Maruti: Volumes down, profits up - Views on News from Equitymaster

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Maruti: Volumes down, profits up

Jul 25, 2005

Performance summary
Maruti Udyog, the country's largest passenger car manufacturer, announced its 1QFY06 results today. Despite a 1% decline in volumes sold during the quarter, gross sales grew at a faster pace of 7%. However, higher excise incidence and relatively firm raw material costs subdued the growth in operating profits to 6% YoY. Lower depreciation charges resulted in profit before tax outpacing operating profits.

(Rs m) 1QFY05 1QFY06 Change
Volumes sold (units) 123,624 121,866 -1.4%
Net sales 24,793 26,271 6.0%
Expenditure 21,726 23,024 6.0%
Operating profit (EBDITA) 3,067 3,248 5.9%
Operating profit margin (%) 12.4% 12.4%  
Other income 889 982 10.5%
Interest 91 91 0.0%
Depreciation 1,193 783 -34.4%
Profit before tax 2,672 3,356 25.6%
Extraordinary items - - -
Tax 963 1,091 13.3%
Profit after tax/(loss) 1,709 2,265 32.5%
Net profit margin (%) 6.9% 8.6%  
No. of shares (m) 288.9 288.9  
Diluted earnings per share (Rs)* 23.7 31.4  
P/E (x)   14.9  
(* annualised)      

What is the company's business?
Maruti Udyog Ltd (MUL), incorporated in 1981, is the country's largest passenger car manufacturer with a market share of 60% in FY05 of the domestic car market. While Suzuki, Japan holds a 54.2% equity stake in the company, the Government of India has brought down its equity stake to 20.8% through two phases of disinvestment. 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 performance in 1QFY06?
Exports tumble, domestic lacklustre:  Total volume sales in 1QFY06 is lower by 1%. However, if one were to delve deeper, domestic volume sales were higher by 3%. But exports were down almost 44% in 1QFY06, especially in April and May 2005 (in June, the company reported an 8% rise in export volumes). The overall decline has to be viewed in this context. On the domestic front, the slower growth in volumes could be attributed to two factors. One, first quarter is typically a lean season and second, the company is feeling the pinch of cannibalisation i.e. new models from competing companies eating into the volumes of existing models. While the launch of 'Swift' is a big positive (considering the six months order backlog), we believe that volume growth of other models in the 'Segment B' i.e. Wagon R and Zen are likely to be affected.

Raw material costs ease:  Despite lower raw material cost to sales in 1QFY06, operating margins are at the same level as in 1QFY05 owing to a faster increase in other expenditure. This, we believe, is owing to additional costs incurred towards launching of the new model 'Swift' in 'Segment B'. The company has clarified that "under an agreement with its parent, Suzuki Motor Corporation, certain discounts were available, effective on components purchased from it by Maruti upto June 30, 2005. Following the completion of the term of this agreement, this discount is no longer available. However, the benefit of not charging royalty on existing models of Maruti-800, Omni, Gypsy, Esteem and Zen continues". In our view, this will have an upward pressure on raw material costs going forward.

Cost break-upů
(Rs m) 1QFY05 1QFY06 Change
Raw materials 19,470 20,459 5.1%
% sales 78.5% 77.9%  
Staff cost 461 561 21.6%
% sales 1.9% 2.1%  
Other expenses 1,795 2,005 11.7%
% sales 7.2% 7.6%  

Over the last few quarters:  As is evident from the graphs below, despite firmness in steel prices in the international markets in the last three years, Maruti has been able to improve margins consistently. This could be attributed to negotiations with Suzuki with respect to discounts on certain raw materials, new aluminium foundry and the ongoing re-engineering initiatives. Having said that, the consistent improvement in margins also has to be viewed with respect to the fact that there was a turnaround (coming out of operating losses). Nevertheless, the performance is commendable. In our view, whilst there is an upside from softness in steel prices, raw material costs to sales is likely to be higher owing to new model launches. Further, competitive pressure will increase promotional expenses and lower the bargaining power of the company with the customers.

What to expect?
The stock currently trades at Rs 467 implying a price to earnings multiple of 14.9 times annualised 1QFY06 earnings. The company's commanding market share, strong support from the parent and potential upside to margins from softening of steel prices are positives. However, taking into account the risk of higher crude prices, possibility of interest rates rising in the future and competitive pressures, we would advice investors to exercise caution.

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