Maruti Suzuki: The parent trap

The timing and extent of the increase in royalty payment have taken analysts by surprise.

The sharp increase in royalty payments by Maruti Suzuki India has surprised the Street and attracted widespread criticism. This comes at a time when operational matrices were also below expectations. Net earnings, at around Rs 510 crore, were lower than the consensus estimates of around Rs 680 crore. Operating profit margins, at around 9.5 per cent, were also less due to increase in raw material costs and an 80-basis-point sequential fall in realisations in the June quarter.

To top it all, the company raised its royalty payments from around 3.5 per cent to five per cent. This made analysts rework their earnings estimates downwards by 15-20 per cent. The company’s move also raised questions about corporate governance. With a 54 per cent majority stake, and a royalty payment of around five per cent, there will be little left for the minority shareholders, reckon analysts. It is estimated that the company will pay around Rs 400 crore every quarter, or Rs 1,600 crore annually. “We note that this is even higher than the Tata Motors’ annual research and development (R&D) expense of Rs 1,500 crore. The Tata group has the biggest range of vehicles, which includes utility vehicles, cars, light commercial vehicles, heavy trucks, buses and defence vehicles. In comparison, Maruti Suzuki sells only small cars, many of which have been in the market for years. Therefore, the royalty expenses charged by Suzuki look very steep,” say analysts at Nomura.

It takes about Rs 500-600 crore to develop a new model in India. Maruti Suzuki is selling two or three new models that have been worked out by the Indian R&D team. Also, the company plans to spend an additional Rs 1,000 crore on R&D and related facilities in FY11. With increased competition from global players in the small-car segment, it will be difficult for the company to maintain leadership. Lower realisations in the current quarter show that pressure on pricing is building up and would only increase from here. With the royalty costs coming into play, more bumps are expected in the days to come.