Maruti: Another good quarter

Performance summary

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While the financial results of two-wheeler companies in 2QFY07 has been a surprise (on the negative side), looking at Maruti's financial results in the same period, it has been a good quarter for four wheeler manufacturers. While volume growth is commendable, what is impressive is the expansion in operating margins in 2QFY07. Led by lower interest and depreciation charges, net profit outpaced operating profit during the quarter.

(Rs m)	2QFY06	2QFY07	Change	1HFY06	1HFY07	Change
No of units sold	140,543	157,683	12.2%	262,409	302,631	15.3%
Net sales	30,378	34,192	12.6%	56,632	65,447	15.6%
Expenditure	26,880	29,436	9.5%	49,886	56,124	12.5%
Operating profit (EBDITA)	3,498	4,756	36.0%	6,746	9,322	38.2%
EBDITA margin (%)	11.5%	13.9%		11.9%	14.2%
Other income	1,091	1,217	11.6%	2,073	2,650	27.8%
Interest (net)	61	31	-49.8%	153	63	-58.5%
Depreciation	665	596	-10.4%	1,448	1,237	-14.6%
Profit before tax	3,863	5,346	38.4%	7,219	10,672	47.8%
Extraordinary income/(expense)	-	-	-	-	-	-
Tax	1,236	1,672	35.3%	2,327	3,302	41.9%
Profit after tax/(loss)	2,627	3,674	39.9%	4,891	7,370	50.7%
Net profit margin (%)	8.6%	10.7%		8.6%	11.3%
No. of shares (m)	288.9	288.9		288.9	288.9
Diluted earnings per share (Rs)*					49.7
Price to earnings ratio (x)					19.1

What is the company's business?

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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 influenced performance in 2QFY07?

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India shows the way: While total volume sales during the quarter was up 12% YoY, domestic sales was much higher at close to 17% YoY. While Maruti 800 continues to decline on a YoY basis, all other small car segments have witnessed impressive growth in volumes (the Wagon-R, Zen, Alto and Swift combined volumes were higher by 22% YoY during the quarter). After the rise in the first quarter of the fiscal year, exports sales once again showed negative growth and continues to account for an insignificant portion of total volume sales. As against our initial estimate of 8% to 10% volume growth in FY07 (based on the premise of higher fuel prices), the passenger car segment has grown at a faster clip. Nevertheless, we do not foresee any need to revise our topline estimates for FY07 (we have estimated 16% YoY growth in topline in FY07 for the company).

A contrarian at work: While all the two-wheeler companies have witnessed a significant contraction in EBDITA margins on the back of higher steel and aluminium prices during the quarter, Maruti has witnessed a decline in raw material costs as a percentage of sales. However, in the same period last year, there was an unusual increase and to that extent, the decline is not necessarily an indication of any downward trend in input costs. In fact, the company enters into the procurement contracts for steel purchases in October/November of any year and given the fact that commodity prices have been volatile in the international markets, not much leeway can be expected. On the contrary, we expect the company to incur higher costs towards raw materials and promotions in line with the launch of new models from Suzuki's stable going forward (new models typically have higher import content for the six months of the launch). Over the next two to three years, we have a cautious view on margins because of competitive factors. However, if commodity prices were to soften significantly, there could be an expansion in margins.

The costs side…

(Rs m)	2QFY06	2QFY07	Change	1HFY06	1HFY07	Change
Raw materials	23,660	25,570	8.1%	44,121	49,165	11.4%
% sales	77.9%	74.8%		77.9%	75.1%
Staff cost	576	714	23.8%	1,137	1,339	17.8%
% sales	1.9%	2.1%		2.0%	2.0%
Other expenses	2,643	3,152	19.3%	4,629	5,620	21.4%
% sales	8.7%	9.2%		8.2%	8.6%

Depreciation saves the day: Despite the fact that the company has outlined around Rs 100 bn as capital expenditure by 2010 towards new product development and capacity augmentation, depreciation charges have declined in 1HFY07. Last year, the company wrote back excess depreciation provisioning to the tune of Rs 1 bn, which seem to have continued in FY07 as well. Improved cash flow from operations has enabled Maruti to retire debts in 1HFY07, which is reflected in lower interest costs (the company was debt free in FY06).

Over the last few quarters: As is evident from the charts below, while EBDITA and net margins have expanded on a YoY basis, they are more or less in line with what has been reported in the previous quarters. This supports our view that despite seasonal fluctuations, significant upside to margins is limited. At the end of the day, the auto sector is volume driven and volumes determine operating leverage.

What to expect?

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At the current price of Rs 950, the stock is trading at a price to earnings multiple of 16.1 times trailing twelve month performance. As mentioned earlier, we do not foresee any need to revise our estimates upwards post the 1HFY07 results. Given the increasingly competitive domestic market, we feel product cannibalisation and higher promotional expenses are a reality in the offing for car makers. In this regard, at current valuations, we believe that the risks outweigh returns from a medium-term perspective.