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Raghuvir Srinivasan

IT APPEARS to be more an act of faith rather than one dictated by cold investment logic. Whichever way one looks at it, the overwhelming feeling is that investors in the Maruti IPO have been driven more by faith, preferring to ignore the arithmetic of investment.

Just consider this. Maruti's earnings per share in 2002-03 was Rs 5.06. This means that the stock has been discounted by 25 times its latest earnings, which is a whopping number by any standard.

Even stocks from the information technology sector — the market darlings — do not boast of similar price earnings multiples.

So, what should the stock list at for a decent return on investment for those who applied for the shares? Assuming an annualised return of 20 per cent, which is just about the normal expectation for a stock market investment, the stock should trade at Rs 150 a year from now. Assuming that the present discounting factor of 25 holds, we are looking at an EPS of Rs 6 per share for the current fiscal.

Now, there are two important factors to consider — first, is it realistic to expect the stock to sustain its price earnings multiple of 25 and, second, are we right in assuming a 20 per cent growth in the company's post-tax earnings for 2003-04?

Let us take the second question first. Maruti has indeed done pretty well in bouncing back from a Rs 269-crore loss in 2000-01 to a profit of Rs 146 crore in 2002-03.

In fact, the profit rose by 40 per cent in the last fiscal compared to the previous one, which is quite impressive. But, then, a stock investment is done with an eye on the future, and while past record gives us an idea of the company's ability to take on future challenges, it is by no means a guarantee of future performance.

So what is the company up against in the market now? It is doing rather well in the entry segment where its model is the sole representative. While that ensures a certain base volume of sales, profitability can be improved and sustained only by pushing sales in the critical "B" and "C" segments which are highly competitive. And that is where Maruti has a problem. It has three models in Zen, Alto and Wagon R in the "B" segment which together post higher sales than competition.

Yet, Maruti needs a makeover in this segment if it is to sustain and improve its position given that its models already suffer from fatigue. Of course, it is certain that Suzuki Motor Corporation will soon step in with newer models that could give Maruti fresh momentum in the market.

Yet, new models come with a price tag — royalty to the parent, capital investment, and, of course, advertisement and promotion — all of which can bite into the margins. And such expenditure will be in addition to the existing heavy outlay on advertisement and promotion that has on an average been 7 per cent of sales. Consequently, margins can come under pressure, probably beginning this fiscal itself. Which means that even the conservative 20 per cent earnings growth target could turn a stiff one.

Now, to the question of whether the discounting of 25 times is sustainable. Given that Maruti's will be a one-of-a-kind stock in the Indian market with no peers it is not easy to take a view on this question. Yet, going by such parameters as Maruti's position in the market, which is declining (see graphic), and the anticipated growth pattern, both for the industry and Maruti, it appears that the valuation is on the higher side.

Maruti has seen a steady erosion in its market position, both in terms of share and absolute sales volumes. In the last five years since 1997-98 when competition really began for Maruti, its volumes have dropped from 3.53 lakh to 3.30 lakh even as total industry volumes (cars and utility vehicles) have shown a compounded annual growth rate of 5 per cent. Maruti's share of the total market today is 47 per cent compared to 64 per cent five years ago, and it remains to be seen if this will be sustained.

So, what has prompted such a high valuation then? The obvious answer is Suzuki's presence as a dominant shareholder and the expectation that it will help Maruti sustain its leadership position. Indeed, the applicants to the IPO appear to have gone blindly by this one factor placing their faith completely in Suzuki's support to Maruti, ignoring all arithmetic in the process. If investments are acts of faith, then one cannot find a better example than this.

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