>Maruti Suzuki (IDFC SSKI)

Maruti Suzuki (MSIL) has outdone street expectations as volumes have rebounded (up 17%yoy) in Q4FY09 on a high base. While rural initiatives and focus on tapping PSU employees (higher incomes owing to the recently doled out fiscal incentives) have helped, hefty discounts on older models (like WagonR) and strong demand for the Swift family have primarily driven the growth. However, inventory has reverted to 3-4 weeks as of end- March09 (also confirmed by MSIL in a recent conference call). Hence, we believe the ~70,000 units run rate clocked in Q4 in the domestic market is not sustainable. Further, Swift – a key volume driver – is likely to face stiff competition from the new Honda Jazz (likely to be launched in June09) and diesel variants of i-10 and i-20 from Hyundai in FY10. Further, export volumes have picked up only on account of A-Star – currently being sold by Suzuki in Europe as the new Alto. But given recessionary trends in Europe, A-Star exports may decelerate. On the operational front, operating costs have gone up significantly due to higher power and fuel costs due to Manesar plant ramp-up, increasing royalty on new model launches and rising sales promotion expenses to push volumes. The incremental costs, we believe, would nearly wipe out the gains arising from lower raw material prices in FY10 (we have assumed a 100bp margin expansion to 11%). To build in the volume ramp-up in Q4FY09, we upgrade our FY09 and FY10 estimates upwards by 15% for FY09 and by 2% for FY10. However, the stock has outperformed the Sensex by 45% in Q4FY09 and at 15.5x FY10E earnings and 9.7x EV/ EBIDTA, we believe, valuations appear expensive. Our best case estimate for MSIL (15% volume growth and 150bp margin expansion in FY10) would yield an EPS of Rs62.1 with a target price of Rs869 – based on 14x FY10E earnings, 3% upside from here. Given the lack of volume visibility in FY10, we value MSIL at 12x FY10E earnings with a price target of Rs655. Maintain Underperformer.

Strong recovery posted in domestic market in Q4FY09…
MSIL has posted a strong recovery in Q4FY09 with 13%yoy volume growth in the domestic market after a 15%yoy decline in Q3FY09. Higher rural penetration (rural sales have gone up to 8.5% of the total in FY09 from ~3.5% a year ago) and focus on PSU employees (sales to this segment increased to 11% from 5%) have helped MSIL post higher volumes in the quarter. Also, aggressive discounting on older models (like the hefty ~Rs45,000 discount offered on WagonR in March 2009), incremental volume addition from the latest launch A-Star as well as strong demand for the Swift family have been the key volume contributors in Q4FY09

…unlikely to be sustainable going forward
While volumes have recovered from the December lows, we do not expect the current momentum (hit rate of ~70,000 units monthly for Q4) to sustain going forward. A ground level analysis reveals that although MSIL had managed to bring down dealer level inventory from almost 28 days in November 2008) to ~15 days by January 2009, it has again gone up to 3-4 weeks as of end-March 2009.

Higher A-Star exports may drive volumes, not margins
Exports have received a significant boost primarily on account of exports of A-Star. Adjusting for the 19,000 units of AStar in the three months since its launch, export volumes have actually declined by 4%yoy in FY09. Currently, A-Star is being exported to European markets and is sold as the new Alto from Suzuki. Given the prevalent recessionary trends in Europe, A-Star export momentum may not be sustainable. Further, given that the parent Suzuki has suffered a loss of ~¥12.6bn in Q3FY09, Suzuki is likely to seek price cuts from MSIL. Further, MSIL had earlier also entered into a contract manufacturing agreement to supply A-Star to Nissan for the Japanese market, for which negotiations are on. Given the nature of the deal (contract manufacturing) with Nissan, we do not expect it to be margin-accretive for MSIL.

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