Sell Maruti Suzuki - Elara Capital

• Maruti Suzuki
• Rating : Sell
• Target Price : INR1,076
• Downside : 21%
• CMP : INR1,360 (as on 23 July 2010)

Minority taken for a royal ride

Margins skid on royalty costs; downgrade margins outlook

Maruti Suzuki's (MSIL) adjusted EBITDA margins for the quarter at 10.4% were, 150 bps lower than our estimates. The variance was on account of sudden increase in royalty costs by the company from around 3.5% to 5% of the revenues. The government recently relaxed the restrictions on outbound remittance of royalties which was earlier capped at 5% of domestic sales and 8% of exports. The amendment document does not specify any caps and the future royalty costs are now left to parent, Suzuki's discretion. The company's EBITDA margins also suffered on account of unfavourable exchange rate and higher input costs.

Lower other income on drop in yields, investment mix change

The company's other income at INR 1bn was 53% lower than the same quarter last year as the investment mix between mutual funds and fixed deposits changed in favour of fixed deposits (which are relatively lower yield investments). Now the treasury income will be spread throughout the year (rather than being concentrated in the first quarter when dividends on mutual funds are declared).

Outlook and valuations; downgrade to SELL from ACCUMULATE

The sudden increase in royalty due to relaxation of remittance restrictions tells us two things; a) the company's EBITDA margins across all future years would hit to the extent of 170 bps solely on this count and b) in future, the parent company Suzuki (majority shareholder with 54% stake) will look at increasing royalty costs and taking away profits at possible opportunities while the minority shareholders are unlikely to benefit from any incremental profits. We are downgrading our adjusted EPS estimates by 20% and 22% for FY11E and FY12E to INR 76 and INR 83, respectively. We are also revising our target P/E mutiple downwards from 15x to 13x FY12E as we forecast a negative earnings CAGR of 2% over FY11-12E. We downgrade our recommendation on the stock from 'ACCUMULATE' to 'SELL' with a revised price target of INR1,076, a downside of 21% from previous closing price.

Source : Equity Bulls

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