Maruti makes cars. A lot of cars. Over a million cars in the last year. And it’s had problems. Worker union trouble at its plants in Gurgaon and Manesar has had the company considering moving out of the Haryana state. It recently got to acquire land in Gujarat and was going to set up a plant there.

However, news came in yesterday that instead of Maruti investing in the Gujarat plant, it’ll be an investment by Suzuki directly with an unlisted subsidiary. Suzuki has a ton of cash in Japan lying idle. Maruti will then only buy the cars from that subsidiary.

The stock crashed after the news. This is like a promoter saying – don’t build your own cars, I’ll build them, and you take them from me and you sell them. The fear is that the company will over-pay for the cars.

Mint talks about the investment and raises pertinent questions:

For the longer term, however, the negatives outweigh the positives and raise many doubts on the parent company’s intent. How will vehicles made in the subsidiary be priced when transferred to Maruti (in which Suzuki has a 56.2% stake) for marketing? Will exports, which comprise about a fourth of Maruti’s revenue and which improve realizations, be diverted through the Gujarat unit, which in turn could curtail benefits to the Manesar factory in Haryana and hence to Maruti’s profitability? Will this also hinder further localization as more auto components could be imported?

If Suzuki exports cars made in their subsidiary directly, then Maruti will see none of the revenues or profits. In fact, if Suzuki decides to make cars ONLY for exports – cars too expensive for the Indian market or that run on fuels that are not retailed easily, such as high-octane ones – then Maruti will definitely not benefit.

Transfer pricing could be detrimental to Maruti’s profits – currently, Marui company has all the profits of a car. Tomorrow, when Suzuki makes the car, it will take some of that profit as its own when it sells from Gujarat to Maruti, and only the remaining profits come to Maruti. But Maruti says the transfer price will be at cost:

The new plant will sell cars only to Maruti under the deal at a price that will include production costs plus enough cash to cover further capital expenditure requirements, Maruti said.

(This is a “funnymentals” problem. Do you believe them?)

The good thing: That Maruti wouldn’t have to invest in the Gujarat plant itself. But they’ll still have to deal with employee unrest at Gurgaon and Manesar where other factories (like Hero Motocorp) have also seen serious unrest. The hope was that Maruti’s moving to Gujarat would solve that problem – and it might, but to the benefit of Suzuki, not Maruti shareholders.

Good Results From Cost Cutting

The company announced good results, where:

  • Revenue has been down YoY (10,893 cr,. versus 11,200 cr.)
  • Profits are up 36% (681 cr. versus 501 cr.) from lower cost of material due to localization and cost cutting
  • EPS is up 39% (22.55 versus 17.35)

However, the fact that all the growth is coming from cost cutting is not sustainable, and eventually they’ll have to raise prices or increase car sales.

Stock Falls and then Rises

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The stock fell by over 8% yesterday and has recovered about 7% today to Rs. 1680. The support at 1550 seems to have held. This would be a key number for the stock.

My View

Considering car sales have gone hugely down in the last year, Maruti hasn’t looked very attractive, but as you can see the chart has only gone up. Further news about how the Gujarat plant operates, what exactly is charged as capex, how the game on exports will play etc. will determine future direction. But I don’t see much positive news – at best they can say yes, we’ll bill things at cost, and so on. From a fundamental aspect the stock has more weaknesses than strengths.

The chart shows a support area and a downtrend right now. Going long would have to see a breakout above the 1780 line. A retracement from the high to the low shows that the stock might move to the 1680 levels (61.8%, where it is today) before it goes back down. The trend’s negative.

This is more a short position than a long one, but there is the lack of a real trigger for entry. At best, I might go with a small short position with a stop of 1780. The lower support of Rs. 1550 is now far, but it should be a hard stop in case the stock goes through it.

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