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Published on 28/01/2019 9:08:00 AM | Source: HT Media

Has Maruti Suzuki lost track or is it the whole car industry?

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Investors were jolted out of their seats on Friday after Maruti Suzuki India Ltd reported a sharp narrowing of operating profit margin to under 10%. The company’s flagging sales volume data had given the impression that the company has hit a rough patch, but with margins also dropping sharply, it now looks like it will be a rocky road to recovery.

The close to 600 basis points drop in margins came without warning, prompting analysts at Jefferies India Pvt. Ltd to call their report on the company’s results, “Unexpected slowdowns are the worst".

Maruti Suzuki shares fell more than 8% on Friday and hit a 52-week low. Note that some analysts have downgraded earnings estimates by as much as 8-10% each year for the next three fiscal years. A moot question is if this spells gloom for the country’s auto industry too.

Investors were jolted out of their seats on Friday after Maruti Suzuki India Ltd reported a sharp narrowing of operating profit margin to under 10%. The company’s flagging sales volume data had given the impression that the company has hit a rough patch, but with margins also dropping sharply, it now looks like it will be a rocky road to recovery.

The close to 600 basis points drop in margins came without warning, prompting analysts at Jefferies India Pvt. Ltd to call their report on the company’s results, “Unexpected slowdowns are the worst".

Maruti Suzuki shares fell more than 8% on Friday and hit a 52-week low. Note that some analysts have downgraded earnings estimates by as much as 8-10% each year for the next three fiscal years. A moot question is if this spells gloom for the country’s auto industry too.

For investors, increasing competitive intensity, margin pressures and weak consumer sentiments are likely to keep excitement off the road for auto stocks for some time. After all, Maruti Suzuki is still the clear market leader and sets the tone for the rest of the industry.

While there were many reasons for the drop in margins, they all boiled down to one worrying factor—a slowdown in sales. To counter this and clear inventory with dealers, Maruti Suzuki offered a princely ₹24,300 average discount per vehicle, the highest ever by the company. The discount was about 30-36% higher on a sequential and year-on-year basis. Clearly, the carmaker, which enjoys the country’s largest dealer network and product portfolio, struggled to sell its cars.

It goes without saying that the high discounts reflect stiff competitive business conditions for auto companies. Some analysts reckon that Maruti Suzuki has shifted into the slow lane, after unleashing a slew of products over the last three years. With competitors now gearing up for new launches and even reinventing the marketing strategy, competitive intensity may only increase. For instance, Tata Motors Ltd and Mahindra and Mahindra Ltd are launching new products in the higher end, while Hyundai Motor India Ltd has plans to enhance its mid-segment. The moot question then is whether the situation will lead to market share erosion for Maruti Suzuki that outsells every other carmaker in the country today.

Heightened competition also implies that Maruti Suzuki’s marketing and advertising costs are likely to remain elevated for some time now. Note that the substantial increase in other expenses for the December quarter was led by higher marketing costs. That said, a small part of the margin contraction was due to one-time employee settlement expenses. Margin pressure led to a 36% year-on-year decline in earnings before income, tax, depreciation and amortization (Ebitda).

But not all is lost. Falling raw material costs can bring some relief and Ebitda margin may inch up in the coming quarter from the December quarter levels. “But it is unlikely to regain the impressive 15-16% levels soon," says Prayesh Jain, executive vice president (auto and auto components) at Yes Securities Ltd.

It does appear like Maruti Suzuki has lost its mojo, which obviously has worrying implications for the sector as well. According to Edelweiss Securities Ltd, “Unlike in FY15-18, most of its models are now available without waiting period. Most of the product gaps have been plugged too. This is likely to pressurise margin, unless demand revives."

That said, Maruti Suzuki is not the lone ranger on this road. Both the industry and analysts have lowered FY19 growth estimates for passenger vehicles down to nearly 4.5% from 8% earlier. Weak demand and stiff competition could well put the car segment’s margins under pressure in the forthcoming quarters. Plus, fixed costs are expected to increase owing to the new technological changes to comply with new emission norms in a year from now.

The Maruti Suzuki stock currently trades at almost 21 times its estimated earnings for the next fiscal year, based on data from Bloomberg. Including the drop in the share price on Friday, the stock is 26% lower so far in FY19, suggesting poor confidence in the growth outlook for the both the company and the sector.