Investor's Eye: Update - Maruti Suzuki India, Pharmaceutical

 

Investor's Eye [December 20, 2013]  Sharekhan www.sharekhan.com

Summary of Contents     STOCK UPDATE Maruti Suzuki India Recommendation: Buy Price target: Rs2,170 Current market price: Rs1,810 Volume growth may surprise; upgraded to Buy with a revised price target of Rs2,170 In this note, we have summarised factors that could result in a higher than expected volume growth and margin expansion for Maruti Suzuki India Ltd (MSIL) in FY2015. The potential positive surprise leaves scope for an upgrade in the earnings estimates for MSIL and the consequent re-rating of its stock over the next few quarters.  Strong new product pipeline: 14 new launches over next five years  MSIL has planned a product blitzkrieg and would introduce 14 new products over the next five years; that implies an average of three new launches annually over the next five years. Apart from the introduction of new cars in the bread-and-butter compact car space, MSIL is planning to move up the product ladder by introducing products in the utility vehicle and the sedan space. This would help to boost the overall realisations of the company. Further, to mitigate the risk of increased competition in the passenger vehicle space, it plans to foray in the light commercial vehicle space in FY2016.  Export hub: Suzuki's export operations to boost MSIL's revenues Suzuki Motor Corporation (Suzuki) plans to make India the manufacturing base for its exports and shift its entire export operations for the Middle-East, Africa, Latin America and South-East Asia to MSIL by the end of FY2015. The export headquarters will report to MSIL. We believe this would throw up a huge opportunity for MSIL over the medium to long term. MSIL plans to increase the export contribution from 10% currently to about 20% over the next three to four years. Domestic demand to recover in FY2015 After two consecutive years of subdued sales, the passenger vehicle demand is likely to recover in FY2015 on the back of an improvement in the macro-economic conditions (such as economic growth, easing of interest rates and stability in fuel prices) and the low base of the previous two years. We expect the demand for passenger vehicles to return to its long-term compounded annual growth rate of 10-12% in FY2015.  Margins to improve on increased localisation and yen's depreciation MSIL has been working on increasing the localisation levels to improve the profitability of the business. Raw material imports currently constitute about 18% of the overall sales. It has planned to reduce the import content by about 2 to 3% every year by increasing the local sourcing. Increased localisation would help to mitigate the risk of currency fluctuations and lead to margin improvement. Further, the recent depreciation of the yen against the rupee (the yen has depreciated by 5% in the last two months) would aid margin improvement in the near term. We expect MSIL to report margins of 12.6% and 12.3% in FY2015 and FY2016 respectively. Outlook and valuation: volume growth to surprise positively; upgraded to Buy with a revised price target of Rs2,170 We have increased our earnings estimate for FY2015 on the back of improved margins due to MSIL's efforts to increase the localisation and weakness in the Japanese Yen. Our revised earnings per share (EPS) estimate for FY2015 stands at Rs119.9. We have also introduced our FY2016 numbers in this note estimating EPS of Rs144.7 for the period. Given the robust volume outlook on the back of new launches and huge export potential, we upgrade our recommendation on MSIL to Buy with a revised price target of Rs2,170.     SECTOR UPDATE Pharmaceutical Picking stocks based on valuation gap; discount to historic valuation multiples Pharmaceutical (pharma) stocks have been in favour due to the defensive nature of the business (which is the least affected by an economic slowdown), healthy export performance and benefits of a weaker rupee. In this note we have attempted to identify those stocks that are fundamentally strong (have a pipeline of products and re-rating triggers) and can potential provide superior returns based on their valuation gap and the discount to their historic average valuation multiple.  Most players breach historical valuation; a few yet to catch up: The recent market rally in the pharma sector has materially reduced the valuation gap that existed between the historical multi-year average valuation multiple and current valuation. In our pharma universe, we find Ipca Laboratories (Ipca), Aurobindo Pharma (Aurobindo), Sun Pharmaceutical Industries (Sun) and Glenmark Pharmaceuticals (Glenmark) breached their respective three-year and five-year historical average multiples on the back of a strong show in the export markets. On the other hand, players like Dishman Pharma (Dishman), Cadila Healthcare (Cadila), Cipla and Divi's Laboratories (Divi's), which have yet to catch up with their historical average multiples in spite of a healthy growth outlook, can perform relatively better going ahead. A wide gap remains in large-cap and mid-cap pharma valuations: The valuation gap that exists between the large-cap and mid-cap players remains wide which, in our opinion, is not commensurate with the recent performance of the mid-cap stocks and the strong prospects that emanate from a favorable macro-economic environment and company-specific initiatives. We observe some of the mid-cap players have proactively expanded their base business in recent quarters and recorded improved cash flows to ease the pressure on their balance sheet. As the environment becomes more favourable for the sector, we believe the valuation gap would narrow in the course of time.  Niche players to see successive re-ratings: While the outlook for the overall sector remains strong, we observe players having a presence in niche segments, like injectibles, ophthalmic solutions, hormones, nasal spray, sterile solutions, complex products in oncology space, and high-technology new drug delivery systems (NDDS), have yet to gain a premium over players having a presence in vanilla generics like tablets and capsules. Besides, we also observe a larger proportion of the abbreviated new drug applications (ANDAs) pending approval from the US Food and Drug Administration (USFDA) are under Para-IV category (which has the potential to win limited period market exclusivity) in case of Lupin, Glenmark, Aurobindo and Cadila. While Sun and Lupin are getting the due premium for this pipeline, Aurobindo and Cadila have yet to get a commensurate premium.  Price target revision: Owing to better growth visibility, we are introducing estimates for FY2016 and rolling over valuation to the estimated earnings for FY2016 in case of Aurobindo, Cadila and Divi's. We maintain our Buy recommendation on Aurobindo (with a revised price target of Rs470), Cadila (with a revised price target of Rs988) and Divi's (with a revised price target of Rs1,450). Top picks: Cadila, Cipla and Divi's are the top picks in our universe, as these have yet to catch up with their respective historical averages due to certain issues, mostly temporary. On the other hand, we find Aurobindo is available at a deep discount to the other large-cap players despite having rapidly built up a strong pipeline in a niche space. 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.

Regards, The Sharekhan Research Team

 

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