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Demand momentum remains strong

Product life cycle to improve |Levers for margin recovery in place

The MSIL stock has underperformed (27% v/s Nifty and 23% v/s NSE Auto Index) in the last six months, impacted by market share loss and pressure on margin, despite a strong volume recovery. We see both these concerns abating as: a) product life cycle improves, and b) price increase/discount moderation drives a recovery in profitability. We expect ~30% volume growth in FY22E and positive evolution of margin. We see 27% upside at our TP of INR8,700/share. MSIL is our top Auto pick.

Demand momentum remains strong

Demand for Passenger Vehicles was stronger than expected once COVID-related lockdown restrictions were lifted due to shift in preference towards personal mobility. This was reflected in strong demand with first-time buyer (FTB) share increasing to 50% in FY21 YTD (from 45% in FY20) of domestic volumes. Domestic volumes for the industry have been higher than FY19 levels (previous peak) since Sep’20 onwards. Recovery in the PV demand would have been better, but for a sharp rise in fuel prices (~30% increase in the last eight months). This, resulted in an increase in sales of CNG vehicles.

MSIL has several drivers to grow stronger

Significant fuel price inflation resulted in customers preferring CNG vehicles due to significantly lower running costs (INR1.5/km v/s INR4.5/km for WagonR CNG v/s petrol). MSIL enjoys a substantial advantage in CNG as it offers factory fitted CNG in eight models. MSIL’s CNG vehicle sales are expected to grow by 47%/59% in FY21E/FY22E. MSIL gained the most due to increase in demand from first-time buyers, driven by its stronghold in the Mini segment (where its market share increased by ~5pp in FY21 YTD to ~84). While we expect FTB share to normalize over the next 6-9 months, new launches would offset any impact of this.

MSIL’s product pipeline turning favorable

One of the reasons for market share loss for MSIL (48.1% in FY21 YTD v/s 51.2% in FY19) has been the lack of new product launches, especially in the fast-growing Compact UV segment. Its last new product launch came in Sep’19 (S-Presso), which was preceded by XL6 (Apr’19). FY22 looks far more promising for MSIL, with several launches lined up for the next two years, with a mixture of full upgrades of existing models (Alto, Celerio, Brezza, Ciaz, and Baleno) as well as new model launches (Jimny, Grand Vitara, and mid-sized MUVs). These launches are focused on SUVs (all new models and Brezza), but would also address its key entry-level model Alto after a gap of 10 years.

Margin near trough, recovery would be gradual from 2HFY22E

MSIL has already seen a 300bp impact of a sharp commodity price inflation in 3QFY21. Based on spot prices of key commodities, we expect further cost inflation (of 200-250bp) in 1HCY21. We see several levers to margin from the base of 3QFY21 via price increases (~300bp), discount moderation (~100bp), operating leverage (50bp), product mix improvement (not factored into our estimate), etc. We estimate EBIT margin to improve by 220bp (over 3QFY21 levels) to 8.5% in FY23E v/s 9.8% in FY19 and a peak of 12% in FY18.

Valuation and view

After a gap of almost 20 months, we expect new product launches to resume with a mixture of complete product upgrades (five in 2-3 years) and new model launches (three in two years). This should drive volumes and market share growth. Profitability is near the trough and margin improvement should be seen from the lows of 3QFY21. We see further improvement in dividend payouts and a resultant re-rating. The stock trades at 25.7x/21.2x FY22E/FY23E consolidated EPS. Maintain Buy with a TP of INR8,700 per share (27x Mar’23E consolidated EPS). Near term supply-side disruptions and further increase in key commodity prices are key risk.

Demand momentum remains strong

* Demand for Passenger Vehicles was stronger than expected once COVID-related lockdown restrictions were lifted due to shift in preference towards personal mobility. This was reflected in strong demand with FTB share increasing to 50% in FY21 YTD (from 45% in FY20) of domestic volumes.

* Demand momentum has remained strong after the initial benefit of pent-up demand. Domestic volumes for the industry have been higher than FY19 levels (previous peak) since Sep’20 onwards.

* COVID-related lockdown restrictions and work from home (WFH) have led to higher savings due to lower discretionary spending. Lower interest rates (MCLR declined by ~100bp during Feb’20 to Aug’20) and normalization in unemployment reverting to pre-COVID levels further boosted PV sales.

* Improvement in consumer sentiment since Sep’20 as reflected in Future Expectations Index being higher than pre-COVID levels.

* Limited supply of pre-owned Cars have benefitted demand for new Cars as replacement of Cars got deferred during FY21.

* Recovery in the PV demand would have been better, but for a sharp rise in fuel prices (~30% increase in the last eight months). This, resulted in an increase in sales of CNG vehicles.

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