Gujarat foray of Suzuki puts a cloud of uncertainty over the stock
Suzuki Motor Corp (SMC) would be investing Rs30 bn in the Gujarat plant at Mehsana for a capacity of 2.5 lakh which would come on stream by 2017. This was initially planned to be done by MSIL. This will be a contract manufacturing agreement wherein SMC would sell vehicles solely to MSIL as per their demand. The price of the vehicle to be sold by SMC to MSIL will be including only the cost of production actually incurred by the subsidiary plus just adequate cash (net of taxes) to cover incremental capex requirements. Return on this investment for SMC would be realized only through growth and expansion of MSIL’s business. This means after the initial capacity of 2.5lakhs units have been setup, the financing of the second unit with similar capacity will be done from the earnings of the sale of first 2.5lakh cars. According to the management this would not hamper the net margins of MSIL but would be maintained at current levels (~8%). SMC would sell vehicles to MSIL at zero % profit margins and would earn only 56% of the profit earned by MSIL. The rational given by SMC is cheap money in Japan plus lack of investment opportunities in Japan thus saving MSIL from straining its balance sheet from incurring capex itself. This would in turn save depreciation costs to MSIL. Given that MSIL has excess cash and investments to the tune of Rs 80 bn on their balance sheet, the rationale behind SMC investing in Gujarat plant through establishing a new subsidiary is still unclear despite the management stating that this move is EPS accretive. This to our mind puts an overhang on the stock especially because going forward this subsidiary could end up with a capacity equivalent to MSIL’s existing capacities.
Strong set of numbers in Q3 FY14
Maruti Suzuki India Ltd (MSIL)’s Q3 FY14 numbers were in-line with our expectations. The topline fell by 2.7% yoy and grew by 4.1% qoq at Rs108.9 bn. The company’s numbers are to be compared on sequential basis as the SPIL merger had not happened in the last year same quarter. Volumes in the quarter decreased by 4.4% yoy while growing at 5% qoq to 2.88 lakh units. EBITDA grew by 2.5% qoq while margins remained almost stable at 12.8% qoq. Company’s efforts on vendor rationalization, localization and cost reduction at the employee costs front along with reduction in ocean freight on low export demand led to stable and strong margin performance. Net realizations grew by just 1.4% yoy, while declined 0.5% qoq as discounting grew sequentially and exports remained weak. RM to sales came went up to 73.5% from 71.1% qoq as ASPs declined and RM cost increased on unfavorable currency. Employee costs to sales moved down to 2.82% of net sales as there was a one-time bonus payment to employees in the last quarter. Other expenses also moved down to 13.5% from 14.8% qoq as the ocean freight charges for MSIL fell on the back of lower exports. Depreciation moved up 8% qoq as the Manesar Phase 3 (which commissioned this quarter) plant got commissioned this quarter along with the SPIL engine plant which recently got merged. Other income fell by 16% qoq to Rs1.17 bn. Tax rate moved down to 23.1%, lower than our expectations. In line with operational outperformance PAT surpassed market expectations at Rs6.82bn.
Outlook and Valuation
MSIL’s volume performance has been shaky in FY 14 on the back of the weak macros. However, with expectations of economy revival in FY 15 along with new launches from the company in the form of an SUV XA Alpha in FY 15 and compact car Celerio in Q4 FY14, we believe the strength in volume will return. MSIL is aproxy to the recovery in auto industry. Considering the resilience observed in margins despite a few concerns, we are maintaining our margin forecast for FY14E/15E to 12.3%/12.8%, while slightly increasing our volume forecast for FY 14E/15E as well to 1.2%/6.5% respectively. However, the Gujarat plant investment by Suzuki is a new overhang on the stock as the uncertainty behind the rationale of SMC to invest in an altogether new subsidiary in India will play on the minds of the investors. Although the real impact of this development will be felt in FY 17/18 when the plant goes on stream in the near to medium term the impact of this will be negligible. We are downgrading the stock to Neutral from BUY, but slightly increasing our target price on better volume expectations in FY 15E to Rs 1,828
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