Rising concerns over demand, the rate of margin improvement and the recent episode of labour unrest have led to stock underperformance (20% vs. 3m Sensex; 8% excluding impact of plant closure). We believe the current price reflects these concerns and with minimal downside to our target price, we upgrade Maruti to Hold. We cut our EPS and target price by 17% and 8% to reflect the concerns but do not factor in the plant closure. We are 14% below consensus EPS. Maruti?s financials should recover from the trough in FY12 (two-year EPS CAGR of 23%) but valuations (PEG of 0.7) reflect the outcome. An improved demand outlook would be a key catalyst for sustainable stock performance. Despite soft volumes (+5% YoY in 1QFY13), an improved mix should offset the impact of Yen appreciation. Our 13% volume CAGR (FY12-14E) is driven by sales momentum of higher-ASP models (Swift, Dzire, Ertiga). The share of diesel vehicles should increase from 23% in FY12 to 43% in FY14E, leading to an increase in Ebitda/car from R22,165 to R28,098.
Maruti?s margins are significantly FX-linked as costs equivalent to c.27% of revenues are JPY denominated. 5% JPY appreciation leads to a 12%-15% fall in EPS.
The current episode should be viewed in the context of the series of labour disruptions which have taken place over the last 18 months. Our checks suggest that the underlying issue is the employment of contract labour (albeit at a shade lower skill level) in the factory at a lower salary compared to permanent staff. At end-FY11, contract workers accounted for 48% of Maruti?s total workforce, which we believe is higher than its peers (details inside).
Our DCF (discounted cash flow) based target price of R1,100 implies 15.5xFY13E and 13xFY14E EPS. Upside risks: an uptick in demand and depreciation of the JPY. A sustained slowdown in diesel car demand is a downside risk. Deutsche Bank
