BoA ML: Favor under-performing, undervalued stocks: add Maruti

Favor under-performing, undervalued stocks: add Maruti
In our report dated 20 September, 2010 “Which stocks to buy” (India Strategy, 20
September 2010), we had identified under-valued, under-performing stocks that
may outperform the market going forward. We are adding Maruti which has been
the worst performing auto stock YTD to our model portfolio. We are funding this
largely by removing M&M from the model portfolio after its strong performance for
the year. We are also partly funding this by cutting our existing O/W position on
banks by 200 bps. While we are still O/W banks, we think tactically it makes
sense to take some profits from SBI after its 30%+ move over the past 3 months.
Maruti: Why Buy?
Our auto analyst, S Arun, has today upgraded Maruti to a BUY from
Underperform and raised his forecasts which are now 10-15% above consensus.
We expect EPS growth of near 24% over FY11-13. 3 factors drive our positive
view:
1. Strong sales: We think Maruti will maintain market share and grow sales
over 20% CAGR.
2. Margins may surprise: While the royalty hit on margins is discounted, we
think margins can rise 80 bps (app 10%) over next 2 years as operating
leverage kicks in and sales shifts to higher margin products like Swift, Dzire
and Alto.
3. Factoring subsidiaries in earnings: We have consolidated Maruti’s
subsidiaries in our earnings and believe associates and subs will account for
over 7% of total profits. This includes Suzuki Powertrain India (30% owned by
Maruti) which supplies diesel engines to Swift, Dzire and Ritz. On a
consolidated basis, the stock looks attractive at 13x FY12 earnings.
Why will sales grow strongly?
In spite of rising competition, we believe Maruti will maintain market share as (a)
the Alto K-10 and Eeco have been strong successes (b) the upgraded K-series
engines should continue to drive demand for Swift, Dzire (c) introduction of CNG
vehicles on popular models like Zen Estilo, Swift, Eeco etc should give Maruti an
early mover advantage and (d) entry in new segments like premium cars (Kizashi
sedan launch by April, 2011) and utility vehicles should help sales outlook.
Secondly, we are positive on management’s plans to ease capacity constraints
through de-bottlenecking (10% capacity increase from H2FY11) and a unit in
Manesar for 250,000.