Maruti Suzuki

The fixed burden of royalty payments to its parent and its stinginess in paying dividends make Maruti Suzuki a risky bet in the auto sector

MARUTI Suzuki has been one of the star performers among large-cap stocks. Since the beginning of this year, the car maker’s stock price has nearly trebled and the company is India’s most valuable automobile company now.

So, what should the retail investors do now? The company is one of the fastest growing car makers in India and its revenues and profits are at an all-time high. On the downside however, the company acts miserly while rewarding its shareholders with dividends unlike other automakers.

Despite being one of the largest campany in the sector, Maruti Suzuki has one of smallest dividend pots. In FY08, the company paid a total dividend of Rs 101 crore and the amount was less than 10% of its net profit. In contrast, Tata Motors and Mahindra & Mahindra distribute nearly a third of their net profits as dividends. And 2009 was no exception. This makes Maruti Suzuki’s shareholders overtly depended on the vicissitudes of the stock market to make money from this stock. And given the company’s cost structure and its capex plans, the situation is not likely to change much in next few years. This raises the risk-to-reward ratio and may not suit investors who believe in buy and hold strategy and like to savour the fruits of their investment over the long term.

BUSINESS:

Maruti Suzuki controls over 50% of the domestic market. In the near term there is no threat given its high brand recall, superior sale and service network and the widest product range in the industry. Its dominance in the all-important small and compact car segment is even stronger. With six models and dozens of variants, it controls nearly two-thirds of the segment. It has further consolidated its position in this segment by launching a slew of international models in last few quarters . The company has also expanded its export business and is now one of the leading suppliers of fuel-efficient cars to European markets. Export now accounts for nearly 15% of its production and has more than doubled this year.

FINANCIAL PERFORMANCE:

The company’s net sales have expanded at a compounded annual growth rate (CAGR) of nearly 18% between FY04 and FY09. The growth was aided by 11% CAGR in its sales volume during the period besides price hikes and launch of higher priced models. However, the company’s operational cost grew at even faster rate, which eroded its operating margin. Its operating profit expanded by just 9% CAGR during the period. It’s operating margin has shrunk from a high of 14.6% during year-ended September ’06 to 6.7% in March ’09. It has recovered in last two quarters, thanks to gains from excise duty cut, but is still below its historical levels. Rise in operational cost was mainly because of rise in raw material costs and royalty payments to its Japanese parent, Suzuki Motor Corporation. Maruti Suzuki pays 5% (of net sales) for domestic sales and 8% for exports as royalty to Suzuki for the use of latter’s brand and technology. In last five years Maruti’s expenses on royalty has jumped six times against two-and-half times growth in net sales. Given the fact that operating margin in auto industry now hovers at around 10-12% for most manufacturers, royalty payments may act as a drag on company’s profitability in future. In the past, the company was able to restrict the impact of falling margins on its net profit, thanks to copious growth in its other income, which expanded by 21.5% (CAGR) in last five years. In FY09, other income—comprising dividends, interest, profit from sale of investments and scrap sale—accounted for 60% of its profit before tax. Going forward, it would be difficult to achieve this given the turmoil in financial markets. Moreover, its capex programme forced it to liquidate a substantial chunk of its investments last year.

VALUATIONS:

At its current price, the stock is trading at around 28 times it’s earnings per share in last four trailing quarters and looks expensive on historical valuations of around 20-22x. Besides, the stock offers one of the lowest dividend among all leading auto majors. High valuations coupled with the fact that metal prices are once again on an upward trajectory, makes us cautious on this counter.