Why Suzuki's Gujarat plant continues to torment Maruti shares

Maruti Suzuki shares fell over 5 per cent on Friday despite the automaker coming out with more details on its decision to source cars from a Gujarat plant to be built by its parent Suzuki Motor. Maruti's clarification on Wednesday came days after large Indian investors wrote to the company saying minority shareholders would be better off if Maruti made the cars itself. (Read the full story here)

Maruti's statement, which came out late Wednesday, included the following major points:

1) Maruti will not buy cars from Suzuki Gujarat's plant at negative margins. Nomura analysts Kapil Singh and Nishit Jalan say this is a positive for investors as earlier there were concerns that in years of high capex requirements, Maruti might incur losses on Gujarat production.

2) Maruti said capital expansion of Suzuki Gujarat would be met through a) depreciation amount available with the Gujarat subsidiary b) net surplus from car pricing and c) through Suzuki Motor's infusion of fresh equity. Nomura analysts say that Suzuki's willingness to invest beyond first phase of capacity expansion is a positive for shareholders.

3) Maruti said assets of the Gujarat subsidiary would be transferred to Maruti at a fair value if the contract with its subsidiary is not renewed post expiry. Nomura analysts say the final value that Suzuki will earn from the merger may be around the equity value it invests, which is again a positive.

However, Nomura analysts also pointed the following uncertainties about the deal,

1) Maruti will not make profits from incremental production at Gujarat in the initial 4-5 years as Suzuki Gujarat will charge higher cost of production to Maruti to fund its capex requirement. There is a possibility that Maruti's profits may remain stagnant for 4-5 years beyond 2016-17 fiscal year.

2) Traditional valuation methods (like price/earnings) will not work as there will be no earnings growth for Maruti. Free Cash Flow (FCF) would increase, but markets may not pay any premium for it given the complexity created due to this structure.

Many other analysts were also not convinced with Maruti's arguments,

1) In a note to clients on Friday, Jefferies said, "While management tried to explain how the deal doesn't hurt Maruti, no attempts were made to explain why this structure makes sense in the first place."

2) CLSA said it did not expect markup price to be a part of deal with Suzuki. Maruti's margins on Gujarat can be lower than Haryana plant, it added.

3) Morgan Stanley said more details have emerged but final terms are still unclear. Why Suzuki ownership is required in this structure is not clear, it added.

4) Manish Sonthalia, VP & fund manager at Motilal Oswal AMC told NDTV that the deal is an example of corporate governance issues at Maruti. He said his company sold its entire holding in Maruti on January 28, when the deal was announced. (Read: Why are investors worried about Maruti's Gujarat plans)

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