Maruti hogs the road

Insight

With an adverse change in the macro environment, viz. high interest rates, the situation is different for each auto segment and for each player. Here, we look at how the car and UV players have performed.

Maruti continues to be the best performer in passenger cars. Its domestic sales jumped 24.8%, helped by new launches. And except for economy Maruti-800, all other segments did well. Higher contribution from the premium segment (SX4, Swift, Grand Vitara) should provide some cushion against rising costs.

For Maruti, exports were up nearly 60%, but that's because of lower base-in August 2006, export sales had dipped 25% to 3596 vehicles from 4792 a year ago. Thus, total sales jumped 27.22% to 65,968 vehicles in August.

However, Tata Motors reported a 5.25% decline in domestic passenger vehicles (car and UV) sales at 16,620 units, failing to sustain the 17,000-mark (May 2007) as seen in the past two months. In passenger vehicles, Indica sales fell 4%, Indigo by 1% and utility vehicles (Sumo and Safari) by 12%. Besides rising interest rates, the lack triggers in the form of new launches and stiff competition hurt the firm.

Total exports, too, fell 7.8% as export of cars fell 26.5% to 1,329 units-for the first five months, cumulative car exports were down nearly 29% thanks to the South African market where sales are dropping due to the strong currency there. Thus, overall sales were down 5.51% to 18,397 units in the passenger car & UV space.

For Mahindra & Mahindra (M&M), the leader in the UV space selling thrice as much UVs as Tata Motors, August sales were good, despite the 2% decline in sales of Scorpio for the first time in many months.

The boost came from higher sales of Bolero, its re-launched flagship brand around March 2007-UV sales excluding Scorpio have grown 30% during April to August 2007 as compared to just 13% for Scorpio. In passenger cars, sales of Logan stood at 2,252 vehicles - 22% lower than sales in July 2007 - largely due to supply problems.

All the three stocks have underperformed the Sensex in the last one year, thanks to the change in the macro environment. The company, which has been most hit so far may be Tata Motors, given that its heavy & medium commercial vehicle (H&MCV) sales are down 8.8% during the first five months.

Tata's ACE in the light commercial vehicle segment has helped grow LCV sales by 11%, which, though, is unlikely to help compensate for the drop in high-margin H&MCV sales. For M&M, the only drag has been the flat tractor sales during the first five months. And Maruti continues to be the least affected.

No wonder, Maruti remains a favourite of analysts, who have rated Mahindra as a 'buy' and TAMO as 'market performer'.

R&D boost for Nicholas

De-merging businesses into separate companies is not unusual and Nicholas Piramal (NPIL) is not the first pharma company to announce de-merger of its new chemical entity (NCE) research and development unit (to be listed separately later).

But, the markets are impressed by the move; the stock has risen 25.84% since August 27th, the day it announced the board meeting date for considering the de-merger. That's because the de-merger has various benefits - first, since research outfits need to spend lots of money before they can claim to have developed a successful product, it will mean reduction in R&D expenditure. As per analysts' estimates, this should boost Nicholas' EPS by about 20% annually.

The second advantage is that it will help unlock value for NPIL's shareholders, as typically, focused companies enjoy better valuations. The de-merger will also provide an exit opportunity to shareholders who do not wish to hold a stake in the high-risk and high-reward R&D business.

NPIL will transfer assets as well as cash (worth Rs 95 crore) to the new company. For this, existing shareholders will get 1 share of Rs 10 each in the new company for every 10 shares of Rs 2 each held in NPIL. The combined stake of existing NPIL shareholders will be 82%, as NPIL itself will also be holding an 18% stake in the R&D company. This means NPIL's stock will also have some rub-off from developments at the R&D company.

Since promoters currently hold 49.97% in NPIL, their holding will stand reduced to 40.97%, which together with Nicholas Piramal's 18% holding will provide an effective control of 58.97% in the R&D unit (equity capital of Rs 25.49 crore).

As the new R&D company will have 13 new compounds under various development stages (4 in clinical trials already and 4 more expected in 2007-08), it is expected to require huge funds to develop these-clinical trial costs account for about two-thirds of total R&D cost to develop a product.

While the Rs 95 crore should be sufficient in the medium term, the proposed equity holding pattern indicates that the ground is being laid for sale of equity through strategic investor or private placement route in future, without leading to dilution of promoter-holding to uncomfortable levels.

The de-merger will help Nicholas de-risk its business model with more stable revenues and profits, besides allowing it to concentrate on domestic formulations and contract manufacturing. In short, the move is positive. At Rs 299, the stock trades at a PE of 18 times its post de-merger estimated EPS for 2007-08, and merits attention.

Contributed by Pallavi Pengonda & Vishal Chhabria