Analyst - Japan Autos, Hirakata Office

Noriaki Hirakata, CFA

Analyst - Japan Autos

Hirakata Office

Equity Bottom-Up

Tremendous improvements during the past 5 years After we returned to Equity Research and looked into Suzuki again, we noticed significant improvements, probably the most impressive ones among Japanese automotive companies.We believe that Suzuki will outperform the Japanese automotive industry above consensus, based on factors that the Street Analysts are not aware of right now, including a limited impact of rising global regulatory requirements on Suzuki.<h2></h2>Sustainable Growth Suzuki significantly surprised with positive results in its FY16 earnings report.  FY16 operating profit margin exceeded 8% even though fixed costs like R&amp;D and depreciation came in higher than compared to last year.  This is a significant achievement given that Suzuki`s product portfolio is mainly based on relatively low margin ASP mini-vehicles and the A/B segments. In addition, it was achieved without any support from sales finance business which the J3 have enjoyed in the past few years. Finally, R &amp; D expenses, depreciation and capital investments have also been continuously at a high absolute level, hence this level of profitability is a high-quality one. We expect the current high-level profitability at Suzuki to be sustainable for the future.Valuation It is well-known that Suzuki had depreciated fixed asset at an accelerated rate in the past inflating the effective tax rate and therefore P/E multiple of Suzuki tend to be higher than the automotive industry average. The effective tax rate for FY16 is about 33% and it is headed towards a normalized level. We expect the effective tax rate for FY 17 - 18 to fall to 30%. The current P / E ratio based on these forecasts is about 14 times and it is not yet overly expensive compared to its past range.Given the relative and absolute growth potential of the company, there is no excessive expansion of valuation multiples unless the stock price exceeds 6,000 yen.Reasons for Suzuki Call There are two major factors that we are reasonably confident with our call on Suzuki.Firstly Suzuki will be very unlikely affected by the strengthening global environmental regulations and hence there is no need to take into account a scenario where R &amp; D expenses increase significantly or profitability of “environmental compliant vehicle” sales decrease significantly. Secondly, sales mix is improving further with the introduction of new generation products. On a different note, we are concerned that street consensus significantly underestimates the impact of decelerating US automotive sales on Japanese automotive industry. Our ex-colleagues at Morgan Stanley Research reduced US SAAR estimates substantially but in parallel earnings estimates of Japanese automotive companies were barely adjusted. This looks unrealistic to us considering what we have learned from previous down-cycles.

Tremendous improvements during the past 5 years After we returned to Equity Research and looked into Suzuki again, we noticed significant improvements, probably the most impressive ones among Japanese automotive companies.We believe that Suzuki will outperform the Japanese automotive industry above consensus, based on factors that the Street Analysts are not aware of right now, including a limited impact of rising global regulatory requirements on Suzuki.Sustainable Growth Suzuki significantly surprised with positive results in its FY16 earnings report.  FY16 operating profit margin exceeded 8% even though fixed costs like R&amp;D and depreciation came in higher than compared to last year.  This is a significant achievement given that Suzuki`s product portfolio is mainly based on relatively low margin ASP mini-vehicles and the A/B segments. In addition, it was achieved without any support from sales finance business which the J3 have enjoyed in the past few years. Finally, R &amp; D expenses, depreciation and capital investments have also been continuously at a high absolute level, hence this level of profitability is a high-quality one. We expect the current high-level profitability at Suzuki to be sustainable for the future.Valuation It is well-known that Suzuki had depreciated fixed asset at an accelerated rate in the past inflating the effective tax rate and therefore P/E multiple of Suzuki tend to be higher than the automotive industry average. The effective tax rate for FY16 is about 33% and it is headed towards a normalized level. We expect the effective tax rate for FY 17 - 18 to fall to 30%. The current P / E ratio based on these forecasts is about 14 times and it is not yet overly expensive compared to its past range.Given the relative and absolute growth potential of the company, there is no excessive expansion of valuation multiples unless the stock price exceeds 6,000 yen.Reasons for Suzuki Call There are two major factors that we are reasonably confident with our call on Suzuki.Firstly Suzuki will be very unlikely affected by the strengthening global environmental regulations and hence there is no need to take into account a scenario where R &amp; D expenses increase significantly or profitability of “environmental compliant vehicle” sales decrease significantly. Secondly, sales mix is improving further with the introduction of new generation products. On a different note, we are concerned that street consensus significantly underestimates the impact of decelerating US automotive sales on Japanese automotive industry. Our ex-colleagues at Morgan Stanley Research reduced US SAAR estimates substantially but in parallel earnings estimates of Japanese automotive companies were barely adjusted. This looks unrealistic to us considering what we have learned from previous down-cycles.

Suzuki Motor

Suzuki: Technology-Driven Growth