WITH THE Q3 results, Maruti Suzuki India
announced that the investment ($500m) in the planned Gujarat plant will occur via a 100% subsidiary of Suzuki, and Maruti will only distribute and sell the vehicles. We view this as a significant strategic mis-step, as: (i) Maruti has enough cash to adequately fund the Gujarat requirements on its own; (ii) a higher share of earnings from distribution is a structural shift of the earnings profile; (iii), Maruti’s lack of control over the cost of production is a worry although Maruti claims that Suzuki Gujarat (SMG) will not make a profit; (iv) SMG eventually is expected to scale up to 1.5m units (as large as Maruti is today), essentially satisfying five-six years of requirements; and (v) this could set a precedent for other similar steps.
We reduce our FY14/15e EPS (earnings per share) by 1.3% and 0.5%, respectively, and believe that the risk of earnings deterioration and cash drain by Suzuki is likely to remain an overhang in the near term. We downgrade the stock to EW (equal weight) with a reduced PT (price target) of Rs 1,563 based on 6.4x FY 15 EV/Ebitda (vs 9x previously).
What are Maruti’s reasons for the SMG investment?
(i) by investing the money through Suzuki, its cash is conserved for future requirements; (ii) it is enhancing shareholder value based on the interest income from unused funds; (iii) SMG will sell goods to Maruti on an arms-length basis, as SMG’s costs will include cost plus cash requirements for future capex requirements; (iv) profitability will be unchanged.
Q3 update: Maruti’s Q3 earnings were operationally ahead of expectations at 12.4% Ebitda margin (vs expectations of 11.8%), despite a 3% miss in revenue terms. PAT (profit after tax) of Rs 6.8 bn (+ 36% y-o-y) was adversely impacted by a higher depreciation charge due to new capacity at Manesar. Average discounts increase to Rs 19,412/ unit (+11% q/q) in Q3.
Downgrade to EW: With the increased corporate governance headwinds, we expect the stock to trade at the lower end of its valuation band till clarity emerges. We lower our valuation multiple to 6.4x FY15 EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation and amortisation).
Management call takeaways
Details of the 100% subsidiary: Maruti has allowed Suzuki to set up a 100% subsidiary in India (provisionally named Suzuki Motor Gujarat Pvt Ltd, which will set up a production facility on the