Maruti Suzuki’s (MSIL) Q3FY11 results were disappointing on all counts as profits declined 18% YoY to Rs5.7bn as against our estimate of Rs6.2bn. Lower realisations, increase in input cost and a wage hike translated in a 560bps contraction in margins to 9.5%. Going forward the increasing competitive intensity of the industry is expected to cap margin expansion.

Volumes continue to flow: The domestic passenger vehicle industry has had a dream run in FY11 with YTD growth of 32%. Market leader MSIL too has been a beneficiary with a volume growth of 27%, despite facing severe capacity constraints in H1FY11. During Q3FY11, MSIL’s domestic volumes increased by 36.8% to 300k units. However, exports were weak, declining by 28.2% to 31k units. Overall volumes were higher by 28.2% to 331k units.

Realisations Slump: Realisations for the quarter were down 2% QoQ to Rs281k/units. Drop in realisations is attributable to an inferior domestic product mix and weaker Euro lowering export realisations.

Margins below expectation: The company faced a double whammy in terms of exchange rate. The yen appreciation inflated the import bill for raw materials while a weak Euro led to lower export realisations. Raw material cost as a percentage of sales was higher by 400bps YoY. Employee cost surged 48% QoQ to Rs2.3bn on account of a wage hike alongwith arrears for previous two quarters. Margins contracted 100bps sequentially to 9.5% and were significantly below our expectation of 10.6%.

Outlook: We have marginally raised our volume estimates for FY11 and FY12 to 1.25mn and 1.43mn units respectively. In a rising cost scenario the company’s ability to take price hikes is capped by the competitive pressures. Hence, we have reduced our margin estimates for FY12 by 110bps leading to downward revision in earnings estimate by 8% to Rs91.2.

VALUATIONS AND RECOMMENDATION

The stock is currently trading at 13.5x its FY12 earnings estimate. The heightened level of competition and input cost pressures continue to haunt the stock and same is reflected in lowering our target multiple to 15x (earlier 16x). We remain cautious on the stock and reiterate our ‘HOLD’ recommendation with a revised target price of Rs1,368 discounting FY12E earnings 15x.