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Maruti Suzuki's top management held a closed-door meeting with analysts recently to explain its recent decision to let its Japanese parent Suzuki set up a manufacturing plant in Gujarat but doubts continue to linger.
Last week, Maruti announced its parent would set up a wholly-owned subsidiary, Suzuki Gujarat Ltd, that would build a Rs 3,000 crore plant. The unit would become operational by 2017-18 and produce 2,50,000 cars, it said.
As per the terms, Suzuki would lease land from Maruti and would manufacture cars only for the latter as per its demands and sell them for "zero profit", the company's release said at the announcement.
On the face of it, the move appeared like a win-win for Maruti. Chairman RC Bhargava likened it to "someone else putting up a plant free of cost for us," when, in an interview with CNBC-TV18, he was asked why the company did not choose to build the unit by itself given its Rs 7,500-crore cash chest and debt-free status.
Some analysts see this as a move by Japanese Suzuki to invest further in its subsidiary (since profits from the Gujarat plant would go to Maruti in which Suzuki owns 56 percent) and put to better use its own Rs 25,000-crore equivalent cash, given the slowness in its home market.
Also read: Guj plant will take only Maruti orders: Co tells analysts
But other complexities in the deal, including a key clause that says Maruti would pay "cost plus incremental capex" for cars produced at the Gujarat unit, have had analysts concerned though many are still maintaining a positive outlook on the stock.
"There are doubts regarding the funding of future capacity expansion," brokerage firm Nomura said in a note after meeting with the company.
In essence, Maruti is getting only the first 2,50,000 cars at a cost that would have been the same had it chosen to produce them at its own plant. But by adding incremental cost of capex, cars produced beyond the initial capacity are being paid for by Maruti itself.
"Essentially, Maruti is funding the growth of the Gujarat plant without owning the asset at the end of its 15-year agreement period," Deutsche Bank said in a report.
Also, if Maruti is billed for future capacity expansions, its own profitability could be impacted depending on annual capex requirements, Nomura said.
This would also make it difficult for analysts to value the stock using traditional models such as price-to-equity or EV/EBITDA and may prompt the need to look closer into the company's free cash flows, it added.
"The specifics on how the second and third phases of expansion, where internal cash generation will not be sufficient, will be done are still not clear as the final agreement has not yet been signed," analysts at Credit Suisse said. "While the move does raise some questions, Chairman Bhargava's strong intent on protecting minority shareholders' rights gives us comfort."
The capital Maruti will save by not investing its own money initially can put to use in other areas such as marketing and distribution, Kotak pointed out, adding that it would not be overtly concerned about the deal as long as the company was earning a "desirable" return on capital.
Maruti Suzuki stock price
On February 03, 2014, at 14:48 hrs Maruti Suzuki India was quoting at Rs 1622.00, down Rs 13.35, or 0.82 percent. The 52-week high of the share was Rs 1864.00 and the 52-week low was Rs 1217.00.
The company's trailing 12-month (TTM) EPS was at Rs 106.68 per share as per the quarter ended December 2013. The stock's price-to-earnings (P/E) ratio was 15.2. The latest book value of the company is Rs 615.03 per share. At current value, the price-to-book value of the company is 2.64.
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