 5,204 4,374 -15.9%
Domestic   135,819 146,275 7.7% 478,878 527,038 10.1%
Export   10,941 8,125 -25.7% 48,899 34,781 -28.9%
Total   146,760 154,400 5.2% 527,777 561,819 6.5%

Operating profit–a good show: Reduction in raw material costs (as % of sales) has helped Maruti perk up its operating margins during the quarter. While the company has benefited from declining steel prices (on a YoY basis), efficient procurement policies for the entrie chain of component suppliers have also played its part. Similarly, Maruti has also benefited from its efforts in improving productivity since the last couple of years (known as the ‘Challenge 50’ program). The company has also embarked on a new program (called ‘Next Leap’) to bring in further improvements in productivity. We believe that these initiatives are likely to stand the company in good stead in terms of improving or maintaining its profitability levels.

Cost break-up...
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Raw materials 23,100 24,187 4.7% 85,837 92,170 7.4%
% sales 75.9% 73.8%   78.3% 76.5%  
Staff cost 522 567 8.6% 1,960 2,287 16.7%
% sales 1.7% 1.7%   1.8% 1.9%  
Other expenses 2,633 2,975 13.0% 8,427 11,759 39.5%
% sales 8.6% 9.1%   7.7% 9.8%  

Net profit – depreciation effect: There has been a substantial increase in bottomline during the quarter and FY06, 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 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. Similarly, a 2.2% and 2.5% decline in effective tax rates in 4QFY06 and FY06 has also aided the net profit growth for the company.

OVER THE LAST FOUR QUARTERS
In FY06, while the topline growth was modest, the company’s efforts on improving its internal efficiencies resulted in significant improvement its operating performance. The company also benefited from a softening steel cycle. Increasing demand of ‘Swift’ and Segment ‘A3’ cars also aided the profitability. It should be noted that Maruti has re-introduced its ‘A3’ vehicles at the beginning of the current year with a significant addition/variation in the features. Apart from that, improving cash flows have enabled the company to reduce its debt burden. This has resulted in savings on interest outgo.

WHAT TO EXPECT?
At Rs 925, the stock is trading at price earnings multiple of 22.5 times its FY06 earnings. Despite intensifying competition, we do not doubt the company’s capability to continue its dominance in the passenger car market. In fact, we expect Maruti to gain market share in the next two years on the back of new products and variants launches. However, we expect the benefits of lower depreciation, which has aided performance in FY06, to even out going forward. This is considering the huge capex plans that the company has drawn out for the future. Apart from this, we expect competitive pressures to act as a hindrance to the topline growth and thereby the operating margins expansion. Considering the above facts, we believe that the stock is fairly valued at the current juncture.

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