The shares of India’s biggest car company by sales, Maruti Suzuki India Ltd, had outperformed the Nifty by 23% in just five trading sessions since the Budget 2008 announcement that excise duty on small cars would be cut by 4%. Maruti immediately cut prices by about 4%, leading to the view that lower prices would fuel demand growth. But the stock has underperformed by about 10% since, partly because the initial reaction to the Budget seemed overdone.
The automobile maker has now said that it would spend an additional Rs9,000 crore in capital expenditure (capex) on research and development, and building its distribution capability, over and above its normal capex for expanding the production capacity.
The company had said last year that it would spend Rs9,000 crore through fiscal year 2009-10 for expanding capacity and for investments in the engine plant of an associate company.
The additional capex will lead to an increase in the estimates of depreciation, and a decrease in the cash position of the company, and hence a drop in other income estimates. In sum, profit estimates could be brought down a tad because of the higher capex. It’s no wonder Maruti’s shares underperformed on Monday as well, falling 1.34% even as the Bombay Stock Exchange Sensex rose 1.96%.
The stock has now fallen nearly 20% since the beginning of the year, which, according to an analyst, is because of the market’s concerns about the launch of Tata Motors Ltd’s Nano. Besides, sales growth has been ordinary in the past couple of months partly because of a large base and partly because of successful launches by competitors, such as Hyundai Motor India Ltd’s i10. Furthermore, the sharp appreciation of the yen versus the rupee, recently, will hurt Maruti’s input costs, since it still imports some components from its Japanese parent company. What’s more, steel prices are still soaring and would dent the company’s profitability.
All this points to the possibility of pressure on margins in the near-medium term, but it must be noted that the company has maintained its margins in the past despite various cost pressures. And although last year’s high base and the pressure of competition may continue to weigh on volume growth numbers in the near term, most analysts are confident that growth rates would soon pick up. But what’s most compelling about the Maruti story currently is that it’s available for just 12 times trailing earnings.
Rising costs to squeeze margins
It’s not just the high inflation number that’s a concern—it’s the type of inflation that we’re having. While headline inflation, in terms of the wholesale price index, stands at 5.92%, what are the main items pushing it up? Non-food primary articles are up 13.8% year-on-year (y-o-y), with the price of fibres going up 24.1%. The price of raw cotton, for instance, is up 25.1%. In the manufactured products group, it’s the price of food articles that’s soaring: edible oils are up 17.5%. Here are a few more: basic metals and alloys are up 16.7%, and chemicals and chemical products are up 5.4%. Within basic metals, iron and steel is up a huge 20.9%.
In short, inflation is rising mainly on account of higher international commodity prices. That’s seen from the increase in iron and steel prices, edible oil prices, chemical prices and in the prices of fibres such as cotton. While factory-gate prices, too, are rising, their rate of rise is nowhere near that of basic commodities. That’s true internationally as well—US import prices in February for “industrial supplies and materials excluding petroleum” were up 12.5%, “foods, feeds and beverages” were up 11% and “finished metals related to durable goods” were higher by 12.4%. In contrast, the price of imported capital goods went up 0.9% y-o-y and consumer goods by 2.1%.
In the Indian wholesale price index, too, the prices of manufactured articles hasn’t been going up much: textiles prices are down 3.5% y-o-y, machinery and machine tools are up 3.8%, and motor vehicles are up 4.4%. As the seasonally adjusted ABN Amro Purchasing Managers’ Index for February pointed out, “Input price inflation accelerated sharply in February and was the strongest for six months. There were reports of higher prices for a range of inputs, including metals, plastics and chemicals. Indian manufacturers raised factory-gate prices again in February, with average charge inflation picking up from the previous month. Panellists indicated that they had increased their output prices in an attempt to protect profit margins in the face of rising average costs.”
In other words, commodity inflation is a global phenomenon and there isn’t much the Reserve Bank of India can do to stem rising prices, except perhaps to shore up the rupee, because a depreciating rupee will add to imported inflation. At the same time, the government is unlikely to let prices rise with the elections so close. Since it’s unable to do anything about imports, pressure will be applied on Indian manufacturers. If the higher commodity prices persist, while the economy continues to slow, a squeeze in margins is inevitable.
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