Maruti Suzuki's (MSIL) Q2FY11 results were inline with our estimates as the company reported a 5% growth in net profits to Rs6bn. On an impressive volume growth of 27.4% net sales were up 26.8% to Rs91bn. Increase in raw material costs and hike in royalty payments led to a 220bps contraction in margins to 10.5%.

De-bottlenecking to achieve volume growth: During the start of FY11, surprised by the spurt in demand, MSIL faced a severe capacity constraint. Through de-bottlenecking in Q2FY11, the installed capacity was increased by 10% to 110k units/month. This helped the company to achieve an impressive volume growth of 27.4% at an average monthly run-rate of 105k units.

Market share gain: Decline in exports (down 3.7% YoY) led to more focus on domestic sales which grew by 26.5% YoY to 236k units. Car segment market share improved 60bps QoQ to 48.2% while MPV market share expanded by 926bps to 31.8% helped by the Eeco launch. Although the company undertook price hikes, drop in export realisations due to weaker Euro resulted in flat average realisations. Net sales increased by 27% to Rs91bn.

Raw material cost and royalty impact margins: Raw material cost per vehicle increased by 1.8% to Rs226k/unit as the company ceded price hikes to vendors effective 1st April'10. The company also had hiked royalty payments to its parent during Q1FY11 due to which royalty as a percentage of sales was higher by 231bps at 5.2%. Margins contracted by 220bps to 10.5%. Net profits at Rs6bn were up 5% and were in line with our estimates.

Outlook: In wake of the increased capacity we have marginally raised our volume estimates for FY11 and FY12 to 1.24mn and 1.40mn units respectively. To account for the raw material cost pressures faced we have reduced margin estimates by ~20bps each. As a result of these mutually counter effective changes, our earnings estimate for FY11 and FY12 remains unchanged at Rs80.8 and Rs99.1 respectively.

VALUATIONS AND RECOMMENDATION

The stock is currently trading at 15.6x its FY12 earnings estimate. We reiterate a `HOLD' recommendation with a target price of Rs1,586 discounting FY12E earnings 16x.

Q2FY11 Performance and Concall Highlights

With new high profile launches in the MSIL's stronghold of A2 segment, the company lost market share during the previous two quarters. However, the company has been upto the task during Q2FY11 and has succeeded in regaining a part of its lost market share with a 30% growth in the segment. Its market share in the segment during Q2FY11 has clawed back to 56% levels.

Total domestic sales aided by growth in the A2 segment and MPV segment, were up 26.5% to 236k units. MPV segment volumes were up 87.4% to 42k units due to strong demand for `Eeco'. With buoyant conditions in the domestic market, discounting in the system has lowered. Average discounts in Q2FY11 were lower by 18% YoY at Rs8.5k/unit.

Exports on the other hand declined 3.7% YoY to 36k units. Ending of scrappage schemes in Europe led to a fall in the market. However the company has done well to compensate the volumes lost in European markets by increasing its exports to other geographies. The profitability on exports declined as INR appreciated compared to the Euro.

In Q1FY11, the company faced severe capacity constraint leading to an underperformance compared to the industry and a tangible market share loss. During the quarter, through a de-bottlenecking exercise, the company achieved a 10% increase in capacity to 110units/month. MSIL has further laid out plans to add 0.5mn annual capacity at its Manesar plant in two phases. The first phase is scheduled to be commissioned during Q3FY12 while the second phase will get completed in FY13.

On the issue of nature of partnership with Volkswagen, the company stated that discussions were ongoing between parent Suzuki Motor, Japan and Volkswagen, Germany. MSIL is currently not a party to the discussions.

The management reiterated its desire to construct regional warehousing facility and display rooms across the country. The first warehouse is coming up near Bangalore and will be operational by Q1FY12. Display rooms will be established across 16 major cities and few of them are scheduled to be operational by Q1FY12.

MSIL launched CNG variants of six models in select markets across the country. The management stated that these models have received a good response. In high CNG penetration markets of Delhi and Gujarat, these variants now account for 16% of the sales.

MSIL currently has diesel variants only on three of its existing models i. e. Swift, Ritz and Dzire all powered by a 1.3ltr engine. Diesel variants account for upwards of 50% in these models and are currently averaging
17k units per month. The company has no plan to launch any other diesel variant in the near future.

The yen appreciation has impacted the company's profitability due to its exposure to imports and royalty payments in yen. Total import content including royalty is currently at 28% with 80% in yen terms. MSIL has hedged 25% of import exposure for the year. Similarly 80% of the exports have been hedged.

During the quarter, company has given price increases to its vendors which are effective from April-2010. Hence the current quarter, raw material cost also includes impact of price increase of Q1FY11.