Why Suzuki's Gujarat subsidiary may hurt Maruti shareholders
Maruti Suzuki shares recouped their losses on Wednesday after witnessing the sharpest fall in a year and a half on Tuesday. India's biggest car manufacturer said on Tuesday that the planned Gujarat plant will be a 100 per cent subsidiary of its parent Suzuki Motor Company. (Refer to the image above for deal structure)
Maruti shares fell as much as 9 per cent on Tuesday after analysts said sourcing vehicles through the Suzuki will hurt Maruti's margins. However, Maruti chairman RC Bhargava allayed investors' concerns at a conference call yesterday.
Here's what Mr Bhargava said: (Watch)
1. Suzuki's 100 per cent subsidiary will invest Rs 3,000 crore in setting up the first phase of capacities in Gujarat. Suzuki will realize returns on this investment only through the growth and expansion of Maruti's business.
2. Suzuki, which has reserves of Rs 25,000 crore, will get higher returns by investing the idle cash in India because there are not many opportunities in Japan.
3. All cars manufactured at the Gujarat plant will be purchased by Maruti at cost plus some margin sufficient to fund the second phase of capex at the Gujarat plant. There will be zero margin for Suzuki's subsidiary over and above the cost and capex reimbursements.
4. Royalty agreements will be similar to those with Maruti, and the royalty paid by the Gujarat subsidiary will be built into the cost of the cars purchased by Maruti.
Asia-Pacific focused brokerage CLSA said the Gujarat plant arrangement will materially boost Maruti's free cash flow. (Read the full story here)
However, some analysts have raised red flags about the arrangement. Barclays analysts Sahil Kedia and Shobhit Bhansali downgraded Maruti to "equal weight" and cut their price target on the stock to Rs 1,563 citing increased corporate governance headwinds.
Institutional Investor Advisory Services, which provides market participants with independent opinion, said Suzuki appears to be going down the same route as many of the other MNCs in India that have parked their most profitable businesses lines in 100 per cent subsidiaries.
"Suzuki has been slowly losing investor confidence as it steadfastly doubled royalty payouts over a 5 year period to 5.8 per cent of net sales in FY2013. Maruti paid royalty aggregating around Rs 2,450 crore to Suzuki, which, in turn, accounted for 47 per cent of Suzuki's 2013 profit after tax. The current move adds to investor distrust," IIAS analysts said.
Here are some questions raised by Barclays and IIAS analysts:
1. Given Maruti's healthy returns, shareholder wealth would be maximised by reinvesting in the business or via a higher payout against choosing to conserve cash.
2. Maruti will not have control of the cost of production as incremental production moves to Gujarat.
3. The arrangement structurally changes the earnings profile of the company (incremental shift to a distribution margin) over the longer term.
4. Since Suzuki's Japan subsidiary will be an unlisted company, financials are unlikely to be shared, making it difficult for us to monitor the agreement terms.
5. Suzuki will fund the first phase of the Gujarat plant, but Maruti will indirectly fund the second phase, through the price of the cars purchased. Yet, shareholders of Maruti will not have an equity stake in the Gujarat entity.
6. Will the more profitable models be housed in Maruti or in Suzuki's 100 per cent subsidiary?
7. What happens when car sales fall? Will Maruti cut production at its own factories or will Suzuki's subsidiary take the hit?
For now, investors seem to have given a thumbs-up to Maruti's rationale considering the 8 per cent rise in shares on Wednesday. (Track stock)
