Maruti Suzuki

The fixed burden of royalty payments to its parent and its stinginess in paying dividends make Maruti Suzuki a risky bet in the auto sector

MARUTI Suzuki has been one of the star performers among large-cap stocks. Since the beginning of this year, the car maker’s stock price has nearly trebled and the company is India’s most valuable automobile company now.

So, what should the retail investors do now? The company is one of the fastest growing car makers in India and its revenues and profits are at an all-time high. On the downside however, the company acts miserly while rewarding its shareholders with dividends unlike other automakers.

Despite being one of the largest campany in the sector, Maruti Suzuki has one of smallest dividend pots. In FY08, the company paid a total dividend of Rs 101 crore and the amount was less than 10% of its net profit. In contrast, Tata Motors and Mahindra & Mahindra distribute nearly a third of their net profits as dividends. And 2009 was no exception. This makes Maruti Suzuki’s shareholders overtly depended on the vicissitudes of the stock market to make money from this stock. And given the company’s cost structure and its capex plans, the situation is not likely to change much in next few years. This raises the risk-to-reward ratio and may not suit investors who believe in buy and hold strategy and like to savour the fruits of their investment over the long term.

BUSINESS:

Maruti Suzuki controls over 50% of the domestic market. In the near term there is no threat given its high brand recall, superior sale and service network and the widest product range in the industry. Its dominance in the all-important small and compact car segment is even stronger. With six models and dozens of variants, it controls nearly two-thirds of the segment. It has further consolidated its position in this segment by launching a slew of international models in last few quarters . The company has also expanded its export business and is now one of the leading suppliers of fuel-efficient cars to European markets. Export now accounts for nearly 15% of its production and has more than doubled this year.

FINANCIAL PERFORMANCE:

The company’s net sales have expanded at a compounded annual growth rate (CAGR) of nearly 18% between FY04 and FY09. The growth was aided by 11% CAGR in its sales volume during the period besides price hikes and launch of higher priced models. However, the company’s operational cost grew at even faster rate, which eroded its operating margin. Its operating profit expanded by just 9% CAGR during the period. It’s operating margin has shrunk from a high of 14.6% during year-ended September ’06 to 6.7% in March ’09. It has recovered in last two quarters, thanks to gains from excise duty cut, but is still below its historical levels. Rise in operational cost was mainly because of rise in raw material costs and royalty payments to its Japanese parent, Suzuki Motor Corporation. Maruti Suzuki pays 5% (of net sales) for domestic sales and 8% for exports as royalty to Suzuki for the use of latter’s brand and technology. In last five years Maruti’s expenses on royalty has jumped six times against two-and-half times growth in net sales. Given the fact that operating margin in auto industry now hovers at around 10-12% for most manufacturers, royalty payments may act as a drag on company’s profitability in future. In the past, the company was able to restrict the impact of falling margins on its net profit, thanks to copious growth in its other income, which expanded by 21.5% (CAGR) in last five years. In FY09, other income—comprising dividends, interest, profit from sale of investments and scrap sale—accounted for 60% of its profit before tax. Going forward, it would be difficult to achieve this given the turmoil in financial markets. Moreover, its capex programme forced it to liquidate a substantial chunk of its investments last year.

VALUATIONS:

At its current price, the stock is trading at around 28 times it’s earnings per share in last four trailing quarters and looks expensive on historical valuations of around 20-22x. Besides, the stock offers one of the lowest dividend among all leading auto majors. High valuations coupled with the fact that metal prices are once again on an upward trajectory, makes us cautious on this counter.

Stock Views on Axis Bank, Hindalco Industries, ITC, Jet Airways, Maruti Suzuki, Tata Motors

BNP PARIBAS on HINDALCO INDUSTRIES


BNP Paribas initiates coverage on Hindalco Industries with a ‘reduce’ rating. Hindalco’s operating performance is leveraged to aluminium prices. Global aluminium consumption growth is likely to slow to about 3% (from 11.6% in ’07), and remain in the range of 3-4% in ’09 and ’10. Weakening global demand will cause aluminium prices to remain subdued at $2,100/tonne in the near term, based on trends witnessed in previous market downturns. BNP Paribas thinks a price level of $2,100/tonne is unsustainable and expects a bounce-back, but overall, a weak pricing environment will persist in the short term. Hindalco will need to raise additional $ 3 billion in debt to spend $ 4.5 billion on capital expenditure (capex) in the next three years. These projects are in initial stages and may be postponed if aluminium prices remain subdued, while copper prices continue to move up due to rising energy and input prices. The target price of Rs 68 is based on an enterprise value (EV) to FY10 EBITDA multiple of 5x. In the past, Hindalco’s valuation has trended towards a 5x EBITDA multiple in an environment of declining prices.


CLSA on TATA MOTORS


CLSA maintains ‘underperform’ rating on the stock with a revised target price of Rs 320. It views Tata Motors as a risky bet even after the sharp 60% year-to-date (YTD) correction. Domestic truck sales are weakening. Following the company’s exit from West Bengal, the large ‘Nano’ volumes will flow only in FY11. Jaguar Land Rover (JLR) sales in the western world remain weak and the sales growth in emerging markets may not last long. Moreover, the JLR pension fund and re-financing of JLR acquisition bridge loan remain overhangs on the stock. Tata Motors needs to refinance $3 billion of the JLR acquisition bridge loan by June ’09. This still leaves $1.9 billion, which needs to be raised via a combination of foreign equity issuance ($500 million), sale of stakes in subsidiaries ($670 million) and raising of working capital facilities at JLR ($700 million). Also, the extent of deficit in the JLR pension fund (size ~$8 billion) will be known only by April ’09, when the next actuarial valuation takes place. Till JLR manages to strike a favourable deal with pension trustees, this will remain an overhang on the stock.


CITIGROUP on JET AIRWAYS


AIRLINES are trading plays — given the cyclical nature of their business, high operational and financial leverage, and an earnings profile that is excessively volatile and sensitive to macro variables like oil prices and currency movements. The target price of Rs 440 is a simple average of two methodologies — current equity value (based on residual cost) and oneyear forward price/book of 1x (in line with regional peers). The ‘medium risk’ rating on Jet Airways is also in line with the risk ratings on regional peers. Citigroup believes that Jet merits a ‘medium risk’ rating, given: a) the competitive scenario in the domestic market; b) its international operations are still at a relatively embryonic phase and should take at least 2-3 years to stabilise; and c) turnaround of the Air Sahara acquisition.


MERRILL LYNCH on AXIS BANK


MERRILL Lynch reiterates a ‘buy’ rating on Axis Bank with a target price of Rs 890. Axis Bank’s Q2 FY09 results were almost 30% ahead of estimates, with its net profit surging 77% to Rs 403 crore. The bank continues to reap the benefits of its increasing customer base, enhanced product penetration and geography arising from its expanded distribution. Axis Bank’s gross and net non-performing loans (NPLs) grew by 11% and 3% quarter-on-quarter (q-o-q) and 44% and 36% YTD, respectively. The spike in NPLs can result in higher loan loss provision, though NPLs remain manageable. Merrill Lynch raises its earnings estimates by 3-6% for FY09-10 to factor in higher fee revenue and topline, as the bank further expands and leverages distribution. Merrill Lynch believes the stock, trading at 2.5-2.6x FY09 book, can continue to trade at 2.8-3.0x book, one-year forward (lower end of its historic trading multiples of 2.5-4.0x), given the +38% CAGR earnings growth through FY08-10 and return on equity (RoE) bouncing back to +18.5%.

Stock Views on Hindalco Industries, Tata Motors, Jet Airways, Axis Bank, ITC , Maruti Suzuki

BNP PARIBAS on HINDALCO INDUSTRIES

BNP Paribas initiates coverage on Hindalco Industries with a ‘reduce’ rating. Hindalco’s operating performance is leveraged to aluminium prices. Global aluminium consumption growth is likely to slow to about 3% (from 11.6% in ’07), and remain in the range of 3-4% in ’09 and ’10. Weakening global demand will cause aluminium prices to remain subdued at $2,100/tonne in the near term, based on trends witnessed in previous market downturns. BNP Paribas thinks a price level of $2,100/tonne is unsustainable and expects a bounce-back, but overall, a weak pricing environment will persist in the short term. Hindalco will need to raise additional $ 3 billion in debt to spend $ 4.5 billion on capital expenditure (capex) in the next three years. These projects are in initial stages and may be postponed if aluminium prices remain subdued, while copper prices continue to move up due to rising energy and input prices. The target price of Rs 68 is based on an enterprise value (EV) to FY10 EBITDA multiple of 5x. In the past, Hindalco’s valuation has trended towards a 5x EBITDA multiple in an environment of declining prices.

CLSA on TATA MOTORS

CLSA maintains ‘underperform’ rating on the stock with a revised target price of Rs 320. It views Tata Motors as a risky bet even after the sharp 60% year-to-date (YTD) correction. Domestic truck sales are weakening. Following the company’s exit from West Bengal, the large ‘Nano’ volumes will flow only in FY11. Jaguar Land Rover (JLR) sales in the western world remain weak and the sales growth in emerging markets may not last long. Moreover, the JLR pension fund and re-financing of JLR acquisition bridge loan remain overhangs on the stock. Tata Motors needs to refinance $3 billion of the JLR acquisition bridge loan by June ’09. This still leaves $1.9 billion, which needs to be raised via a combination of foreign equity issuance ($500 million), sale of stakes in subsidiaries ($670 million) and raising of working capital facilities at JLR ($700 million). Also, the extent of deficit in the JLR pension fund (size ~$8 billion) will be known only by April ’09, when the next actuarial valuation takes place. Till JLR manages to strike a favourable deal with pension trustees, this will remain an overhang on the stock.

CITIGROUP on JET AIRWAYS

AIRLINES are trading plays — given the cyclical nature of their business, high operational and financial leverage, and an earnings profile that is excessively volatile and sensitive to macro variables like oil prices and currency movements. The target price of Rs 440 is a simple average of two methodologies — current equity value (based on residual cost) and oneyear forward price/book of 1x (in line with regional peers). The ‘medium risk’ rating on Jet Airways is also in line with the risk ratings on regional peers. Citigroup believes that Jet merits a ‘medium risk’ rating, given: a) the competitive scenario in the domestic market; b) its international operations are still at a relatively embryonic phase and should take at least 2-3 years to stabilise; and c) turnaround of the Air Sahara acquisition.

MERRILL LYNCH on AXIS BANK

MERRILL Lynch reiterates a ‘buy’ rating on Axis Bank with a target price of Rs 890. Axis Bank’s Q2 FY09 results were almost 30% ahead of estimates, with its net profit surging 77% to Rs 403 crore. The bank continues to reap the benefits of its increasing customer base, enhanced product penetration and geography arising from its expanded distribution. Axis Bank’s gross and net non-performing loans (NPLs) grew by 11% and 3% quarter-on-quarter (q-o-q) and 44% and 36% YTD, respectively. The spike in NPLs can result in higher loan loss provision, though NPLs remain manageable. Merrill Lynch raises its earnings estimates by 3-6% for FY09-10 to factor in higher fee revenue and topline, as the bank further expands and leverages distribution. Merrill Lynch believes the stock, trading at 2.5-2.6x FY09 book, can continue to trade at 2.8-3.0x book, one-year forward (lower end of its historic trading multiples of 2.5-4.0x), given the +38% CAGR earnings growth through FY08-10 and return on equity (RoE) bouncing back to +18.5%.

JM FINANCIAL on ITC

JM FINANCIAL reiterates a ‘buy’ rating on ITC with a target price of Rs 230. Despite defensive stocks being the flavour of the season, the market has ignored ITC this time. JM Financial forecasts a 19.7% growth in the cigarette segment’s earnings before interest and tax (EBIT) in FY09E — one of the highest in recent times. JM Financial has increased its FY09E ‘FMCG-others’ segment loss to Rs 400 crore (earlier Rs 300 crore) and also deferred the break-even projection for the segment to FY12E (earlier FY11E). While extension into related categories is on the cards, oral care looks unlikely in the immediate future. Most of the increase in FMCG losses is likely to be offset by improved earnings in the cigarettes segment. JM Financial has introduced marginal cuts in its overall FY09E (-0.3%) and FY10E (-1.1%) earning per share (EPS) estimates and prices in higher projected losses from ‘FMCG-others’ segment. Accordingly, it has reduced the sales multiple for the segment from 2.4x to 1.5x. The target price stands at Rs 230 (Rs 238 earlier). The price also reflects the discounted cash flow (DCF) value and implies an FY10E price/earnings growth (PEG) of 1.5 — in line with the past three years’ average.

EDELWEISS on MARUTI SUZUKI

EDELWEISS maintains ‘accumulate’ recommendation on Maruti Suzuki. The company is India’s largest passenger vehicle manufacturer with a market share of more than 50%. It has an installed production capacity of 870,000 units per annum and is expected to increase this to 1 million units by the end of H1 FY09. The company is likely to face intense competition from several global players, most of which plan to enter the Maruti-dominated compact segment for the first time. In recent times, higher input costs have adverse affected the company’s operating margins. Going forward, Edelweiss expects Maruti’s margins to remain under pressure due to higher costs associated with new model launches and exposure to yen-denominated component imports. On the positive side, the company is likely to get a major boost in sales from exports and leverage its market leader position in the growing domestic market. Increasing input costs and higher product launch costs may hit margins significantly. A slowdown in growth in the compact segment can hit Maruti, as it is substantially dependent on this segment. Further, intense competition is likely to ensue over the next few quarters, as more players enter the market with new products. The near-term outlook for the company remains subdued, given modest domestic sales and expectations of low margins for the second quarter in a row.

Religare Securities Views on Larggecap Autos - Hero Honda, Maruti Suzuki

Hero Honda

With two launches already made in first half FY09 and three more variant launches scheduled to occur in the second half, Hero Honda is likely to maintain its market dominance in the two wheeler industry. The company has registered a 27% growth to 305,516 vehicles till date this fiscal and has gained market share in all segments, despite higher interest rate and consequent higher equated monthly installment (EMI) for a retail customer taking a bank loan to purchase a bike. Hero Honda has also announced price hikes across all segments in motorcycles, which consequently has led to a boost in its margin. We expect the company to report a revenue growth of 19% during FY09, aided by volume growth and improvement in realisation per vehicle. The company's move to step up its capacity utilization at its Hardwara, where excise and tax benefits will help improve operating margins going forward as compared to its competitors who would be under margin pressure.

MARUTI SUZUKI

Maruti Suzuki is set to grow on the back of strong performance of its new launches viz. Dzire, SX4 and Swift Diesel. The launch of the A-Star and Splash should further help the volume and will improve price realization. The company's product mix is increasingly getting richer with growth seen in models with higher realizations. The scaling up of the Manesar plant should complete in the third quarter of FY09 and address the concerns on capacity constraints of the more successful models. Exports should be the key driver, with manufacturing agreements with Nissan and Suzuki helping to maintain high capacity utilisation for the recent expansion. We expect exports to grow at a compounded annual growth rate of 90% over FY08-FY10E. The sixth pay panel would be a key driver, as more government employees are likely to buy cars with salary arrears that they would get, we consider this as a near term trigger to sales growth.

Motilal Oswal View on Mahindra, Maruti Suzuki, Hero Honda

Buy Mahindra & Mahindra

Motilal Oswal has maintained buy rating on Mahindra & Mahindra, in its report dated September 2, 2008.

"Overall volumes improved by 7.9% YoY to 26808 units and 12.6% YTD growth. Tractor sales increased by 15.6% YoY to 7597 units (16% domestic growth and 6% export growth), and YTD growth of 10.6%. We estimate 10.7% volume growth in FY09E, implying residual growth of 9.7%. There is a strong possibility of volume upgrade in tractors and 3-wheelers, whereas we would revise downwards our volume estimates for Logan. On our current estimates, the stock trades at 8.6x FY09E EPS of Rs 68.6 and 7x FY10E EPS of Rs 84.3. Maintain Buy," says Motilal Oswal's research report.

Buy Maruti Suzuki

Motilal Oswal has maintained buy rating on Maruti Suzuki, in its report dated September 2, 2008.

"Domestic volume de-grew by 10% YoY to 54113 units, first significant contraction in a long time. Exports grew by 1% to 5795 units. Our current estimate is FY09 volume growth of 11.6% (8% domestic & 60% export growth), implying residual growth of 15% v/s YTD growth of 6%. We would be revising our volume estimates downwards. The stock trades at 10.6x FY09E EPS of Rs 62.8 and 9.3x FY10E EPS of Rs 71.2. Maintain Buy," says Motilal Oswal's research report.

Buy Hero Honda

Motilal Oswal has maintained its buy rating on Hero Honda in its September 2, 2008 research report. "Hero Honda volumes increase 26.8% YoY to 305,516 units, in-line with our estimates and the strongest growth among all two-wheeler companies. YTD volumes grew by 19% to 1,481,077 units. Motorcycle volumes grew by 28% YoY to about 293,000 units and YTD growth of 19%. Also, scooters registered about 4% volume growth to about 12,000 units and YTD growth of 30.5% to about 49,800 units. Our FY09 estimates factor in a 8.1% volume growth, implying a 1.7% residual growth. We are in the process of reviewing our volume estimates. Based on our current estimates, the stock trades at 15.1x FY09E EPS of Rs 56.6 and 13.4x FY10E EPS of Rs 64. Maintain Buy." According to Motilal Oswal report.

Ten stocks worth investing in – Part II

IDFC

The country's infrastructure needs should only rise as the economy grows bigger. Even at current projections, the opportunity is huge. The proof: the Eleventh Five Year Plan indicates that $500 billion worth of investment will be required for creation of new infrastructure space, which in turn is positive for companies like Infrastructure Development Finance Company, a leading infrastructure financing institution.
The company's infrastructure lending business is expected to grow at CAGR of 37 per cent during FY08-FY10. While interest spreads could see some pressure, better fund management should help offset some of this.
Additionally, non-interest income should continue to contribute about 47 per cent of total income during FY08-FY10, driven by consistent increase in asset management fee, income from its principle investment book and growth in IDFC-SSKI (broking and investment banking) business.
IDFC has also entered into an agreement to acquire 100 per cent stake in Standard Chartered AMC.
Overall, the net interest income is expected to grow at CAGR of 28 per cent during FY08-FY10, with net interest margin expected to hover at 3 per cent.
Looking at its business growth and expertise in infrastructure financing, we believe the stock is undervalued and provides an investment opportunity for decent return in medium term.
At Rs 105, the stock is trading at 16 times its FY09 estimated earnings and 12.5 times FY10 earnings. The research house has puts a price target of Rs 160 per share.

L&T

Thanks to the slower growth in industrial production and capital goods output in the recent past, Larsen & Toubro (L&T), too, has seen its share price being hammered down. This offers an opportunity to buy into the country's largest engineering and construction player, which is among the best plays on India's infrastructure and industrial capital expenditure (capex) boom.
Also, the benefits of its diversification into power equipment, shipbuilding, defence equipment and railways are yet to pay, and help sustain growth in the long-run.
Flush with cash flows from high oil prices, the Middle East region is likely to achieve infrastructure spend of $1,000 billion. L&T has not fully exploited the opportunity in the region due to constraints of resources. In case of slowdown in India, the company can derive more growth in Middle East.
These factors and a strong order book of Rs 52,700 crore, the company is expected to maintain its growth at about 35 per cent over the next two years. Any value unlocking from its IT and Finance subsidiaries (expected to be listed separately) would further add to the shareholders wealth.
Regards valuation, at Rs 2,357, the stock is trading at 22 times its estimated FY09 consolidated earnings and 17 times FY10 earnings, which is not very expensive historically.
On SOTP basis (factoring valuations of different businesses and subsidiaries), analysts have estimated a fair value of Rs 3,000-3,200 per share.

Maruti Suzuki

India's leading passenger car company, Maruti Suzuki is available at half the price compared to its 52-week high of Rs 1,252 per share seen in October 2007.
Historically, the share price of Maruti has been trading in the PE band of 13-17 times. But, thanks to the market turmoil, it is now trading at just eight times its FY09 estimated earnings.
The correction was partly on account of concerns over the rising input cost (for the company) and, high crude oil prices and interest rates (for its customers).
Analysts believe that though concerns remain in the near term, the stock should get rerated in the long run on account of benefit accruing from new launches, including WagonR Duo, Zen Estilo, Diesel Swift and SX4.
Also, with the ongoing expansion at Manesar plant, exports are expected to go up. The company will manufacture small cars for supply to its parent's customers in global markets.
Estimates indicate that Maruti will be exporting about 100,000 units to its parent, Suzuki Motor Company of Japan, while another 50,000 units would be supplied to Nissan Motor Company. The expansion of its capacities should also help company to maintain its margins, helped by economies of scale.
Along with the benefits of new launches and the expansion, the company's target of selling one million cars in the domestic market by FY2011, translates into a volume growth (for domestic market) of 12 per cent over next three years.
Overall, the company is expected to grow at decent pace. Investors can use the current market conditions to gain from the stock's re-rating once the macro concerns ease out in the future.