Will the diesel car tax gatecrash Maruti Suzuki’s merger party?

It could simply be a case of bad timing. A day after it announced the decision to absorb diesel engine unit Suzuki Powertrain India Ltd, Maruti Suzuki India Ltd’s stock fell 3.38%. But then, stocks of all car makers were down as the government considers levying excise duty on diesel cars, reportedly ranging from Rs 1.7 lakh on small cars to Rs 2.5 lakh on bigger models.

That may scupper what should have been Maruti’s party—a sensible business decision that could have acted as a trigger for the stock after months of underperformance. The merger makes sense on a lot of fronts. After all, there is a waiting period for diesel vehicles, and with that fuel about 40% cheaper than petrol, the future seemed secure with those models.

The transaction involves no cash outgo for Maruti. The company will fund the acquisition by issuing fresh shares to parent Suzuki Motor Co. Suzuki Powertrain has been valued at roughly 4.5 times its enterprise value to earnings before interest, taxes, depreciation and amortization. The company has better operating margins of around 12%, way better than Maruti’s metrics. Those numbers are expected to start reflecting positively on Maruti’s income statement.

Note that Suzuki Powertrain is already running at its full capacity of 300,000 units a year, and with Maruti building another diesel engine factory, there is scope for improving operating performance through common sourcing, using more local components and economies of scale. Brokerage firm Motilal Oswal Securities Ltd expects the merger to be “marginally earnings accretive (0.8%) for MSIL (Maruti Suzuki), as equity dilution is (approximately) 4.6% whereas accretion to profit after tax is (approximately) 4.9%”.

While the tax on diesel cars is only on paper now, it’s easy to figure out the impact on Maruti. The company had guided for 10-12% sales growth in fiscal 2013, or volumes of about 1.1 million cars. Of this, more than one-third, or 400,000 vehicles, are diesel cars. What’s worse, this news is floating around at a time when the recent surge in petrol car sales has petered out. Maruti had to cut production of some models, including the Alto, as inventories started piling up and total domestic sales have declined this fiscal year for the company.

Unless there is more clarity on the diesel car tax, the stock is likely to continue to underperform. Nothing short of a drastic cut in interest rates that would boost consumer sentiment will pull up the stock in the short term.

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