Maruti Suzuki's Q2FY20 results (Outperformer) - Operating margins surprise

Q2FY20 results

• Operating performance surprises: Maruti Suzuki’s Q2FY20 PAT at Rs13.6bn (-39% yoy) was 28% above our estimates. The variance was on account of higher than expected gross margins and a tax reversal.
• Gross margin stable: Revenues declined to Rs 170     bn (-20% yoy) on account of a volume decline of 30%. Revenues benefitted from higher realisations (up ~2% qoq). The sequential realisation increase despite higher discounts largely reflects price hikes on account of the transition to BSVI.  Notably despite the pressures (higher discounts, lower production at the Gujarat plant) gross margins showed a small improvement (up 22bps qoq). The management attributed the uptick to cost cutting measures and lower overheads. The margins may also have benefitted from increase in finished inventory. While the impact of operating deleverage was visible (other expenses/employee costs rose by ~110bps qoq), this was partly offset by lower royalty payouts and controlled ad spends. Overall, EBITDA margins at 9.5% (Q1FY20: 10.4%; est: 8.3%) surprised positively. The strong operating performance was complemented with a tax reversal and higher other income (up 75% yoy).
• Concall highlights: (a)While retail volumes were down 22% for the quarter, nonetheless the sales during Navratras showed a small growth. The sustainability of the recovery though remains uncertain given that the volumes may have been aided by high discounts and pent up demand. (b) The decline in rural areas in the quarter has been lower than the urban market (c) Dealer inventory stands about 30 days – with BSVI vehicles comprising ~50% of the inventory. (d) Average discount for the quarter stood at ~Rs 26000/vehicle (+53% qoq) skewed upward towards diesel vehicles. (e) The company expects further benefit from commodity costs in the coming quarters.

Key positives: Steady gross margins; demand during the festival season

Key negatives: Sharp increase in discounts

Change in estimates: We cut EPS for FY20/FY21 by 13.8%/7.1% respectively as lower volume growth/ margin pressures offset a lower tax rate.

Valuations & view

While retail volumes have shown a recovery at the beginning of the festival season; nonetheless a sustainable uptick is uncertain. However, despite the sharp slowdown, the medium to long term outlook remains positive given the highly underpenetrated Indian car market. MSIL’s structural advantages (distribution, economies of scale, brand) will continue to work in its favour. While the current valuations at ~28xFY21 seem stretched, we do note that in case of a volume recovery margins/profitability could move up sharply. Maintain Outperformer.