Maruti stares at a rough ride in India as cost pressures rise
The price increase taken by the company has not been commensurate with the rising raw material prices and other expenses.
Higher costs would also mean moderation in profits, shrinking of valuation premium. Maruti is trading at 24.8 times its projected 12-month earnings, a 37 per cent premium to its 10-year average. The shares corrected 12 per cent in the past 45 days because of concerns over margins and intensifying competitive pressure, particularly from second largest car maker Hyundai. Kotak and Deutsche Bank have already cut earnings estimates, citing cost headwinds.
The price increase taken by the company has not been commensurate with the rising raw material prices and other expenses. Raw materials account for 69-70 per cent of revenue. Steel, copper, rubber and plastic components are major input cost-heads. Steel alone makes up 60-70 per cent of the total raw material cost.
Prices of steel rose 16 per cent in the past one year, and aluminium costs should climb 10-15 per cent by December 2018, according to Deutsche Bank. The rupee depreciation could further support the northward trajectory of prices of steel and aluminium. Maruti has recently increased prices by less than 1 per cent on a blended basis; however, given the quantum of raw material price increase, this would not suffice to maintain operating margins.
The impact of rising commodity prices was visible in the June quarter, with gross margin dropping 110 basis points sequentially to 31 per cent.
Furthermore, the pressure on operating margins will be felt due to the Japanese yen’s relative movement with the rupee. The company pays nearly 5.5 per cent of its revenue as royalty in yen terms, and the current rupee movement will hit margins by around 100 basis points.
In the past three years, Maruti has benefitted from moderation in the average discount due to increasing proportion of vehicles - Baleno, Brezza, New Swift and Dzire - sold at ‘zero’ discount, helping offset the impact of commodity pressures. However, as the waiting period of these ‘zero’ discount models is coming down, Maruti may have to increase the discount or exchange bonus on these models.
According to Deutsche Bank, the share of ‘zero’ discount has peaked at 50 per cent in the first quarter of FY19 and gradually will come down to 16.7 per cent in FY20. Besides, competition will intensify as Hyundai is launching a new entrylevel car in October and a compact SUV next year, which has been the dominant segment for Maruti. Hyundai has recently said that it would focus at home and an annual capacity of one lakh units earlier dedicated for exports will now be used locally.