Maruti: Expansion headaches

Among other things, a lack of clarity on terms of transaction between Suzuki and Indian firm an overhang

The Street gave a thumbs down to Maruti Suzuki board’s decision to accept Suzuki Motor Corp’s (SMC) proposal to contract manufacture vehicles from the proposed manufacturing facility in Gujarat. Its stock fell eight per cent on Tuesday.

While the Maruti management said the deal was a cheaper option and would free resources for expanding its marketing network and appropriate avenues, analysts were divided on whether the deal was beneficial to shareholders.

Yaresh Kothari of Angel Broking, while agreeing there is uncertainty, says following the management comments, stock correction is overdone. There could be some bounce-back in trading, given there is no short-term impact, as production at the proposed Gujarat plant will only start in 2017.

  J N Gupta, who runs a proxy advisory services firm, is in favour of the deal. He says the only catch is the transaction terms between SMC and Maruti. According to him, the rate of depreciation, which will be included in the cost of production, is another dark area. Those against the deal such as Amit Tandon of IIAS, an investment advisory firm, believe the deal creates a layer of uncertainty and raises issues on the current capacities and how they are to be utilised. Such a situation would arise when volumes are volatile and would come below the combined capacity of Maruti and proposed plant.

Another argument is that Maruti could have set up the plant, given its cash chest of Rs 7,500 crore, annual profits of Rs 2,500 crore and given the estimated plant cost of Rs 3,000 crore. Analysts also don’t see the cost of doubling marketing network (in line with higher capacities and sales) over the next five-six years an impediment. Moreover, annual R&D expenses, too, at one to two per cent of sales are not an issue.

Analysts estimate while operating margins could fall a bit, interest cost savings and the returns from its cash hoard (about Rs 650 crore annually) is likely to improve net margins. While the Maruti management has so far not indicated any rise in royalty, any increase on that count would be a dampener. The royalty fee was last increased in FY11. As a percentage of sales, it currently stands at six per cent.

The SMC deal overshadowed Maruti’s better-than-expected December quarter results wherein Ebitda margin at 12.44 per cent fell just 18 basis points (bps) sequentially, against 100-140 bps estimated by analysts, thanks to cost control measures as well as benefits from localisation. Consequently, bottom line at Rs 680 crore was also ahead of estimates.