Maruti Suzuki. CMP: INR1,395 TP: INR1,730 Buy

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1 BSE SENSEX S&P CNX 18,431 5,598 Bloomberg MSIL IN Diluted Equity Shares (m) Week Range (INR) 1,498/906 1,6,12 Rel.Perf.(%) 5/-5/20 M.Cap. (INR b) M.Cap. (USD b) October QFY13 Results Update Sector: Automobiles Maruti Suzuki CMP: INR1,395 TP: INR1,730 Buy Maruti Suzuki s (MSIL) EBITDA margin for 2QFY13 was higher than our estimate, buoyed by lower than expected staff cost and other expenditure (due to write-back of 1QFY13 royalty provision). Further, higher other income and lower tax boosted PAT to INR2.27b (v/s our estimate of INR1.18b). Volumes declined 22% QoQ (9% YoY), impacted by labor issues at Manesar (production loss of ~77,000 vehicles) and poor demand for petrol vehicles. Higher sales of Ertiga (including CKD exports) diluted the impact of adverse mix (lower share of diesel vehicles) and higher discounts. Realizations declined 1.6% QoQ (grew 19.5% YoY) to INR350,302/unit (v/s our estimate of INR347,724/unit). EBITDA margin contracted 120bp QoQ (20bp YoY) to 6.1% (v/s our estimate of 4.7%), impacted by (a) adverse mix, (b) lag impact of a weak INR in 1QFY13 on vendor imports, (c) higher discounts on weak petrol demand, and (d) negative operating leverage. Royalty was lower by 80bp QoQ due to marking-to-market (MTM) of 1QFY13 royalty provisioning at a favorable exchange rate as at September Earnings call highlights: (1) Demand has improved with the onset of the festive season and new Alto launch, (2) Order backlog: New Alto ~30,000; diesel vehicles ~125,000 units, (3) Raw material cost to remain largely stable, barring exchange rate movement, (4) Overall royalty to remain in the 5.5-6% range, despite new Alto launch, (5) 2HFY13 average discount to be lower both sequentially and YoY, (6) Phase-1 of new diesel engine plant (capacity of 150,000 units) to come on stream in Sep-13. Valuation & view: We are upgrading our EPS estimates for FY13/FY14 by 3.4%/3.6% to INR69.5/INR98.2 to factor in higher realizations and lower fixed costs. The stock trades at 14.2x FY14E consolidated EPS of INR98.2 and 8.1x FY14E cash EPS of INR Maintain Buy with a price target of INR1,730 (~10x FY14E cash EPS). Jinesh Gandhi (Jinesh@MotilalOswal.com) Chirag Jain (Chirag.Jain@MotilalOswal.com) Investors are advised to refer through disclosures made at the end of the Research Report.

2 Labor issues at Manesar plant impact 2QFY13 performance Overall volumes declined 22% QoQ (9% YoY) to 230,376 units. While domestic volumes declined 5.6% YoY (20% QoQ), exports declined 31.7% YoY (37% QoQ). The labor issue at Manesar impacted volumes by ~77,000 units in 2QFY13. Realizations declined 1.6% QoQ (grew 19.5% YoY) to INR350,302/unit (v/s our estimate of INR347,724/unit), impacted by lower diesel vehicle sales (on production constraints) and higher discounts (on weak demand for petrol vehicles), partially negated by higher Ertiga sales (including CKD exports). MSIL s market share in the domestic PV industry declined ~600bp QoQ (340bp YoY) to 34.1%, reflecting loss of volumes due to the Manesar labor issue. Average discount increased by INR3,100/unit QoQ (INR2,150/unit YoY) to INR14,750/unit in 2QFY13, reflecting higher discounts on petrol cars and adverse mix (lower supplies of Swift and Dzire). Revenue declined 23% QoQ (grew 8% YoY) to INR83b (v/s our estimate of INR82.5b), driven primarily by lower volumes. Trend in volumes ( 000 units) 2Q 2Q YoY 1Q QoQ FY13- FY12- CHG FY13 FY12 (%) FY13 (%) YTD YTD (%) A % of total MPV % of total A % of total A % of total % of total UV % of total Exports % of total Total Sales Total PV (Incl Exports) MS (%) bp bp bp Total Dom. Car MS (%) bp bp bp Total Dom.Car(ex-Nano) MS (%) bp bp bp Source: Company, MOSL Trend in domestic PV market share (%) Source: Company, MOSL 31 October

3 Trend in realizations (INR '000) Discount increases due to weak petrol demand & poor mix Source: Company, MOSL EBITDA margin shrinks due to poor mix, lower volumes and lag impact of a weak INR in 1QFY13 on vendor imports Gross margin declined 180bp QoQ (110bp YoY) to 20.4% (v/s our estimate of 21.2%), driven by lower share of diesel vehicles, increase in average discount and adverse forex movement (lag impact on vendor imports). EBITDA margin declined 120bp QoQ (20bp YoY) to 6.1% (v/s our estimate of 4.7%), impacted by negative operating leverage, but supported by write-back of 1QFY13 royalty provision of INR380m on favorable forex rates as at the end of 2QFY12. Overall, other expenses (including staff cost) were lower by 60bp QoQ (150bp YoY). It has not provided for the model fee and royalty on the new Alto 800, as it is yet to finalize the royalty rate on the new Alto. EBITDA declined 35% QoQ (grew 15% YoY) to INR5.01b. Adjusted PAT declined 5% YoY (46% QoQ) to INR2.27b (v/s our estimate of INR1.18b). Other income grew 39% QoQ (9% YoY) to INR1.56b (v/s our estimate of INR1.25b), primarily driven by INR430m MTM gain on commodity hedges. The tax rate for 2QFY13 was 18.7% (v/s our estimate of 19.5%). The management has guided tax rate of ~20% for FY October

4 Trend in EBITDA Royalty & Other exp drops on a sequential basis Source: Company, MOSL Forex USD/INR leg remains open; a cause of concern Direct exposure: The management indicated that it has hedged 1/3 rd of its USD/ JPY direct exposure for the remainder of 2HFY13. Considering the recent favorable movement in USD/JPY, MSIL has started taking hedges for the balance part of the direct exposure. For its USD/INR exposure, the company has a natural hedge through exports. Indirect exposure: While MSIL has taken some hedges for its USD/JPY exposure, the USD/INR leg is largely open. To reduce forex exposure, the company aims to increase its exports to 15% of sales and reduce its import exposure. Exports would be increased through a combination of exploring new markets (like Africa) and exporting newer products. On the other hand, the company is working on reducing its import exposure through localization at the vendors end. Its initiatives to increase localization and reduce dependence on imports should reflect over the next 2-3 years. Our estimates factor in JPY/INR of 0.684/0.663 for FY13/FY14. For a 1% JPY/INR movement, MSIL s FY14E EBITDA margin would change by ~15bp and EPS would change by ~2.3%. Dieselization continues, with no trend reversal yet During 1HFY13, ~58% of the industry s passenger vehicle sales were of diesel variants, as against 35% five years ago. While petrol vehicle volumes declined 20%, diesel vehicle volumes grew 40%. While the gap between petrol and diesel prices has narrowed post the recent INR5/liter hike in diesel prices, MSIL has not witnessed a meaningful shift in demand back towards petrol vehicles. The management expects demand for diesel vehicles to remain strong, with high disparity between petrol and diesel prices (despite the recent diesel price hike) and increase in income levels. The UV segment has been outperforming the PV industry due to (1) UVs being primarily diesel powered vehicles, (2) maturity of Indian customers, who are now looking to upgrade from premium hatchbacks/sedans to UVs, and (3) new launches in the segment. 31 October

5 Other conference call highlights The management indicated that the overall demand scenario has improved, with the start of the festive season and the launch of new Alto. Demand during various festive seasons such as Onam (South), Ganapati (West), Navratri has grown YoY. However, demand for petrol cars, though higher sequentially, remains weak in line with the overall weakness in the petrol car segment. Response to the new Alto has been good, with over 30,000 bookings already received since launch. The current order book for diesel vehicles stands at over 125k units. The Manesar plant has ramped-up well and is currently producing 1,600units/ day. MSIL expects to reach its peak production level of 1,800units/day at Manesar, shortly. It would sell 400,000 diesel vehicles in FY13; MSIL did not stop making diesel engines (at SPIL) even during the Manesar plant lockout. Channel inventory remains under control at 2-3 weeks v/s 4-6 weeks around six months ago. MSIL took a price increase of ~1% on an average with effect from October Raw material cost is likely to remain largely stable, barring forex movement. Recent wage negotiations would result in a 15-30bp increase in employee cost over the next 2-3 years. Despite the launch of new Alto, the management expects royalty payments to continue to be in the range of 5.5-6%. The management expects discount levels to have peaked and expects a decline in 2HFY13, driven by higher diesel cars in its sales mix and better demand for petrol cars. Phase-1 of the new diesel engine plant, with a capacity of 150,000 units, is likely to come on stream in September Phase-2, with another 150,000 unit capacity will come up by June MSIL is contesting a claim of INR5b from Haryana State Industrial & Infrastructure Development Corporation Limited (HSIIDC) in the Supreme Court. This relates to additional compensation for landowners for land acquired by MSIL for industrial purposes. The company has not made any provision for the claim, as the amount is not determinable at this stage. Further, it has written back ~INR2.35b provided earlier, based on HSIIDC s demand. Upgrading FY13/FY14 estimates by 3.4%/3.6% We upgrade our consolidated EPS estimates by 3.4%/3.6% for FY13/14 to INR69.5/ INR98.2, driven by improvement in our margin assumptions on better mix, higher volumes and lower discounts. We expect MSIL to register volume growth of 4% in FY13 and 15% in FY14 (FY12-14E CAGR of 9.2%, FY11-14E CAGR of 2.1%). EBITDA margin for FY13/FY14 would be 8.8%/10.3%. Our estimates factor in JPY/INR of 0.684/0.663 for FY13/FY14 and 0.5%/1% reduction in import content. 31 October

6 Revised forecast (INR B) FY13E FY14E Rev Old Chg (%) Rev Old Chg (%) Total Volumes ( 000) 1,177 1, ,352 1, Domestic 1,055 1, ,197 1, Exports Net Sales EBITDA Margin (%) bp bp PAT Consol EPS (INR) Cash EPS (INR) Source: MOSL Valuation and view The operating environment for MSIL is gradually improving, with (a) initial signs of demand recovery, driven by new Alto launch and onset of the festive season, (b) discount stabilization, (c) INR appreciation, and (c) possible permanent solution to its industrial relationship problem (with the conversion of temporary workers to permanent workers, and liberal wage hikes). Continued volume revival, discount reduction and higher diesel engine availability (expected from September 2013) would be the key catalysts for operating / stock performance, apart from favorable forex movement. We expect upside risk to our volume growth estimates if demand momentum continues to be healthy beyond the current festive season. The stock trades at 14.2x FY14E consolidated EPS of INR98.2 and 8.1x FY14E cash EPS of INR Maintain Buy with a price target of INR1,730 (~10x FY14E cash EPS; 17.6x FY14E consolidated EPS). 31 October

7 Maruti Suzuki: an investment profile Company description Maruti Suzuki is the largest passenger vehicle manufacturer in India, with 1.2m units. It dominates the domestic cars segment with ~41% market share. It is also emerging as the global export hub of small cars for Suzuki, with world strategic model A-Star exclusively produced in India. It has recently launched Ertiga and new Alto 800. Its two plants are in Haryana - Gurgaon and Manesar. Key investment arguments Volumes momentum to remain intact in long run, despite short-term headwinds, resulting in 12% CAGR (FY12E-15E) in MSIL s domestic volumes Volume growth in domestic market driven by focus on tier-ii cities and rural market, recent launches and increase in diesel engine capacity. Improving product mix with increasing share of A2, A3 and UV segment, driven by newer products. Key investments risks Increasing competition in the key A2 segment. Adverse forex movement may impact margins negatively. Higher royalty and strengthening of commodity prices could impact margins. Recent developments Manesar plant is ramping up well and currently production ~1600 units/day. The company has recently launched the new Alto 800 and has received over 30k bookings. Valuation and view The stock trades at 14.2x FY14E consol EPS of INR98.2 and 8.1x FY14E Cash EPS of INR Maintain Buy with price target of INR1,730 (~10x FY14 CEPS/17.6x FY14 consol EPS). Sector view Short term pressure notwithstanding, passenger vehicle segment is expected to continue its growth momentum over medium to long term. With low car penetration levels and rising income levels, the upside potential for growth is tremendous. However, increasing competition poses threat in long term. Comparative valuations Maruti M&M Tata Motors P/E (x) FY13E FY14E EPS Gr (%) FY13E FY14E RoE (%) FY13E FY14E EV/EBITDA (x) FY13E FY14E EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) 1,395 1, Buy Stock performance (1 year) Shareholding pattern (%) Sep-12 Jun-12 Sep-11 Promoter Domestic Inst Foreign Others October

8 Financials and Valuation 31 October

9 N O T E S 31 October

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