Maruti: the valuation of the Maruti premium depends on the recovery of margins

ET Intelligence Group: Objects in the rearview mirror are closer than they appear.

This standard disclaimer might help explain why

Suzuki, which sells one in two cars on Indian roads, has struggled in recent times to stay ahead of soaring inflation in input costs. Margins fell to a multi-year low in the September quarter at the maker of S-Cross and Baleno, while a chronic shortage of chip supply forced the automaker to sacrifice volumes at a time of bookings. exceed 200,000 units.

This raises the question of whether, structurally, the cycle could turn later. It is not easy to guess the trends in global metal prices, but the odds are now growing that the global commodity recovery will continue.

This would mean some moderation of input cost pressures in Maruti, which can hardly afford to pass the full inflationary impact on to customers in a fiercely competitive market. There are some initial signs of increasing chip supply and moderating metal prices, although these changes in direction will need to last for some time for them to translate into concrete positive trends for an industry that is spending money. usually 7 of the 10 rupees she earns in raw materials.

Maruti’s operating profit margins fell to 4.2% in the September quarter, a contraction of 50 basis points on a sequential basis and 530 basis points on an annual basis. Maruti enjoyed an operating margin of over 13% in the pre-Covid period. One basis point is equal to 0.01%.

The impact of rising input costs can be measured by the fact that raw material costs as a percentage of sales reached 75.8%, compared to a long-term average of 69.7% for the company. This reduced gross profit margins to 24% in the September quarter.

On the other hand, lower usage due to a chronic shortage of fleas inflated overhead costs. About 116,000 units, with a potential value of around 6,000 crore in sales, could not be produced due to the unavailability of chips.

In addition, depreciation expense for the Gujarat plant owned by Suzuki Motor is reflected in Maruti’s “other expenses”, and these had a pronounced impact on margins due to low utilization. The Gujarat plant has depreciation expenses of about 500 crore per year; it therefore increased the fixed costs per unit in case of low use.

Thus, “other expenses” reached 15.6% of total income, a gain of 100 basis points compared to the previous quarter. The Gujarat plant produced about 120,000 units in the second quarter, or about 31% of total volumes.

Admittedly, the margin squeezing trajectory could be reversed with the drop in semiconductor supplies, particularly from the ASEAN block. In addition, underlying demand appears to be encouraging and the growing contribution of exports could offset a tightening in local sales. The company is looking to manufacture nearly 150,000 units in November, or about 30 to 40 percent more month over month.

This would help operating leverage to improve margins. The monthly run rate of 1.5 lakh per month for the remaining period of the fiscal year would translate into production of around 1.63 million units, which is 13% year-on-year growth.

On the demand side, the company has an order book of over 200,000 units after the September results. This reinforces the hypothesis that people do not postpone car purchases despite long waiting periods. Finally, exports more than doubled, with African countries accounting for more than half of overseas shipments. If this trend continues, it could open up a large market for Maruti Suzuki and reflect the performance of Indian two-wheeler manufacturers in Africa.

Maruti shares trade at 31 times one-year futures earnings, a 38% premium over long-term averages. The sustainability of this premium will depend on how quickly Maruti can achieve operating profit margins of at least 8-9%.

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