New Gujarat plan likely to lift Maruti PE, brokers up target price
Most brokerages have increased their target price on Maruti after the company board reviewed the Gujarat unit in a bid to placate its angry investors.
The cash surplus will remain elevated, as the company will not deploy funds for the Gujarat facility. Rather, parent Suzuki Motor will provide the initial funds and take care of any shortfall during the later stages of expansion. The company will be able to leverage the benefit of new capacity of up to 15-lakh vehicles without incurring a single penny on capital expenditure.
On the valuation front, after the management addressed investor concerns on margin and transfer of assets, the Maruti stock’s average price-earning, or PE, multiple is likely to rise after it was recently de-rated due to corporate governace issues. The PE ratio is a measure of how much an investor will pay for the stock for each unit of profit.
With fears of dilution in margins also being addressed, the new plant will be more free cash flow accretive.
Minority investors had raised concerns about margin erosion on sale of vehicles manufactured at the Gujarat plant. In a statement released on February 26 to the stock exchanges, the company included the concept of “mark-up” as one of the sources to fund capital expenditure at the plant.
The “mark-up” implies Maruti Suzuki will have to share profits from vehicles manufactured in the plant, which would have dented margins from FY18. Minority shareholders were wary of Maruti emerging as a potential trading company in the future and being open to the risks of earnings volatility in a cyclical downturn.
In the changed scenario now, as the company will not incur capital expenditure from its books, cash reserve will continue to expand. The ballooning cash reserve will boost other income and, thus, profitability. At the end of September 2013, Maruti had cash and cash equivalent of Rs 8,500 crore on its books. The volume growth is expected to pick up on sales volumes of Celerio and other new models to be launched over the next 12-18 months.
Profitability will rise with more models and free cash flow is likely to be high. Free cash flow means cash in the books of the company after deducting capital expenditure from cash received from operations.
A report by IIFL, authored by Joseph George and Kevin Mehta and released on Tuesday, said Maruti’s FY18-FY32 EPS will see a 4-10% positive impact due to interest income on higher cash balance as Suzuki finances capacity expansion.
The biggest respite for the car maker will be on the valuation front, as a majority of analysts have adjusted to the new target price on the prices of historical averages.
The assigned price-multiple of the stock had been de-rated to 12-13 times from a historical average of 15-16 times on uncertainty relating to the Gujarat plant. IIFL has now assigned a PE of 15 times from 13.5 earlier and revised its target price toRs 2,040 from Rs 1,820. IDFC and Edelweiss, too, have projected a PE multiple of 15 times and upgraded the target prices for the stock.
The stock closed up 7.4% at Rs 1,868 on National Stock Exchange on Tuesday.