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Maruti: 'Royalty' takes profits off course - Views on News from Equitymaster

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Maruti: 'Royalty' takes profits off course

Jul 26, 2010

Maruti Suzuki Ltd has announced its 1QFY11 results. While the company has reported a 27% YoY increase in revenues, profits came in lower by 20% YoY. Here is our analysis of the results.

Performance summary
  • Revenues grow by 27% YoY during the quarter, on the back of a 25% YoY growth in volumes.
  • Operating profits remain flat as margins contract by 2.6% YoY. Higher raw material costs and royalty expenses are key reasons for the same.
  • A poor operating performance coupled with lower other income and higher depreciation costs lead to a 20% YoY decline in profits.

(Rs m) 1QFY10 1QFY11 Change
Units sold 226,729 283,324 25.0%
Net sales 64,930 82,315 26.8%
Expenditure 56,998 74,390 30.5%
Operating profit (EBDITA) 7,932 7,925 -0.1%
EBDITA margin (%) 12.2% 9.6%  
Other income 2,165 1,002 -53.7%
Interest (net) 63 80 26.5%
Depreciation 1,961 2,417 23.3%
Profit before tax 8,073 6,430 -20.3%
Tax 2,238 1,777 -20.6%
Profit after tax/(loss) 5,835 4,654 -20.3%
Net profit margin (%) 9.0% 5.7%  
No. of shares (m) 288.9 288.9  
Diluted earnings per share (Rs)*   82.4  
Price to earnings ratio (x)*   14.8  
(*On a trailing 12-month basis)

What has driven performance in 1QFY11?
  • Maruti Suzuki (Maruti) reported a 27% YoY increase in net sales on the back of a 25% YoY rise in volumes. Growth in volumes was led by both - domestic and export markets. While domestic sales increased by 23% YoY (about 85% of total volumes), export volumes increased by 38% YoY. Growth in domestic sales was led by the companyís A3, C and A2 segments, where growth came in at 45% YoY, 51% YoY and 16% YoY respectively.

    Maruti continued to do well on the exports front as demand from Europe seemed to remain strong. Also, the company's increasing focus on non-European countries could have helped boost volumes as well. However, realisation from Europe took a hit as the Euro has depreciated significantly (against the Indian Rupee) over the past quarter.

    Marutiís gross revenues (including excise duty) increased by 29% YoY during the quarter ended June 2010, while net sales (excluding excise duty) increased by about 27% YoY. This means that the company did not pass on the hike in excise duty to its customers. A key reason for the same would be higher competition leading to the company pricing its vehicles competitively.

    Sales break-up...
    Domestic Models 1QFY10 1QFY11 % change
    A1 M-800 7,119 6,906 -3.0%
    C Omni, Versa 22,233 33,521 50.8%
    A2 Alto, Wagon -R 146,733 170,513 16.2%
    A3 SX4, Dzire 19,947 28,958 45.2%
    Total passenger cars   196,032 239,898 22.4%
    MUV Gypsy 1,383 2,989 116.1%
    Total domestic   197,415 242,887 23.0%
    Exports   29,314 40,437 37.9%
    Grand total   226,729 283,324 25.0%

  • Maruti's operating performance took a major beating during the quarter. The company's operating margins dropped by 2.6% YoY to 9.6%. With this, operating profits remained flat during the quarter. There were two main reasons for the same - higher raw material and royalty expenses. Raw material costs rose to 77.9% of net sales during the quarter as compared to 76.3% during 1QFY10. In absolute terms, the increase stood at 29% YoY. The other was a 42% YoY in other expenditure. Royalty expenses, which form a major portion of the other expenditure head, saw an unusual rise this quarter. As per management, Maruti paid an additional royalty expense of Rs 1,887 m this quarter. This includes about Rs 652 m for the December 2009 to March 2010 period.

    Cost break-up
    (Rs m) 1QFY10 1QFY11 Change
    Raw materials 49,551 64,102 29.4%
    % sales 76.3% 77.9%  
    Staff cost 1,336 1,610 20.5%
    % sales 2.1% 2.0%  
    Other expenditure 6,112 8,678 42.0%
    % sales 9.4% 10.5%  

  • Maruti recorded a 20% YoY decline in net profits. While operating profits were flat for the quarter, lower other income (due to lower gains on investments), and higher depreciation expenses led to a significant decline in profits. However, if we ignore the other income for both the periods, then profits are lower by 0.5% YoY only.

What to expect?
At the current price of Rs 1,220, the stock trades at a multiple of 9 times our estimated FY12 cash flow per share and at 13.5 times our estimated earnings per share. (ResearchPro subscribers, kindly click Here). The stock of Maruti Suzuki has declined significantly today. As of now it is trading lower by about 10%. Should investors take this decline as an opportunity to enter the stock? Well, we still believe that the stock is fully priced at current levels, and as such we maintain our 'SELL' view on the stock.

While a poor financial performance is one factor, the fact that Maruti is seeing increasing competition in the auto space, especially in the small car segment, is a key concern for us. For Maruti to gain its lost market share, the company can only do two things - take a hit on margins (by keeping prices low) or offer better technology cars (and charge a premium on the same). It seems though for the short to medium term, the company will have to resort to the former strategy in order to maintain its leadership position.

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