Maruti’s rich valuations difficult to sustain

Record discounts, tepid demand highlight its struggle to achieve volume growth

The Maruti Suzuki stock has gained over 35 per cent in the last three months on expectations of volume gains in the second half of the fiscal year, market share improvement, and edge over competition on the transition to the BSVI emission norms. The corporation tax cut helped boost sentiment for the stock. Given the price surge since August, the stock is now trading at over 33 times its estimated FY20 earning per share and 31 times one-year forward estimates. Current valuations are at the highest levels in at least 14 years. Barring Eicher, most of its peers in the auto sector are trading at a sharp discount to its valuation in the range of 14-17 times.

The valuation was one of the reasons the stock did not react much to the October sales volume number even as growth at 4.5 per cent year-on-year was better than expectations. “Bunched up demand, festival sales, and higher discounts led to an uptick in Maruti’s volumes. After the sharp run-up, the stock is now trading at expensive levels,” says Mitul Shah of Reliance Securities. While sales were up, analysts highlight the fact that the two periods are not strictly comparable as the festival season last year was split between October and November; this year it was almost entirely in October.

While Maruti’s strengths are well known, the Street seems to have run ahead of itself given that the outlook remains muted. One of the reasons for Street’s optimism has been the hope of an uptick in volumes, which remains the key trigger for the company. The Maruti management indicated that retail sales in the festival period have seen some green shoots, and there has been an uptick in retail momentum. However, they added that there is little clarity on the sustainability of the trend in the absence of festival demand and current discounts.

Analysts at ICICI Securities, too, remain sceptical. “We have just witnessed a festive season with all-time high discounts (~25,800 per unit in September quarter or Q2) failing to unleash consumer purchase frenzy. This probably signals a slow grind for demand recovery. Surprisingly, valuations remain divergent.” Given five consecutive quarters of volumes decline, the company has had to give higher discounts to improve volumes.

The other worry is the market share loss. Maruti’s market share has declined 120 basis points quarter-on-quarter to 49.8 per cent in Q2. Analysts at HDFC Securities believe that this was mainly because of a decline in the share of the utility vehicle (UV) segment to 25.7 per cent from 26.3 per cent, led by the phasing out of the diesel portfolio. The company will not be converting its diesel offerings to BSVI for now. The change in consumer choices could also be hurting Maruti.

Nirmal Bang Institutional Equities believes that consumer preference is moving towards utility vehicles, with 10 of the 13 new launches in the passenger vehicle segment being UVS. Analysts at the brokerage say since Maruti is dominant in the car segment, which is declining faster than UVS, it has been losing share. This trend of market share loss is expected to continue as more models are launched by rivals in the UV segment.

There are, however, some positives for Maruti. Despite a sharp 30 per cent decline in volumes, revenue fall was contained due to higher realisations. The company was able to increase average selling prices of its vehicles by 7 per cent yearon-year in Q2 to pass on the safety equipment and Bsvi-related cost increases. Its new offerings (S-presso and XL6) also saw good response post launch, which is important given the volume decline in entry-level and other segments. The decline in commodity prices is another positive given the pressure on margins on account of falling volumes. Margins in the quarter fell 500 basis points year-on-year to 9.5 per cent. While lower commodity costs are a tailwind, the biggest drag on margins is negative operating leverage. Thus, if sales volume does not increase, the stock, which has outperformed most of its peers over the last quarter, will find it difficult to maintain its gains.