Q3 results: Bad miss

Ebitda margins expected to improve to 15.5% in Q4FY16

ASSESSING the margin impact from change in factory inventory: Maruti follows full cost accounting method to value finished goods inventory which could lead to some variation in gross margins on a quarterly basis. As per our assessment, the margin impact of this was 40 bps negative in Q3FY16 and 30 bps positive in Q2FY16 which implies that the primary reason for margin miss in Q3FY16 was higher discount and weaker product mix. We expect Ebitda margin of Maruti to improve to 15.5% over the next few quarters led by normalisation of factory inventory, non-recurrence of excessive plant maintenance expenses and potential reduction in discount and advertising expenses. Maintain Buy with unchanged TP (target price) of R4,900 which is based on

20X Sep. 2017 EPS.

Maruti follows full cost accounting method to value finished goods inventory Maruti Suzuki follows full cost accounting to value the inventory of finished goods. In fact this accounting policy is being followed by other auto companies as well as companies across several sectors in India. In this policy, the cost of finished goods includes raw material cost, variable manufacturing expenses as well as other fixed manufacturing overheads. As a result, in a particular quarter, when vehicle production is greater than wholesale volumes sold by the company, then there will be a positive impact on gross margins as closing inventory will include a part of fixed overheads which will reduce overall costs in that quarter. Higher closing inventory will increase inventory items in the balance sheet and reduce overall expenses in the income statement. Changes in factory inventory impacted gross margins by 10-40 bps in last 7-8 quarters As per our calculations, fixed manufacturing overheads accounted for 27% of total employee cost and other expenses of Maruti in FY2015. Assuming a similar ratio, we note that fixed manufacturing overheads was in the R16,00021,000 range per vehicle for the company over the past 7-8 quarters. Thus, reduction of factory inventory by ~37,000 units in Q3FY2016 would have negatively impacted gross margins by ~40 bps and there was a positive benefit of 30 bps in 2QFY16. We expect Ebitda margins of Maruti to improve to 15.5% in Q4FY16.