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Below our estimate: Higher cost hurts margin; order backlog strong

Strong demand environment to enable cost absorption

* MSIL’s 3QFY21 operating performance was impacted by higher costs, which more than off-set operating leverage benefits. While the demand environment is strong, cost absorption would be gradual keeping margin in check for FY22.

* We lower our FY21E/FY22E EPS by 6%/2% to factor in higher cost, which is diluted by volume upgrades, lower depreciation, and higher other income. Maintain Buy with a TP of INR9,000/share (27x Mar’23E consolidated EPS).

Higher cost impacts margin; greater other income supports PAT

* Revenue/EBIDTA/PAT grew 13%/6%/24% YoY in 3QFY21 to ~INR234.5b/INR22.3b/INR19.4b. The same in 9MFY21 fell 19.3%/43%/30%.

* Net sales grew 13.3% to INR234.6b, with net realizations flat YoY (-0.8% QoQ) to INR473k (v/s our estimate of INR475.6k) due to higher discounts and adverse mix. Discounts increased QoQ to INR20.1k/unit (v/s INR17.3k/INR33k in 2QFY21/3QFY20).

* Gross margin declined 250bp QoQ (-160bp YoY) impacted by RM cost inflation (+3pp QoQ), poor mix, and higher discounts (+70bp QoQ).

* EBITDA margin fell 70bp YoY (-80bp QoQ) to 9.5% (v/s our estimate of 11.3%) due to weaker gross margin and higher staff cost. EBIT margin rose 30bp YoY (+10bp QoQ) to 6.3% (v/s our expectation of 8%) due to lower depreciation. Higher other income boosted PAT growth by 24% to INR19.4b (v/s our estimate of INR20.3b)

Highlights from the management commentary

* Post festive demand, better than expected and contrary to its expectation demand didn't decline. Fresh bookings have also been positive. Current order backlog stands at 215k vehicles, with low dealer inventory at 21k units at the beginning of Jan’21.

* Currently, there is no impact on part supplies. However, the management is monitoring the situation closely as some OEMs are impacted.

* Replacement demand (at 19% of sales v/s 26% last year) is yet to see an improvement. Rural markets (over 40% of volumes) and CNG (+18% YoY in 9MFY21) have done much better.

* Capacity utilization is near ~100%. 3QFY21 has already seen good operating leverage benefits. As it adds capacity, MSIL would have a negative impact in the interim. It expects marketing cost to increase from the lows of FY21.

Valuation and view

* While MSIL has seen a strong demand recovery, commodity cost inflation has delayed margin recovery. We expect a gradual margin recovery as cost is absorbed over the next 2-3 quarters. Strong demand and stable competitive positioning would drive convergence of P/E towards its 5-year avg. of ~30x.

* The stock trades at 28.1x/22.8x FY22/FY23E consol. EPS. We value the stock at 27x Mar’23E consol. EPS (at a 10% discount to its 5-year avg P/E v/s 25x earlier to factor in for strong demand & stable market share). Maintain Buy.