Maruti Suzuki: corporate governance is the issue

 

Maruti Suzuki India Ltd’s clarifications regarding the funding structure of its proposed new venture at Gujarat is unlikely to allay investor concerns. True, Maruti will be saved of the initial capex estimated by analysts at about Rs.3,000 crore. But then, funds constraint was never a deterrent for Maruti, given its strong cash balance and cash flows from operations.

 

From a shareholder’s standpoint, the issue is one of corporate governance. The Gujarat unit will sell cars to Maruti at a so-called cost plus surplus value. Going by the Haryana plant model, Maruti’s sale price mark-up to dealers would hinge on market conditions prevailing at that time. “The release (from Maruti) does not specifically clarify regarding the quantum of surplus that Suzuki Gujarat will charge to Maruti,” a Nomura Securities Co. Ltd report says. “Although the maximum surplus that Suzuki Gujarat can charge is defined as normal margin earned by Maruti.” Poor transparency stems from the fact that the Gujarat plant is unlisted and the ability to forecast profit margins on Maruti’s sales from the Gujarat factory depends on the guidance from the company.

 

Further, the release states that future capacity expansion at Gujarat will be funded by depreciation from the unit, net amount of surplus generated from car pricing and, if need be, from equity infusion by the parent, in that order. So, incremental profit margins earned as the auto cycle turns positive will perhaps fund expansion, which in turn implies stagnation in long-term profitability. Also, will Maruti have lower control on costs as additional production will be driven from Gujarat?

 

In other words, the question is: from a minority shareholder’s perspective, will Maruti’s profit become more volatile based on Gujarat expansion? The long-term plan (post fiscal year 2017) is to expand to up to 1.5 million units a year, which is about the current size of Maruti. A Barclays Research report says that post-Gujarat, there would be a structural change in the earnings profile of the company towards higher proportion of distribution margin. Note that in fiscal year 2010, Japanese parent Suzuki Motor Corp. had raised royalty from 3% to 5% of sales.

 

In other words, the clarification issued only skirts around the structure of funding. The huge cash flows generated by Maruti are expected to be used for research and development and expansion of distribution network.

 

These issues related to Gujarat expansion and the stronghold of Suzuki post-2017 could cloud Maruti’s stock valuations. No wonder, in spite of a reasonable performance in the December quarter, the stock has hardly moved up—about 1.5% since the results were announced in end-January, compared with the BSE auto index’s 9% rise.

 

In the near term, the stock price would remain subdued given that the passenger car market does not have a positive story to sell at present. Sales growth has fallen to single digits, with contraction seen in segments like utility vehicles and exports. The February sales numbers released on Saturday saw a paltry 1.8% overall growth, propped up mainly by Maruti’s newly launched compact car.

 

RANJAY KUMAR

PGDM 1st YEAR

SOURCE-: MINT