Maruti sources its diesel engines from SPIL. We think this development is neutral with a slightly positive bias as it is earnings accretive, while the transaction multiple is not too expensive (valuation ~4.6x EV/Ebitda on FY12 numbers). Further, we believe there will be greater clarity in transfer pricing.
For Maruti, the transaction appears slightly (around 2.4% EPS) accretive. The accretion to MSILs PAT is ~7%, while the share dilution is ~5%. Further, margins may witness slight improvement on account of synergies in raw material purchases and other SG&A (selling, general & administrative) savings. There are no tax shields or other benefits that MSIL might avail of. Optically, MSILs Ebitda/PAT margin should improve, given the facility has ac12% Ebitda margin (vs. ~7% for MSIL). Our calculations indicate that Marutis margins will improve from 7.2% to ~8.7%. For Suzuki, this transaction appears somewhat neutral for the parent from an earnings perspective. On the flip side, this transaction could result in lower RoCE for the combined entity as the facility is extremely capex intensive, creates the possibility for incremental capex in SPIL that will have to be fully borne by MSIL - though this is ruled out for the short term as the incremental 300k diesel engine capacity will be in MSILs Gurgaon plant. Our target price for Maruti is R1,654. We value the parent business at R1,615 based on 11.5x Sep13e cash earnings (CEPS = PAT + depreciation). At 11.5x we value the parent business at a ~8% premium to its long term historical average - justifiable, given that MSIL will be in the early cycle over much of FY13. We value MSIL's subsidiaries at R39/share, based on 12x Sep13E EPS. We estimate cash earnings CAGR of ~32% over FY12-FY14E. Moreover, MSIL's depreciation policy is per IFRS standards, and is thus more aggressive than those of peers.
Key downside risks to our investment thesis and target price include higher than forecast increase in commodity costs and increase in competitive pressure, which could impact margins.