Company update: Maruti Suzuki (Outperformer) - Toyota deal; hybrid technology versus model sharing

While specifics of the Toyota-Suzuki alliance are still unclear, emergent details suggest a quid-pro-quo arrangement between the partners, Toyota and Suzuki. At a broader level, while Toyota is clearly seeking to enhance access to the Indian market, Suzuki is looking to gain access to new age technologies (including Toyota’s hybrid system). Although the swap seems beneficial (and ‘win-win’), from MSIL’s shareholder perspective, the question arises if the swap is worth the cost?

What is MSIL offering? How much can Toyota gain? While attempting to calculate the cost of the deal to MSIL, we consider two aspects: (a) MSIL intends to offer its Brezza, Ciaz, Baleno and Ertiga models to Toyota, which comprise ~25%/33% of MSIL’s FY19 volumes/revenues, respectively. (b) Given that Toyota has scale disadvantages vis-a-vis MSIL and also that badge manufacturing has historically failed in India (Nissan-Renault, Skoda-VW), we assume Toyota is unlikely to gain more than 20% volume share of the offered models. Consequently, MSIL could lose 5%-7% of its overall potential revenues to Toyota by FY21E/22E.

Toyota’s technological offering – are Hybrids the way forward? The agreement clearly focusses on Toyota’s strength, Hybrid Electric Vehicles (HEV). Apart from lower emission levels (40-60% lower than petrol engines), hybrids are (a) affordable – In Europe, Toyota’s hybrid vehicles are ~8% more expensive than petrol versions (In India, EVs are currently priced ~80% higher than petrol cars) and (b) convenient –hybrid vehicles self-charge, eliminating the need for a charging infrastructure. Hybrid technology seems a perfect fit for Indian conditions (hybrids form ~46% of Toyota’s sales in Europe).

Overall is it favourable? Under reasonably aggressive though simplistic assumptions (and excluding any reduction in MSIL’s plant/R&D capex), on a DCF basis, the loss to MSIL on potentially lower sales works out to ~Rs 70bn or ~US$1bn (details inside). We note that this is an indicative number, based on limited details. There are key questions that need answering - (a) Are more concessions, including sharing of dealerships on the cards? (b) Will Suzuki or MSIL be involved in production and details on transfer pricing between MSIL, Suzuki and Toyota? and (c) will MSIL continue to export to Africa – before a firm view can be taken? However, prima facie, it seems an inexpensive deal for being effectively protected against technological change.

Despite near-term headwinds, we continue to like MSIL for its long-term advantages (brand, distribution, economies of scale). Reiterate Outperformer rating on the stock with a TP of Rs7,900 (22x FY21E).