Will Maruti lose?

INVESTMENT COUNTER/ POUND WISE

The Suzuki samurai have dealt Maruti a deadly blow. Last week the Japanese automobile major Suzuki Motor Corp (SMC) said it would be putting up a brand new plant to make cars, but in a new joint venture - Suzuki Maruti - thereby sidelining the existing Maruti Udyog.

It is planning to invest $90-138 million in the venture. SMC also said it would invest in a new plant for making 2.5 lakh diesel engines a year, in another JV, Suzuki Engineering.

The news left investors stunned and the stock staggering. Ever since it listed in June 2003 after its IPO, which was priced at Rs 135, the stock has been on a roll.

The secular growth in the Indian passenger car market together with the management's aggression and prospects of future investments have fuelled a spectacular run in its share price.

Though of late the stock had been stagnating due to short-term concerns over rising fuel prices, the possibility of a spike in interest rates and escalating steel prices, there was never any doubt about the long-term attractiveness of the stock.

History repeats itself

One announcement has changed all that. On the face of it, SMC's plan to put up a 250,000 per annum car unit in a JV shows that it is keen to ride the growth in the Indian passenger car market by itself, yielding only a small share to Indian shareholders.

Surprising, given that the Japanese firm already has a controlling 54 per cent stake in Maruti. One can't help drawing a parallel with Honda Motors which announced in August 1999 that it would set up a 100 per cent subsidiary in India - Honda Motorcycle & Scooters India (HMSI) - despite already having a JV with the Munjals.

The difference is that in Hero Honda, Honda has an equal stake of 26 per cent as do the Munjals. Moreover, the Munjals are entrepreneur-promoters.

In Maruti, the government of India, which had originally promoted the company, has all but sold out: it holds a residual 18.6 per cent. So there is no co-promoter with a strong interest in the business and once the government sells its holding, SMC need not brook interference from any quarter.

Thus, there appears to be no reason why SMC would want to destroy value of a company of which it is the main promoter.

Choking capacity

There is as yet no clarity on what stake Maruti will have in the JV but it seems unlikely that the stake will be significant so as to make a difference to it.

So there appear to be some speed-breakers ahead. Maruti is running out of capacity at its plant in Gurgaon, which is already operating at levels beyond the installed capacity of 3,50,000 cars per annum.

Last year it sold 4.72 lakh vehicles and it hopes to sell 5.3 lakh vehicles in the current fiscal and 5.98 lakh vehicles in FY06.

So the capacity utilisation is already over 100 per cent. The growth in domestic sales of Maruti, which was 27.6 per cent in FY04, should moderate to 14.5 per cent in FY05 and to 12 per cent in FY06.

Thus, post-FY06, capacity would be a constraint for the company if demand growth continues at the same pace and sales stagnate. Cars from the new JV's assembly line are expected to roll out at the beginning of 2007.

Exports stymied?

Thus, Maruti would lose out on direct opportunities in the domestic and export markets with the gains being limited to profits of the JV in proportion to its stake.

With its fully depreciated plant, strong and cost-competitive vendor base, Maruti has been a sourcing hub for Suzuki. It is already the single source supplier for SMC's global exports of the Alto, the key markets being in Europe.

Since the new JV will be catering to the export market, too, Maruti will probably have to scale back some of its export sales in the future. Its exports were up 58 per cent to 51,172 vehicles in FY04 and are expected to remain around these levels in FY05.

Sibling rivalry

Maruti currently has products in almost all segments; M800 and Omni in the A segment, the Alto,Wagon R and Zen in the B segment, the Esteem, Baleno and Versa in the C segment, the Gypsy in the MUV segment and the Vitara in the SUV segment.

The only segment in which it currently faces no competition is the entry level A segment where no other player is present. While the entry segment, which accounts for 30 per cent of the industry, is tipped to drive car growth in India, the next two years could see action in the C segment, too.

Thus, whatever models are produced in the new venture, they would compete with one or other of Maruti's vehicles. It would also earn commissions from the distribution of vehicles made in Suzuki Maruti, but obviously this is likely to be done at terms more favourable to the JV.

If the new JV is formed with both companies as equal partners then at least half the profits would flow back to Maruti.

As for the Rs 425-crore diesel engine capacity, it will be "controlled and managed" by Suzuki Metal, a 51:49 JV between Suzuki Motor and Maruti. The company, which currently makes aluminium castings, will subsequently be renamed Suzuki Engineering.

Maruti has never been a strong player in the diesel segment and its diesel-powered Zen and Esteem have been more an afterthought. However, given the tremendous success of Tata Motors' Indigo and Indica in the diesel versions, it is apparent that there is a big market for diesel powered cars.

With SMC putting up a new plant there is also some uncertainty surrounding the royalty payments and component discounts that it had offered to Maruti.

Royalty payments had been waived on old models that are Euro II compliant and thus saves Maruti around Rs 70-80 crore a year. Besides, SMC has extended a 10 per cent discount on components that Maruti imports from it.

Valuations

At the current price of Rs 350, the stock trades at around 11x consensus earnings estimates of Rs 30 for FY05 and about 9.5x FY06 expected earnings of Rs 37. Since the growth should continue till FY06, the stock should command a P/E multiple of at least 14.

Analysts say a big correction in the price to levels of Rs 310 or thereabouts could be an opportunity to buy. It may be recalled that after Honda's announcement , the stock had yielded considerable ground even though Honda had made it clear that its products would not compete with those of Hero Honda.

However, the stock bounced back smartly to deliver a return of over 150 per cent from its lows of around Rs 180. So at the current price there is still value in the company.