Strike after, challenges galore at Maruti Suzuki

If analysts are to be believed, the worst is not yet over for Maruti Suzuki India.

Not only does it face a huge task of ramping up production after a crippling strike, the country’s largest car maker also needs to watch out for currency fluctuations impacting margins, rising discounts due to a sluggish market and an increasingly competitive environment.

Chairman RC Bhargava says the company wants to make and sell at least as many cars this fiscal as in the last one at 12.71 million units. But this target may be difficult to achieve especially since it hinges on the company’s ability to ramp up production of diesel cars. For the first half of fiscal 2012, Maruti’s production loss was over 85,000 vehicles.

“We have set ourselves this target of making up lost production in the second half, but frankly it’s a very tough call. First, the market sentiment must improve for sales to pick up and then we need to ramp up capacity for making diesel cars. The diesel engine facility we have is already working at its peak capacity,” managing executive officer (sales & marketing) Mayank Pareek said.

Maruti faces challenges on the currency front also. Ashish Nigam and Kunal Jhaveri of Antique Stock Broking warn that second half of the year may be as bad for Maruti as first.

“While unfavourable currency resulted in a mark-to-market loss of Rs 127 crore (which includes royalty provisioning of Rs 50 crore pertaining to first quarter), these are operational losses in nature which we believe should be treated as recurring. Currency impact on indirect imports (14% of sales) comes with a one quarter lag and it will impact margins only next quarter. Additionally, while the company is lucky to take fresh hedges at a pretty good rate (current yen-US dollar rate of 79.2), it is still adverse to the rates of their previous yen contracts. “

Then, Maruti was forced to offer much higher discounts last quarter to be able to sell its cars. Aditya Makharia and Ritesh Gupta of JP Morgan said that Maruti offered 40% more discounts in Q2, at Rs 13,500 per unit, over Q1.

Sandeep Pandya and Ankit Mehrotra of Goldman Sachs said average channel inventory for Maruti has come down to 2-3 weeks from the normal 4-5 week levels and the current fiscal should be “a second consecutive year of earnings decline, mainly due to higher technology costs (three percentage point impact of higher royalties since fiscal 2011), structurally higher competition, weak demand cycle, adverse foreign exchange movement and the recent industrial relations issues at the company’s Manesar plant.

We believe there are increasing risks of longer-term valuation de-rating for the stock if earnings continue to disappoint further over next four quarters.”

The only positive for Maruti could be increasing diesel powertrain capacity through a sourcing pact with Fiat India. Chairman R C Bhargava said the volume of diesel engines to be sourced would be decided by January.