Hitch a ride

The good thing about a bear market is that stocks of market leaders,which would be prohibitively expensive during a bull run...

Written by Sanjay Kr Singh | Published:March 9, 2009 11:59 pm

The good thing about a bear market is that stocks of market leaders,which would be prohibitively expensive during a bull run,become available at reasonable valuations. So it is these days with Maruti Suzuki,the leader in the passenger car market.

Value hunting

While searching for stocks to recommend,we look for two criteria: strong growth prospects and reasonable valuations. To ensure the latter,we use a series of filters. One criterion we use is that the current earnings yield of the stock must be higher than the yield on a 10-year treasury bond. We divide the EPS (earnings per share) by the yield on a treasury bond to get a hurdle price. If the current price of the stock is lower than the hurdle price,then the stock’s earning yield is better than the yield of a 10-year T-bond. Maruti Suzuki meets this criterion (see table).

Next,the trailing PE of the stock (15.98) is lower than its long-term average PE of 16.88 (for the period between February 3,2004,and February 27,2009,calculated using PE figure for every two months).

Next,the trailing PEG (trailing price-earnings ratio divided by growth rate in earnings for the last four years) comes to 0.5,which is a very attractive level (anything below one is good; the lower this figure,the better).

What we also liked about the company is its strong track record of growth in income and profit after tax (PAT) over the last five years: five-year compounded annual growth rate (CAGR) in income is 18.4 per cent and in PAT is 63.9 per cent. And at 20.23 its return on capital employed (ROCE) for FY08 is also quite high compared to that of most industry peers.

Over the last four years,EPS grew at a CAGR of 33.83 per cent. The debt to equity ratio of the company for FY08 is quite low at 0.11 — a very desirable characteristic as it demonstrates that the company is not carrying a high interest burden. Net cash per share of Rs 148.85 (FY08) demonstrates that the company is well-positioned to withstand the downturn.

Maruti’s strengths

Maruti’s strengths arise from its first-mover advantage in the country,which the company has used to create a strong brand equity (it has secured top rank in the JD Power Customer Satisfaction Index for the last nine years),and an unmatched network of dealerships (627 in 413 cities) and service stations (2,673).

Second,its strength in the economy segment gives it an advantage. “India has a large population of two-wheeler riders who will eventually graduate to owning a car. In all likelihood,Maruti Suzuki is the company they will turn to to fulfil their aspirations,” says Ashish Kapur,chief executive officer of New Delhi-based Invest Shoppe. Moreover,the economy segment tends to be less affected by a downturn. “In these times,people are more likely to postpone the purchase of a luxury car than of a small car,” adds Kapur.

Another strength is its strong product portfolio. Says Kapur: “Between Rs 2.5 lakh and Rs 8 lakh,the company has a model or a variant to offer at almost every

Rs 50,000 price point.” Yet another positive is its parent Suzuki’s ability to provide Maruti with a pipeline of new models that it can launch in India.

Market share. Maruti’s share in the passenger car market stood at 51.4 per cent at the end of FY08. While continuing to lead in the A2 segment (compact cars — the segment that accounts for 71 per cent of the market) with a share of above 58 per cent,Maruti regained leadership of the A3 segment (sedans) in FY08 with a market share of 21.9 per cent.

Growth plans

Broadly,the company’s growth strategy is as follows: increase volumes through greater penetration in all parts of the country; do product variations of existing models to earn better margins; and enter the premium segment through models like SX4 and Swift Dzire.

Target numbers. The company has targeted annual sales of 10 lakh cars in the domestic market by FY11 (in FY08 it sold 7,11,818). It is also targeting export of 2 lakh cars annually by FY11 (from 53,024 in FY08).

New launches. Maruti has launched the A-star this year and plans to launch Splash by April or May ’09 and thus consolidate its position in the A2 segment.

Enhancing manufacturing capacity. The company had expanded its manufacturing capacity to one million units per annum by October 2008 to cater to both the domestic and export markets.

Expanding network. To maintain volume leadership,Maruti plans to increase its sales points from about 600 (at the end of FY08) to 1,000 in three years and its workshop network by 45 per cent over this period.

Bullish on exports. Maruti Suzuki is set to become Suzuki’s manufacturing hub for exports by being the exclusive manufacturer of A-Star,which the company plans to export to Europe. Maruti has also entered into a contract with Nissan to supply 50,000 cars. According to Vaishali Jajoo,senior analyst at Angel Broking,“Export will be a major growth driver in the next two years even if the domestic market slows down slightly.”

Focused on R&D. Maruti Suzuki’s in-house R&D unit has handled the upgrading of engine systems to meet stricter emission norms and to introduce alternate fuel options (diesel and LPG). It has also contributed to global design projects,such as that of Swift and A-Star. Over the next three-five years,the company aims to develop its R&D capability to develop new models. In the meanwhile,in-house R&D will be used to give face-lifts to existing models and to launch their special editions,which will contribute to better margins. During FY08,the number of engineers in R&D went up from 258 to 398.

Threats to business

The threats to Maruti arise from today’s bleak macro-economic environment,industry-specific issues,and from competition.

Economic slowdown. Job losses and losses suffered by businesses are affecting customers’ ability to purchase cars. Says Kapur: “What is adding to the environment of uncertainty is that no one is sure how long the downturn will last — perhaps the next couple of years. In my opinion,we may not have reached the trough in the business cycle yet.” According to Chetan Vora,auto analyst at Brics Securities,“We expect volumes to remain subdued until Q2FY10E and to increase from Q3FY10E on account of a lower base and due to the positive impact of the fiscal stimulus provided by the government.”

To revive falling sales,Maruti reduced the prices of all its models in response to the cut in excise duty,and offered discounts. The company is also encouraging exchange offers (discount on price of new car if you trade in your old car).

Lack of easy financing. Today procedures for taking a car loan have become stringent. Banks are not lending easily because they are scared of loans going bad. This is affecting the sale of cars.

Piyush Parag,auto analyst at Religare Capital Markets points to another issue that is hampering credit flow: “Financers have demanded that the government put in place stringent regulations for repossession of vehicles in case of default on loan repayment. Such a regulation will make them more positive about lending to the auto sector.”

Stiffer competition in future. Three-four years down the line competition is likely to get much stiffer for today’s market leader. Says Vora: “Many foreign players have lined up their launches in FY10 and FY11: Honda’s Jazz,Fiat Bravo,Toyota’s small car,Hyundai’s i10LPG and others. Due to these launches Maruti’s market share could fall.” However,he is optimistic that Maruti’s volumes will continue to increase year-on-year due to its strong brand equity and extensive dealer network (See table: Segment wise competitive scenario).

Adverse currency movements. Many of the car parts for Maruti’s models come from Japan. “The adverse currency movement of the last six months has put pressure on its operating profit margin,” says Jajoo. With its export revenue set to grow,currency movements will have an even greater impact on its bottomline in future.

Quality management

Most analysts spoke positively about the quality of management at Maruti. Says Kapur: “Their ability to launch a long line of successful new products and variants at regular intervals points to their long-term planning horizon.” Adds Parag: “Their plan to infuse Rs 41 billion in capital expenditure between FY10 and FY12,with major investments in developing R&D,exhibits their vision for the company.”

Should you invest?

According to analysts,Maruti’s FY09 estimated EPS is likely to be around Rs 46 (23 per cent lower than FY08). Due to low base,falling commodity prices and falling interest rates,earnings may grow 20 per cent in FY10,and EPS could touch Rs 55. Thus,estimated forward PEG for FY10 is 0.6. Most analysts expect the company’s earnings to grow at a rate of about 12-15 per cent over the next three-five years. For those with at least a medium-term investment horizon,the stock looks attractive.

sk.singh@expressindia.com

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