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Maruti: Our key assumptions - Views on News from Equitymaster
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Maruti: Our key assumptions
Dec 20, 2005

Recently, we have updated our research report on Maruti Udyog Limited. Considering the performance of the industry and based on the strength and weaknesses of the company, we have incorporated following key assumption in our report.

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 50% 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.

Our key assumptions…
Passenger car industry: The demand for passenger car industry is dependent on the performance of the agriculture and the industrial sector. While the domestic passenger car industry has exhibited cyclicality in the past, we expect the industry to grow at around 9% CAGR in next three years. This is primarily based on the assumption of increasing per capita income in the hands of urban as well as rural consuming class.

Segmental assumptions: Based on price points, the Indian passenger car industry is divided in to 5 segments, segment A (entry level) to segment E (premium end cars). Having regards to the low penetration levels (7 per thousand), we expect segment B to the key growth driver followed by segment C. We have factored in a 13% CAGR and 10% CAGR for next three years respectively for these two segments. However, we expect segment A to continue to decline in volume terms, CAGR of -18% in the next three years.

How is Maruti placed? In segment A, we expect Maruti to maintain its monopoly. In segment B, we have factored in an increase in the market share from 53% in FY05 to 62% in FY08. This is based on the assumptions that the company would continue to introduce new models. In segment C, we have increased Maruti’s market share from 17% in FY05 to 22% in FY08. However, we expect major gains in market share starting FY08 in line with the diesel model launch. It should be noted that the management has not clarified about the segment they are looking at. Having regards to the strong position in the segment B, we believe, it would be ideal for the company to launch the model in segment C. Thus on an overall basis, we expect the company to marginally outperform the industry.

Exports: We expect the company to relatively underperform on the exports front. We expect the CAGR growth in the range of 1% to 2% in next three years. These projections are based on two key assumptions. Firstly, we expect that most of the new launches from the Maruti’s stable will be from Suzuki’s ‘global portfolio’ (like the recently launched ‘Swift’). Secondly, being a small car company, European region will continue to be the main destination of exports. Currently, exports to Europe accounts fro around 80% of the total exports. As the parent company has significant presence in this region, we have a cautious stand as far as exports is concerned. Having said that, the company is aggressively looking to widen is geographical reach.

Realisations: We expect average realisations to improve steadily. This is primarily on account of improving product mix. We have factored in a 3% increase in the realisation per annum

Raw material cost: For Maruti, unlike its peers, we do not foresee any significant reduction in the raw material costs (as a percentage of sales), in spite of a declining steel price scenario. This is primarily on account the change product mix as well as new product launches.

Royalty and selling expenses: We expect the royalty charges to increase going forward. This is primarily on account of increasing share of new vehicles in the total volume sales pie. Similarly, we expect the sales and marketing expenses to increase, having regards to the aggressive plans on the new launches front and increasing competition.

To conclude…
Based on our above assumptions, at the current price of Rs 661, the stock is trading at price to earnings multiple of 13.8 times price to cash flow multiple of 10.2 times our FY08 estimates. At the current juncture, we believe that most of the positives have been already factored. Based on the above assumptions, we believe that the risk to reward ratio is skewed in the favour of the former.

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