Stock corner: ‘Buy’ on Maruti Suzuki, earnings cycle expented to bottom out in FY20

By BofA Securities

We expect Maruti Suzuki’s (MSIL’s) earnings growth to bottom out in FY20 and improve materially in FY21/22 (26% EPS CAGR FY20-22e), led by: (i) volume uptick of 10% each in FY21/22e as macro factors improve; (ii) lower channel stress (inventory levels + lower discounts); and (ii) lesser impact from BS6, as MSIL has already transitioned 60% of vehicles. That said, the withdrawal from diesel (25% of volumes) and higher competition are near-term risks. We expect new launches (in collaboration with Toyota) to offset some of these concerns. Over the last 18 months, consensus estimates for FY21/22 have seen a 50% cut, and MSIL has underperformed the broader market (-19% return vs. +18% Nifty 50). With an expected recovery in earnings, we upgrade the stock to Buy (from Neutral), with a new PO of Rs 8,650 (24x FY22e P/E) vs. Rs 7,450 earlier.

Best placed for recovery in PVs

Volume growth for the PV industry has been weak for the last 18 months (-20% YTD y-o-y), wherein MSIL has maintained its market share at close to 50% YTD. Over the last 12 months, it has: (i) cut production to align inventory levels; (ii) increased discounts to boost retail volumes; and (iii) expanded dealer touchpoints. Our channel checks suggest retail demand has improved y-o-y (in recent months), inventory levels are under control, and high discounts seen in Sep/Oct are easing off. We estimate volume growth of 10% each in FY21/22 as MSIL is less impacted by the BS6 transition.

26% EPS CAGR to sustain valuations

MSIL’s Q2 Ebitda margin was the lowest in 25 quarters. With inventory restocking and retail improving, overall wholesale dispatches are already improving in Q3. High volume and pricing improvement (Q4 price increases announced) should lead to Ebitda margin improving to 13.4% by FY22 (vs 9.5% in Q2). This would result in a 26% EPS CAGR over FY20-22e. We expect the market to look through the FY21 transition and value the company on a FY22 basis, and thus sustain its premium over peers (our PO implies 23x FY22e P/E).

Margins expected to bottom out in Q3

Negative impact from low operating leverage is limited now: Volumes are expected to see an uptick from Q3 itself as the overall de-stocking cycle is largely over, in our view. Also, despite discounts being higher in Q3, the overall volumes are expected to be much higher than in Q2, which should offset any negative impact of lower volumes.

Pricing trends also improving incrementally: Pricing trends are suggesting that in Nov-19, discounts are meaningfully lower for Maruti Suzuki (not for the industry overall). While discounts are coming off from their Sept-19 highs, Q3 levels are likely to be a peak on a quarterly basis, in our view. With price increases and new launches, we expect pricing trends to improve from Jan-20.