Nov 2013: Our Investment Process: Maruti – A case study

Some of our clients have been requesting us to talk about the companies we invest in, in our newsletters. So, we want to spend some time in this letter talking about our investment process, with a case study.
We started buying Maruti Suzuki around Sep, 2010 at roughly Rs 1200 per share. We liked Maruti because of its asset light business model and market dominance of an industry that is growing over the long term because of increasing disposable incomes in India. It has very high profitability (core RoE of close to 27% over a 20 year period), largely as a result of its asset light model whereby most of the investments have to be made by its vendors and dealers and Maruti is primarily responsible for core functions like R&D, Assembly and Quality Control. The company has zero debt and is sitting on a cash pile of Rs 6,000 cr which it can use for any future investments in capacity. Much of this cash is as a result of regular cash flows over the years – the sum of the last 10 years’ free cash flow is Rs 5,500 cr. It has raised money from the public only once – at the time of its IPO in June 2003. It has thus used internally generated resources to post a reasonable 17% growth per annum in sales over the last 20 years. Earnings per share have grown at 18% p.a. over the same period.
After we bought the stock, the company has faced a fair amount of labour unrest. Trouble first broke out in September 2011 at its Manesar plant. Subsequently, in 2012, the labour unrest turned ugly and resulted in the death of a key management personnel, which led to a stand-off between the management and its employees. Through this period, the company lost production and had potential market share losses because of not being present at full strength in front of its customers. Further, it had more trouble on another front – the government, in its effort to not have high oil prices affect the common man, continued to heavily subsidize diesel, which distorted the prices in favour of diesel. Maruti had a smaller presence in the diesel car segment, because of its ancestry and limited capacities in diesel engines. As a result, Maruti has had a significant disadvantage against competitors over the last few years.
To add to all this, has been the economic situation in India, where growth has slowed down significantly. Yet at the current price of Rs 1670, Maruti has delivered 11% in price growth over our original purchase price over the last 3 years. While this is below its own averages over the long term and not great in absolute terms, we have managed to achieve our triple goals of capital protection, beating inflation and beating the market index rate of return, with Maruti. One of the primary drivers of stock performance over the medium to long term, is the valuation of the stock at the point of purchase – this was in our favour with Maruti and therefore, despite all this negative news, the stock did not fall a whole lot and has shown moderate appreciation.
What we like about Maruti is, that after 6 long years of slowdown, Maruti offers a quality exposure, to the economic cycle. Just as one can be sure that day follows night, history tells us that a downturn is usually followed by an upturn. It is reasonable to expect that the next 6 years will be significantly better than the previous 6. What will aid Maruti in the future is its established brand, economies of scale and the benefits of dominance in a fragmented market, where a large number of players have very poor profitability. Over time, as the price of a car becomes a smaller proportion of the median household’s annual income, the car penetration will grow and Maruti is well placed as a dominant player.