Kotak Sec is cautious on Maruti

Raising estimates but not pulling out all the stops. We don’t believe strong volume
growth at Maruti would help offset the permanent margin decline brought about by a
higher royalty charge. We show how Maruti’s cost structure has not really benefitted
from operating leverage in the past. We are raising our FY2011E and FY2012E EPS
estimates by 5% and reflect domestic volume growth of 25% and 15%. We retain our
REDUCE rating as the recent outperformance appears to make light of some key areas
of concern.


We have seen limited operating leverage benefits in the past
Most of Maruti’s costs have grown at a rate faster than volumes, driving constant increases in cost
per unit metrics (Exhibit 1). Most of the EBITDA per unit improvement seems to have come from
higher realizations driven by the improving mix, which we don’t expect to repeat going forward.
The higher royalty payment on a percentage-of-sales basis further reduces operating leverage for
the company. Exhibit 1 also shows that our cost estimates could be aggressive compared to past
trends.
Raising EPS estimates to reflect higher volumes estimates
We are raising our FY2011E and FY2012E EPS estimates to Rs80 and Rs93 from Rs78 and Rs88
prior. We are raising our volume estimates to 1.24 mn units for FY2011E, implying 21% growth
from FY2010. We have modeled 25% domestic volume growth and flat exports. Maruti’s
domestic volumes have grown 28% in 1HFY11 and our volume estimates imply 22% growth in
2HFY11. For FY2012E, we have modeled volume growth of 14% to 1.4 mn units. We have
assumed 15% domestic growth and 10% export growth for the year. A 1.25 mn unit domestic
volume estimate implies that the passenger cars grow at a 22% CAGR between 2010 and 2012
and Maruti maintains a 50% market share. On the margin front, we expect EBITDA margins to
come in around 11% for the rest of the year compared to 9.6% for 1QFY11. We have modeled
EBITDA margins of 10.7% for FY2012E.
Raising target to Rs1,330 to reflect higher earnings, maintaining REDUCE
Our 1,330 target implies 13.5X our FY2012E consolidated EPS of Rs98. At our EPS estimate of
Rs93, the company’s earnings are growing at a 4% rate between 2010 and 2012. In addition, we
see risks to our estimates from (1) competition with Toyota entering the hatchback segment in
January 2011, (2) adverse currency movements and (3) commodity cost increases. We could be
aggressive in our assumptions by not modeling a decrease in raw material costs from 1QFY11
levels, increasing average realizations and operating leverage benefits that they have not got in the
past.