Improving margin, festive sales to support Maruti's valuation
The company’s stock is trading at 28 times its one-year forward earnings.
In the September 2019 quarter, Maruti’s operating margins dropped 90 basis points sequentially to 9.4 per cent, a multi-quarter low. This surprised the street as analysts had factored in far lower operating margins for the quarter. The basis for their lower operating margins have been weak demand, higher discounts and a low capacity utilisation.
Savings from cost efficiency and benign commodity prices have helped the company to deal with these challenged effectively. Its average discount per vehicle in the September quarter rose to Rs 25,741-- one of the highest level --from Rs 18700 in the same period last year. Also capacity utilisation was at 79 per cent in the same period. Sales volume dropped 30 per cent in the second quarter. Since the company demonstrated incremental cost savings during the downturn, it may change the street’s view on margin downside. The extent of the saving from cost measure can be gauged from the fact gross margins — revenue minus raw material -- expanded to 28.82 per cent, a four-quarter high.
In the coming quarters, the benefit of benign commodity prices is likely to benefit further as some pricing adjustment happens with a lag impact of six months. On the demand side, the company has been witnessing positive retail growth in the festive season and momentum has continued even after Dussehra.
Maruti Suzuki has already launched eights models which are compliant with BS6 (new emission norms) and looking at bringing down the network inventory. This is likely to further support margins.
According to Bloomberg consensus estimate, operating profit margins stood at 11.27 per cent and 12.50 per cent for the current and next fiscal year, respectively. Maruti’s operating margins stood at 9.92 per cent in the first half of FY20. Thus, the consensus margins suggest recovery in the second half. The Street is pricing in 8-10 per cent volume decline for FY20. It has witness volume decline of 24 per cent to 7.4 lakh in the first half of FY20.
Moreover, a lower tax rate in the current year could enhance the company’s profitability. It guided for the 23 per cent tax rate for the current fiscal, a saving of 5 per cent from the previous fiscal. The effective tax rate of the Maruti Suzuki was 13.3 per cent in the September quarter. Due to these factors, the company has kept its capex unchanged at ?4,000 crore for the current year.
The company’s stock is trading at 28 times its one-year forward earnings, a 55 per cent premium to the its 10-year average. The stock rose 28.1 per cent in the past three months, an outperformance of 16 per cent over the BSE Auto index.