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Maruti Suzuki India Q3FY18: Proposed royalty reduction to cushion impact of rising commodity prices:revise to ADD

Equirus Securities | 31 Jan, 2018  | Follow Author | Add to my Favourites 
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An upsurge in commodity prices poses a risk to MSIL’s FY19E EBITDA margins as there may be a lag in passing on the entire impact to customers. However, the Board’s approval for a downward revision in royalty rates on new models (subject to Suzuki Board approval) would likely cushion the impact on margins. With strong bookings for the upcoming Swift, volume momentum will remain strong for MSIL in FY19E, constrained only by production. MSIL posted a strong 22% yoy EBITDA growth in 3QFY18, which came in 6% ahead of EE driven by the margin beat. Post a sharp run-up in the stock over the last three months, we believe valuations are inflated and the risk-reward not as favorable. We therefore revise our rating to ADD (from LONG) with a Mar’19 TP of Rs 9,772 set at 31x/26x Mar’19/20E EPS.

Board approves downward revision in royalty on new models; final approval from Suzuki is awaited: MSIL’s board has approved the revision in method of calculating royalty, which would result in lower royalty payments for new model agreements starting with Ignis, launched in Jan’17. Management stated that all new models launched post Jan’17, including the new Dzire and Swift, would fall under this new arrangement. Considering the combined volumes of these three models last quarter, warranty would be lower for ~25% of MSIL’s current volumes, a number which will keep increasing with new model launches. While this is subject to approval from Suzuki, Japan’s board, we believe MSIL would not have disclosed this development in the absence of an implicit nod from Suzuki; therefore the chances of implementation are high. If approved, this will be effective from retrospective basis.

Rising commodity prices to hurt gross margins in FY19E: Both steel and aluminium prices have run up sharply over the last six months, with the impact on gross margins likely to be felt from 4QFY18 onwards. While MSIL has taken small price hikes across models from Jan’18-beginning, these may not be enough to cover the cost increase. We believe the entire impact may be passed on only with a lag, and there will be intermediate pain.

Lower other expenses shore up EBITDA; PAT hit by MTM losses: Commodity inflation in 3Q lead to a 33bps qoq gross margin compression. EBITDA margins tumbled 114bps qoq on lower gross margins and operating deleverage. Other income tanked 59% yoy/ 53% qoq due to MTM losses on investments of ~Rs 3.1bn amid rising yields; we expect some losses in 4Q as well due to a further increase in G-Sec yield.

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