Maruti Suzuki India Ltd . (MSIL) Share- INITIATING COVERAGE – Fundamental Research

675
INITIATINGCOVERAGE
CMP: 7,466/-
9th January 2019
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Key Stock Data
CMP 7,466
Market Cap (`Bn) 2255.2
52W High/Low 9,923/6,502
Shares o/s (Mn) 302
Bloomberg MSIL:IS
NSE Code MARUTI
BSE Code 532500
Shareholding Pattern (Sep-18)
Promoters 56.21
FIIs & DIIs 36.15
Public & Others 7.64

Investment Theme
BUY with Target Price of `8,829 (upside potential of 18% over 12-18 months).

Key themes and analysis in this report include:

Competitive intensity (as indicated by the Herfindahl-Hirschman Index (HHI)) has been declining for passenger vehicles (PV’s) in India. This is due to the fact that most global OEM’s continue to struggle in India due to lack of focus and research and development on the small car segment.

Rising industry capacity utilization due to higher penetration of PV’s in India and insignificant capacity expansion plans over the next 2-3 years can further lower discounts and improve the margin profile of the listed players.

On the back of aforementioned positive industry dynamics, we prefer Maruti Suzuki India Ltd. (MSIL) as our top pick in the passenger vehicle space as it is the only pure-play listed PV OEM in India. We believe MSIL is well poised to enter a long term structural growth phase due to vehicle penetration (28 four-wheelers per 1000 people) close to inflexion point as seen in other markets such as Japan, South Korea and China, significant premiumisation as customers upgrade and more features get added, levers for margin expansion in the form of lower royalty payments and increasing contribution from Gujarat plant (though margins would be lower in the near term due to initial start-up costs for the plant) and strong product pipeline over the next 2-3 years.

Other growth drivers include Suzuki’s partnership with Toyota which is steadily gathering momentum with an agreement reached on a number of issues including sharing of EV technology with Suzuki by Toyota. This agreement is likely to play a crucial role in the long term for MSIL as EV penetration gradually scales up in India over the long term.

At CMP of `7,466, MSIL is currently trading at FY20E and FY21E EV/EBITDA of 14.8x and 12.8x respectively. We value

MSIL at `8,829  per share by applying 15.1x EV/EBITDA, at a premium of 20% to its 3 year average EV/EBITDA of

12.6x. We believe MSIL deserves a premium EV/EBITDA multiple compared to its historical 3 year average due to the following reasons:

Why MSIL deserves a premium compared to its historical EV/EBITDA multiple
Scarcity premium: MSIL deserves a scarcity premium as it is the only pure-play listed PV player. Seeing through near term challenges, we believe fundamentals around penetration, rising urban discretionary spends and demographics are attractive. PV industry and MSIL offer reasonable growth potential over an extended period of time.

Limited competition risk: We believe MSIL’s dominance is difficult to challenge given it is far ahead of its competition in terms of its scale, cost structure and distribution. India is of utmost strategic importance to Suzuki unlike global peers.

Superior financial metrics: MSIL’s financial metrics such as margins are far superior, market share has jumped to 52% in YTDFY19 compared to 44% four years ago and product portfolio is far more diversified. RoE, both core and ex- cash are better than the past. Balance sheet has more than $5bn in cash.

MSIL is more of an urban discretionary play. Benchmarking to consumer discretionary companies, all the below mentioned stocks are trading at higher valuation multiples than MSIL, and we see scope for re-rating here for MSIL.

P/E EV/EBITDA ROE
M. Cap
(
`Bn)
EPS Growth (%)CAGR- FY18-21E) PEG FY19E FY20E FY21E FY19E FY20E FY21E FY19E FY20E FY21E
Titan Company 845 24.8% 3.0 58.5 46.5 38.4 40.9 32.6 26.6 25.4 27.0 27.9
Avenue Supermarts 1003 27.5% 4.4 98.5 75.7 59.6 57.7 44.7 35.6 19.6 20.9 21.7
Asian Paints 1348 16.4% 4.2 59.4 49.7 41.5 37.5 31.4 26.3 25.3 26.6 27.6
Pidilite 558 12.7% 4.6 57.3 47.5 40.5 37.9 32.0 27.5 25.0 26.2 26.5
Havells India 426 21.3% 3.0 50.1 41.7 35.9 32.7 27.6 23.8 21.3 22.3 23.2
Crompton Greaves 143 18.8% 2.4 38.1 31.2 26.7 23.7 20.0 17.5 41.1 38.9 36.2
Voltas 177 11.4% 2.7 29.6 25.5 22.5 25.2 21.7 19.0 14.6 15.2 15.4
Jubilant Foodworks 165 35.4% 2.4 54.3 42.6 33.5 26.6 22.2 18.1 26.7 27.4 28.3
Maruti Suzuki 2255 12.8% 2.2 27.6 23.4 20.0 17.6 14.8 12.8 18.2 19.3 20.1

Financial Highlights

Maruti Suzuki India Ltd. (MSIL) is India’s largest passenger vehicle company commanding a market share of 50% in domestic market with ~1.65mn vehicles sold in FY18. It is a subsidiary of Suzuki Motor Corporation, Japan. MSIL has two manufacturing plants with an installed capacity of 1.56mn vehicles per year. In addition, with strong demand outlook, MSIL has set up a plant in Gujarat with a capacity of 7.5L to be commissioned gradually over FY18-21 in order to achieve its target of selling 2mn vehicles by 2020. MSIL has one of the largest sales network with 3,426 sales outlets (including NEXA) and has 3,570 service workshops as on 1st January 2019.

Benign competitive intensity

  • The Herfindahl-Hirschman Index is an index that measures the market competitiveness of  a certain industry. A highly concentrated industry would mean a high degree of concentration, whereby only a few players in the industry hold a large percentage of the market share, leading to a near monopolistic situation. A low degree of concentration would mean that the industry is close to a perfect competition scenario, whereby there are many firms of more or less equal size that share the market. HHI ranges from 1(least concentrated) to 10,000 (most concentrated). According to the U.S. Department of Justice, an HHI of less than 1,500 represents an industry with low market concentration, an HHI ranging between 1,500 to 2,500 represents moderate concentration and an HHI of more than 2,500 represents a hig2h0ly10concentrated industry.
  • Our analysis of the competitiveness of India’s automotive industry, as indicated by the Herfindahl Hirschman Index (HHI) indicates high consolidation across segments.
  • The HHI Index for the Indian passenger vehicle market stands at ~2900, indicating2a01hi1ghly concentrated industry. This is led by MSIL, which has further increased its market share to 52% in YTDFY19. In our view, the consolidation is likely to remain high in the future due to dominant performance by MSIL and weak performance by global players as they are not likely to be aggressive in the small car segment.
  • In  the  Indian  automobile  industry,  HHI  Index  is  highest  for  the  commercial  vehicle  sector  followed  by  passenger vehicles, tractors and two-wheelers. Notably, while consolidation is increasing for PVs, it has been decreasing for commercial vehicles and tractors.
  • Similar analysis for other consumer categories in India indicates that paints, adhesives and toothpaste category are highly consolidated and markets tend to assign higher valuation multiples to companies where consolidation is high.

Tepid Capacity Expansion plans to keep utilization levels high and discounts low

  • The combined capacity utilization of all OEM’s in the passenger vehicle industry stood at ~75%  in FY18. While MSIL and Hyundai operated at close to 100% capacity utilization, their peers operated at much lower (50-60%) utilization levels. With higher penetration in coming years and no significant capacity expansion plans over the next 2-3 years, we believe the overall capacity utilization could inch closer to 80% in the coming years which would lower the risk of pricing indiscipline and improve the profitability of most players.
  • Apart from MSIL adding capacity of 2.5L units each in Jan-19 and Jan-20 and Hyundai adding capacity of 50k units in 2019, there are no capacity expansion plans announced by other OEM’s as they’re running at lower capacity utilization levels. However, we also learn from media reports plans of MG Motor India  (Financial Express) and Kia Motors  (Thehindubusinessline) of entering India
  • MG Motor India has acquired a car manufacturing unit in Halol from General M2o0to1r1s and plans to invest `50bn in India over the next 6 years and launch one new car in India every year. The Halol plant is expected to have an initial capacity of `80,000-85,000 units. MG Motor India has also confirmed that the first product will be an SUV which will be rolled out ahead of the planned schedule of second quarter of 2019.
  • Kia Motors, the South Korean automotive company, is in the process of setting up its plant in Andhra Pradesh at an investment of $2bn after witnessing Hyundai’s strong presence in the market, considering it could also leverage HMC’s supply chain/distribution network and production facilities. The capacity of the said plant is expected to be 300,000 cars annually. Vehicle production is earmarked to begin later in 2019. Also, it is likely to utilize 50% of its capacity for contract manufacturing for Hyundai. We believe this can raise the competitive intensity in the small car segment (~35-40% of industry) and can pose a threat to MSIL’s dominance in the segment (~55-60% share) in future, if executed well.
  • We also note that ~14% of the industry capacity is currently exported, thus it has room for utilizing the capacity more for satisfying the domestic demand. General Motors has exited the domestic market and is only focused on exports at present.

Low penetration to aid robust long term growth

  • Vehicle penetration in India currently stands close to 28 four-wheelers per 1,000 people, as per estimates. The total four-wheeler population was considered while making these estimates due to i) share of CV to vehicle population is very low, ii) there is a very thin line of distinction between passenger vehicles and commercial vehicles globally, iii) too much granularity is not available for very old data. In any case for markets where purely PV data is available, the results are largely similar.
  • Historically, vehicle sales in some of the key global markets have shown an inflexion point at a similar level of penetration. In countries such as South Korea, Japan and China, CAGR of car sales were in excess of 20% over the next 5 years once this level of penetration was achieved. This was supported by strong growth in GDP per capita. GDP per capita registered a growth of over 8% over the same period. India’s GDP per capita is expected to register a growth of 6-7%, and we expect car sales could keep growing at 12-14%. The growth rates could be higher if the GDP per capita growth picks up.
  • The Indian passenger vehicle industry has registered a meagre volume CAGR of ~4.3% over FY13-18. This is primarily due to a cyclical slowdown over the past few years as the period was marked by a sharp slowdown in GDP and industrial growth. As per IMF Forecasts, GDP is expected to growth at 7.3% in FY19 and 7.4% in FY20 which should accelerate car sales going forward.
  • We believe MSIL would be a key beneficiary of an uptick in passenger vehicle sales as it occupies more than 50% of the market share in this space. MSIL’s unparalled distribution network creates a business moat while serving the hinterland. As on 31st March, 2018, MSIL’s sales network stood at 2,627 including 316 NEXA channels and 190 commercial channels. Hyundai, having the second largest dealer network, has ~490 dealers and is nowhere close to Maruti. Further, most global OEM’s have been unable to materially improve their market share or profitability despite their presence in India since quite some time as ~75% of passenger vehicle volumes consist of small cars due to the difference in tax structure and low per capita income prevailing in India. Global OEM’s have limited products in this space due to limited exposure to India and lack of India focused R&D. These are the reasons why they have not been able to challenge the market incumbents.
  • In  view of  the  above, we believe Maruti,  having a  deep entrenched rural network and lack of  competition in  the small car segment, stands to gain the most from an underpenetrated passenger vehicle market which is close to an inflexion point as observed globally and well poised to register double digit growth for many years to come.
  • Premiumization to boost ASP’s going forward
    The PV industry mix has been steadily improving with more Utility Vehicles (UV’s) at approximately 30% market share, while the share of the entry/hatchback/compact sedan segments have been declining marginally over the last 5 years. The share of entry/hatchback has fallen from 20%/22% in FY13 to 16%/19% in FY18, the share of utility vehicles has improved steadily by 600bps from 22% in FY13 to 28% in FY18.
  •  This phenomenon is also due to the fact that customers are willing to pay a premium for additional features such as Bluetooth connectivity, reverse parking cameras, navigation systems, projector headlamps and automatic transmissions, which is leading to a sharp improvement in ASP’s for original equipment manufacturers (OEM’s). For example, MSIL has seen a 4% CAGR jump in its average realizations over the past 5 years following new launches in the utility vehicles segment though its absolute sales realization is still the lowest among OEM’s in India. However, we expect a meagre 2% CAGR in ASP’s over the next few years due to new launches at the lower end of the price spectrum.

A comparison of ASP’s across OEM’s indicates that most OEM’s have seen healthy improvement in ASP’s corroborating our thesis. However, Nissan and Renault have seen a sharp dip in ASP’s primarily due to adverse model mix, as they had new launches in the lower priced segments. Amongst peers, MSIL has the lowest ASP’s, highlighting scope of improvement in the years to come. Thus, we expect MSIL’s ASP’s to materially improve over the next few years on account of improving share in the premium segments.

Multiple levers for margin expansion

  • The MSIL Board approved a revision in the method of calculating royalty in January 2018 which would result in lower royalty payments for all new model agreements starting the Ignis (January 2017 onwards). Under the new agreement, royalty on new models will be (i) denominated in INR, reducing currency volatility and improving margins as JPY appreciation has weighed on margins over the past few years, (ii) Rate paid will come down as volumes reach a certain threshold. As of now, 5 new models are covered under the agreement but this will rise as new models get rolled out. Overall, we expect royalty as a % of sales to come down below 5% in 2-3 years and even lower beyond that.
  • As the Gujarat plant ramps up starts contributing more to revenues (~8% of volumes in FY18 to ~24% of volumes by FY20), margins for MSIL will improve significantly from the current blended margins due to (i) fiscal incentives at Gujarat plant, (ii) better operational efficiencies, (iii) lower labour cost and (iv) improving localisation at Gujarat plant from current 15% to 60-70% by FY21-22e. The Gujarat plant is eligible for SGST refund from the Gujarat Govt. for cars sold in Gujarat. Gujarat contributes ~7-8% of MSIL’s total volumes and could potentially improve MSIL’s margin by 15-20bps over the next 2 years. Further, overall staff cost would be lower at Gujarat plant than the Haryana plant due to (i) younger age profile at Gujarat, (ii) location (Haryana plants are located in the city) and (iii) lower minimum wages (15% lower in Gujarat than Haryana). Improving localisation at Gujarat plant would result in reduced dependence on foreign exchange, savings on inward freight and better cost efficiencies for MSIL going forward.
  • Platform consolidation led benefits will gradually start flowing in as most of the new launches are based on Suzuki’s fifth generation HEARTECH platform. HEARTECH platform offers improved safety, improved rigidness (10% higher) and lowered model weight (15%) which ensures smooth migration to stricter safety/environment norms. New Swift, Dzire and Ertiga have been launched from this platform by MSIL. Platform consolidation also leads to increasing common parts and allows a faster time to market for new launches/refreshes. Overall MSIL has a cost efficiency program under way with a tight control on production processes, material procurement and vendor ramp/efficiencies. Operating leverage benefits should continue to be positive as plants operate at above rated utilisation levels.

On the basis of the above levers for margin expansion, we expect MSIL’s EBITDA margin to improve by 80bps to 15.9% over the next 3 years.

New launches to support market share

  • In 2015, Suzuki had set a target to introduce 20 new models in five years globally- this included five new models in the mini car segment, six new models in the ‘A‘ segment and three new models in B, C and SUV segments each (nine in total) to aid its arm Maruti Suzuki achieve its target of selling two million units annually by 2020. Out of these 20 models, except for the Kei Jidosha (mini cars), rest would be launched in India.
  •        MSIL’s product pipeline remains strong, with at least two new launches over the next 3 years. New launches over the next 2 years include Wagon-R and Alto (Mini segment) and Ertiga (MPV) in full upgrades and  Future S Concept (Micro SUV) and Vitara (SUV) in new launches.
  •           With tepid new launches by Maruti in 2018 (new Swift, new Ciaz and Next Gen Ertiga), the discounts were consequently increasing to push sales of older variants. With contribution of new products to start increasing CY19 onwards, the discounts should moderate from current levels. Also, the product mix should start improving which should aid realizations going forward.new launch1

    new launch2

Category Company 2019 2020 2021
Maruti Wagon-R (Q4FY19)
Maruti Alto (H2CY19)
Hyundai Grand i10 (Oct-19)
Mini Hyundai i20
Renault Kwid (H2CY19)
Premium Hatchback Tata 45X (End CY19)
Micro SUV Maruti Future S Concept (H2FY20)
Mahindra XUV300 (Jan-19)
Hyundai Carlino (QXI) (Apr-19)
Compact SUV Datsun End CY19
Kia End CY19
Compact Sedan Hyundai Elantra (H1CY19) Xcent (H1CY20)
Tata Harrier (Early 2019)
Kia SP Concept (Apr-19)
Maruti Vitara (H1CY19)
Nissan Kicks (Q1CY19)
SUV Renault Duster (Mid CY19)
Hyundai Santa Fe (Mid CY19) Creta
MPV Renault RBC (Mid CY19)

Short term headwind receding

  • Demand for passenger vehicles is negatively correlated to crude oil prices and consequently MSIL stock is negatively correlated to crude oil prices as people prefer to postpone/defer their purchases in a high fuel price environment. Crude oil prices fell sharply by
  • ~70% from June-14 to Jan-16 thereby aiding demand for passenger vehicles. However, crude oil prices rebounded subsequently from
  • ~$34/bbl to touch a high of ~$85/bbl in early Oct-2018 dampening demand for passenger vehicles. However, from its peak of
  • $85/bbl, crude oil prices have slumped close to ~30%.
  •        The increase in crude oil prices witnessed over the past two and a half years was the first inflationary period witnessed after the fuel price deregulation era, which resulted in near perfect transmission of higher crude oil prices to fuel prices, denting auto sentiment. The impact of higher crude oil prices was witnessed far earlier on consumer sentiment, where we have seen stagnant passenger vehicle sales in the current financial year compared to last year.
  • A cool-off in the crude oil prices as witnessed recently should prompt prospective/first time buyers to consider buying a passenger vehicle, thereby boosting passenger vehicle sales in the coming future.


    Valuation & Recommendation

    BUY with Target Price of `8,829 (upside potential of 18% over 12-18 months)

    Competitive intensity (as indicated by the Herfindahl-Hirschman Index (HHI)) has been declining for passenger vehicles (PV’s) in India. This is due to the fact that most global OEM’s continue to struggle in India due to lack of focus and research and development on the small car segment.

    Rising industry capacity utilization due to higher penetration of PV’s in India and insignificant capacity expansion plans over the next 2-3 years can further lower discounts and improve the margin profile of the listed players.

    On the back of aforementioned positive industry dynamics, we prefer Maruti Suzuki India Ltd. (MSIL) as our top pick in the passenger vehicle space as it is the only pure-play listed PV OEM in India. We believe MSIL is well poised to enter a long term structural growth phase due to vehicle penetration (28 four-wheelers per 1000 people) close to inflexion point as seen in other markets such as Japan, South Korea and China, significant premiumisation as customers upgrade and more features get added, levers for margin expansion in the form of lower royalty payments and increasing contribution from Gujarat plant (though margins would be lower in the near term due to initial start-up costs for the plant) and strong product pipeline over the next 2-3 years.

    Other growth drivers include Suzuki’s partnership with Toyota which is steadily gathering momentum with an agreement reached on a number of issues including sharing of EV technology with Suzuki by Toyota. This agreement is likely to play a crucial role in the long term for MSIL as EV penetration gradually scales up in India over the long term.

    At CMP of `7,466, MSIL is currently trading at FY20E and FY21E EV/EBITDA of 14.8x and 12.8x respectively. We value MSIL at `8,829 per share by applying 15.1x EV/EBITDA, at a premium of 20% to its 3 year average EV/EBITDA of 12.6x. Reasons for ascribing a premium valuation compared to its past 5 year average include scarcity premium (being the only pure-play listed PV OEM in India), limited competition risk (far ahead of its competition in terms of scale, cost structure and distribution) and superior financial metrics.

    Risks & Concerns
    Slower than expected industry growth – We have built in a volume CAGR of 9% over FY18-21E in the domestic segment. If industry volumes remain weak or if new launches fail, there could be a downside risk to our earnings estimates.

    Significant increase in raw material costs – If commodity costs increase significantly, there could be downside risks to our EBITDA margin estimates.

    Risk of production disruption – MSIL is expected to operate at greater than 90% capacity utilisation over the next

    2-3 years. Thus, any disruption in production for MSIL or vendors could affect its volumes and market share, and scope to cover up could be quite limited.

    Delay in new capacity addition for its Gujarat plant – We expect Phase 2 and Phase 3 of the Gujarat plant to come on stream by H2FY19 and H2FY20 respectively. Any delay in adding new capacity could lead to a shortfall in volumes.

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