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Steep TCO inflation to impact near-term outlook

At a time when Maruti Suzuki’s (MSIL) gross margin (GM) was rising sequentially along with improving monthly production outlook, global geopolitical turbulence in past fortnight has hit the company hard once again. We believe, the surge in input commodity costs (aluminum, palladium, plastics, etc.) with ~30% increase in Brent crude oil price, if sustained till H1FY23E, would inflate FY23E TCO by ~20% YoY, post similar increase in FY22. Our analysis suggests, post cumulative price hikes of ~10% in CY21, despite another ~10% cumulative hikes in CY22, MSIL would face risk of ~300bps GM erosion, if present input costs sustain. Power/fuel and logistic costs together contribute ~3-4% of revenues, which would put further pressure on profitability in coming quarters. Despite steep TCO inflation in FY22, PV industry volumes are set to grow by ~8% in FY22E; hence we maintain our ~12% industry growth estimate for FY23E, assuming no covid-led disruption. Not factoring-in the recent commodity price inflation in our estimates, we restrict earnings cut to ~4% for FY24E vs ~15% for FY23E. Due to the recent price correction, we upgrade to BUY with a target price of Rs8,745 (earlier: Rs9,382), implying ~25x FY24E core P/E.

Consumers adapting to elevated TCO levels through shift in household expense allocation: At a time when the economy is trying to open up post third wave of covid, focus on hygienic personal mobility remains of paramount importance. This is likely to drive PV demand in FY22E despite ~20% TCO inflation. Thus, with another ~20% TCO inflation in FY23E, we expect industry revival trajectory to remain unperturbed, though incremental hurdles on semiconductor availability through recent geopolitical issues remains a challenge. We believe new launches, rising export volumes and low base effect are likely to aid MSIL’s operating leverage amidst challenges at GM level.

GM to erode ~300bps in FY23E even after cumulative ~7% price hikes in H1CY22 if present commodity prices sustain: Though we are not reducing our volume estimates, we are cutting EBITDA margin for FY23E by ~170bps, assuming partial impact of current commodity inflation on FY23E profit. If cost structure remains at present levels across FY23E, the impact on EBITDA margin would be ~350-400bps, post factoring-in ~7% cumulative price hikes. We believe, it is too early to take the full impact into account as of now, hence we build-in limited impact

A year of FCF erosion moving valuation by ~2%: MSIL stock price has corrected by ~21% in past one month due to adversities led by the ongoing geopolitical turbulence and is trading at ~19x FY24E core P/E vs long-term mean of ~25x. Removing FY23E FCF for MSIL leads to a reduction in fair value by ~2%. Thus, signifying the correction, on back of lower profitability outlook for FY23E, gives an opportunity for long-term investors. Reverse DCF of the present valuation suggests ~3% volume CAGR in FY23E-FY35E with ~11% EBITDA margin for MSIL, in an underpenetrated PV market.

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