Investor's Eye: Update - Maruti Suzuki India (Demand for passenger cars to remain weak; downgraded to Hold); Viewpoint - Orient Paper and Industries (Exit listed entity; hold to-be listed cement business)

 

Investor's Eye [March 26, 2013]  Sharekhan www.sharekhan.com

Summary of Contents     STOCK UPDATE Maruti Suzuki India  Recommendation: Hold Price target: Rs1,678 Current market price: Rs1,286 Demand for passenger cars to remain weak; downgraded to Hold Key points Marked slowdown in demand; expect pick-up only from H2FY2014 The demand for passenger cars has deteriorated in the past quarter. After posting a single-digit growth in April-November 2012, the demand has slipped in the negative territory. The sales for February 2013 declined by 26%, which is a 12-year low. It was the fourth consecutive month of declining sales. Though the petrol vehicle sales declined 17% year on year (YoY) in April-February 2013, the diesel segment recorded a 27% year-on-year (Y-o-Y) growth (driven mainly by the utility vehicles). However, even the sales of the diesel vehicles declined in the last four months, indicating a subdued demand environment. The sales of passenger cars have been impacted by a weak economic scenario and higher fuel prices. Maruti Suzuki India Ltd (MSIL) resorted to production cuts in the current month for the petrol segment to avoid inventory pile-up. Apart from the weak demand for petrol cars, the demand for diesel cars has also moderated. Its popular-selling diesel models, such as Maruti Swift and Ertiga, have also witnessed demand moderation. An increase in the diesel prices in the past quarter has impacted the demand. We expect the passenger car sales to remain subdued in H1FY2014, with recovery expected in the second half. Steep discounts offered even on popular models The inventory levels have increased from the normal four weeks to about five to six weeks. Apart from the high discounts on the petrol cars, the diesel cars have also joined the discount bandwagon due to demand deterioration. The discounts are being offered on popular-selling models such as Maruti Swift, Dzire and Ertiga to push sales. Further, MSIL has for the first time introduced various buyback and financing schemes to lure the customers. The schemes are targeted to convert enquires into sales and are aimed at avoiding the deferment of purchases by the buyer. MSIL maintains market share in the passenger vehicle segment MSIL has broadly maintained market share at 39% in the passenger vehicle segment in YTDFY2013. As against the industry growth of 3.9% YoY in April 2012-February 2013, MSIL recorded a growth of 5.5%. MSIL has increased its market share in the passenger car (due to strong product portfolio) and the utility vehicle (due to introduction of Ertiga) segments. However, it has lost market share in the van segment on account of poor demand for Omni and Eeco. Japanese yen's depreciation to aid margin The Japanese yen depreciated by 12% against the Indian rupee over the last three months. As against rate of rupee 0.67/yen from October 2012 to December 2012, the yen has depreciated to rupee 0.59/yen from January 2013 to March 2013. The yen's depreciation has a direct bearing on the margin of MSIL. MSIL's net exposure to the yen is about 23% of sales (raw material imports form 17% of the sales while royalty forms about 6% of the overall sales). Given the policy of MSIL of hedging for the next quarter, we expect a 250-basis-point improvement in Q1FY2014 margin. Cutting volume assumptions We are lowering our volume assumptions in view of the subdued demand in the domestic passenger car segment. We have reduced our volume assumptions to 1.27 million units and 1.43 million units for FY2014 and FY2015, reflecting a growth of 8.3% and 12.6% respectively. Valuation We have maintained our FY2014 earnings estimate at Rs97/share as the volume decline is set off by the yen's depreciation. However, we have reduced our FY2015 estimate by 7.2% to Rs111.9/ share. Our price target stands revised at Rs1,678. Given the subdued volumes for the passenger car segment, we downgrade our recommendation to Hold.   VIEWPOINT Orient Paper and Industries  Exit listed entity; hold to-be listed cement business  In this note we are giving our view on Orient Paper & Industries Ltd (OPIL), which is engaged in the businesses of paper and electricals. We shall also present our fair valuation of the stock.  Listed entity OPIL reflects paper and electrical businesses; Orient Cement yet to get listed: With the recent demerger of the cement business from OPIL into the newly formed Orient Cement (unlisted as of now), the existing listed entity OPIL is holding interest in the paper and electrical businesses. According to the structure of the demerger, the shareholders of OPIL will get one new equity share of Orient Cement for each share of OPIL held. Further, Orient Cement is to be listed in the next few months.  Paper division-a poor track record: Despite various measurers taken by the management to improve the profitability of the paper business, the company has been continuously posting losses at the earnings before interest and tax (EBIT) level for the past couple of years. The key reasons behind the poor performance are: (a) a lower production level due to a shortage of water; (b) an increase in the input cost; and (c) limited pricing power. In order to overcome the water shortage the management has set up a water reservoir and a captive power plant of 55MW. However, the benefit of the same has yet to reflect in OPIL's earnings performance. On account of severe margin pressure and uncertainty with regard to an improvement in production, the paper division's earnings visibility is poor.  Electrical division-product portfolio expansion to dent margins in the near term: The electrical division traditionally derived a larger chunk of its revenues from fans. However, in the past one to two years the company has expanded its product portfolio by introducing various CFL lighting products and started trading in home appliances, such as geysers, mixers/grinders and electrical irons. The electrical division of the company posted EBIT margin in the range of 7-9% historically. However, with the increase in the advertisement spending and low margin in the home appliance trading business, the overall margin of the electrical division has come under severe pressure in recent times. Going ahead, we believe the EBIT margin of the division will remain under pressure due to a likely increase in the proportion of revenues from the low-margin home appliance business and higher advertisement spending.  Fair valuation and our view: We have carried out fair valuation of the company using the sum-of-the-parts valuation methodology and arrived at a fair value of Rs13 per share for the listed entity, OPIL. This leaves scope for upside but expectations of weak financials would continue to act as a drag on the valuation in the near term. Thus, we advise clients to exit on rallies. In case of the to-be listed cement business, the fair value works out to around Rs65 per share (listing 10-15% lower than the fair value would provide an opportunity to accumulate the stock). Click here to read report: Investor's Eye     Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

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