Maruti Suzuki India’s (MSIL) Q1 results were in line with margins of 11.7% (consensus: 11.6%, Nomura: 12%). Despite record-high discounts of R21,000 a car (5.7% of ASP), MSIL was able to deliver these margins because of its cost-reduction efforts. After many months of slowdown, the company saw ~13% volume growth in urban markets in June 2014. In our view, the cycle is clearly beginning to turn now and discounts can pull back by 100-200 bps over the next year. Along with the expected revival in the passenger vehicles (PV) industry, MSIL also embarks on a structural change.
With the new R&D centre starting in India, the rollout of products would be much faster. Over the next 12-18 months, we are likely to see the best-ever phase of model launches with products like ‘Ciaz’, new LCV & SX4 Cross and the new MUV. It will also enable MSIL to leverage new technology better, e.g. AMT and the smaller 800cc diesel engine being scaled up in other models. Royalty expenses can also start coming down as MSIL gets credit for R&D expenses in India.
The localisation drive would also cut earnings volatility more significantly than earlier. Imports are down to 16% of net sales from a peak of 24% (in part helped by the Japanese yen’s movement). As imports come down further and match exports, earnings visibility should be even better. MSIL’s FCF (free cash flow) generation could further improve significantly if shareholders approve the Gujarat deal.
Expect strong recovery in industry volumes over the next 2-3 years—We note that the period between FY11 and FY14 was one of the toughest for the Indian passenger car industry in the last 20 years. PV volumes remained flattish during this period, reflecting a tough job environment owing to weaker industrial growth and a steep increase in the cost of ownership. Industrial growth has been quite weak over the last three years, but this has likely bottomed out, in our view. There are already some signs of recovery over the last couple of months—IIP growth was about 4% in April-May. Historically, there has been a strong correlation between industrial growth and growth in car industrial volumes. With a revival in industrial growth, we expect strong recovery in PV industry volumes over the next 2-3 years. We expect 12% volume growth for the PV industry