Despite slump in the automobile industry, Bank of America Merill Lynch (BofAML) has upgraded its rating for this stock to 'buy' from 'neutral' and raised its target price to Rs 8,650 from Rs 7,450 earlier. The brokerage expects Maruti Suzuki’s earnings growth to bottom in FY20 and improve in FY21-22.

Share Market Live

NSE

Amid falling sales, decreasing production for most companies due to a fall in consumer demand and liquidity crunch, automobile companies have been under pressure in 2019. Maruti Suzuki has given negative returns this year, down nearly 3 percent for the year.

"Volumes are expected to improve in FY22 after a transitory FY21. While pricing trends are weak, lower input costs are a tailwind. We forecast an earnings recovery (26 percent EPS CAGR FY20-22E) which should sustain the elevated margins. Recent underperformance makes risk/reward favorable, in our view," the report explained.

READ MORE: December auto sales to be better than last year’s, says FADA

Earnings recovery would be led by volume uptick of 10 percent each in FY21 and FY22 as macro factors improve, lower channel stress, and lesser impact from BSVI, as the company has already transitioned 60 percent of vehicles, it said. Withdrawal from diesel (25 percent of volumes) and higher competition are near-term risks, the brokerage added. It also expects new launches (in collaboration with Toyota) to offset some of these concerns.

Over the last 18 months, consensus estimates for FY21 and FY22 have seen a 50 percent cut, and the stock has underperformed the broader market, falling 19 percent against 18 percent gain in Nifty 50.

BofAML also noted that the volume growth for the passenger vehicle (PV) industry has been weak for the last 18 months, still Maruti has maintained its market share close to 50 percent YTD (year-to-date). Over the last 12 months, the company has cut production to align inventory levels, increased discounts to boost retail volumes and expanded dealer touch-points.

These measures have led to an improvement in retail demand on a year-on-year basis in recent months, it stated, adding that inventory levels are also under control, and high discounts seen in September/October are easing off.

READ MORE: 2019 Roundup: Auto sector takes a hit, only 1 stock gave positive returns this year

According to BofAML report, volumes are also expected to see an uptick from Q3, as the overall de-stocking cycle is largely over. Also, despite discounts being higher in Q3, the overall volumes are expected to be much higher than Q2, which should offset any negative impact of lower volumes, it added.

"While discounts are coming off from their September 19 highs, Q3 levels are likely to be a peak on a quarterly basis, in our view. With price increases and new launches; we expect pricing trends to improve from January 20. In addition to pricing trends, Maruti Suzuki is undertaking many cost reduction initiatives to boost margins in the current environment. Also, weak input prices (steel and aluminum in particular) are a tailwind to margins in the near term," the report stated.

With improving volumes and stability of pricing, BofAML expects margins to improve to 13 percent by FY22. This compares to a high of 15 percent in FY16.

Valuations

Despite MSIL already being one of the expensive stocks, the brokerage sees room for the multiples to sustain if indeed the volume recovery goes as expected. During previous cycles, Maruti's valuation multiples have expanded to 30 times on a one-year forward basis. The premium to the valuation is also partially based on the lack of other alternatives in the passenger vehicle sector in India, the rpoert explained.

Given the sharp decline in margins in FY20 and potential recovery from H2FY21, it estimates earnings improvement is back-ended because of which the company still looks expensive on an on-year forward basis. However, on FY22E earnings, the stock is currently trading at 21x P/E, which is below its historical average of 25x, the report noted.

Disclaimer: CNBCTV18.com advises users to check with certified experts before taking any investment decisions

First Published:Dec 17, 2019 11:43 AM IST