Fortuna Advisors

We write this note in the context of strong momentum in the Indian stock market. We discuss our perspective on running a performing portfolio and deploying capital at these times.

PART A: Why are the markets trading higher, in our view.

The market momentum is driven by a strong flow of funds from domestic retail investors (via SIPs), and domestic institutions. This flow is more and more structural and will continue over the coming years. There is also an inflow of funds from foreign institutions, though a part of it is from passive funds driven by bullish momentum. If the US cuts rates, more money will pour into India.

The India macro story is strong and stands out. The markets are pricing in a stable, strong political outcome in India post the 2024 general elections, and the US Fed lowering rates sometime in 2024. There have been signs of weakness in China, with foreign funds moving out. Some of the outflows from global allocations other than India are finding their way to the Indian markets.

The market’s positive view on key assumptions and strong liquidity are the driving forces behind the strong market momentum in CY2023.

PART B: Why is important to know where we are in the market cycle.

The Indian markets are trading at trailing earnings multiple of 25 times, which in historical context has indicated very high levels. There are clear signs of excesses in the mid and small cap equities. The large oversubscription of IPOs shows up as “buying panic” amongst primary market investors.

Periods following market highs have been periods of moderate performance. It is not clear to us which exact event may cause the cycle to reverse, but then cycle reversal does not necessarily require a trigger. Cycles are self-correcting. We need to remain cautious.

PART C: How does our process to assess existing portfolio and find new opportunities, hold up.

We have an intrinsic value estimate and a core set of variables that we track on all our investments. At this time, we are asking only one question on each investment in the portfolio: How much optimism is factored into the current price? For our core portfolio, the answer has been acceptable – the best-case scenario is not priced in yet. For the others, the price has begun to reflect close to the best set of underlying variables. We are exiting those and investing cash in T-Bills / AAA bonds.

While we add to our cash position. We remain focused on preparatory work – building fundamental theses, and getting ready to act as one gets to invest at target entry prices. However, we are finding fewer and fewer opportunities to deploy meaningfully in the current market momentum.

Our process does not deviate from its core. We remain patient investors.

PART D: Outlook – as far ahead as we can see.

India as an economy is well positioned for a nominal growth rate of about 12% in the next few years. While the current valuations seem to be in a zone of discomfort, the possibility of contraction in PE multiples will likely be balanced by the structural flow of liquidity. It will be difficult to stay aside and not participate in the India story.

We continue to work to identify well-run businesses with strong earnings and an ability to grow without requiring fresh equity, driving growth in earnings per share. We think careful selection can bring meaningful returns to the long-term investor in the Indian markets.

We at Fortuna Advisors [SEBI Registered PMS] are focused on building a Long Term compounding investment portfolio for our clients, while ensuring margin of safety for capital preservation.

Our returns for the month of Aug 2023 are +9.1%, while the Benchmark BSE500 returned negative 0.85%. Since July 2023, when we started onboarding clients, our Portfolio has returned +10.7%, against Benchmark returns of +2.7%. [We continue to hold approx. 20% of Portfolio in Cash, waiting for better entry points].

We do not give significant weightage to short term outperformance (after all, short term returns may partly be due to luck, rather than our skill). With challenging global macro (US rates high, staying high for longer, slow growth in China and EU), we remain prepared for volatility in the latter part of the year.

We invest in India. We like the Indian macro and the opportunity this brings our clients over the next decade.

As long-term investors, we work on consistent and independent investment thinking (deep dive on company specific analysis, not go with market favorites), low turnover (our holdings are for the long term, ensuring low brokerage and taxes), and alignment with clients (we invest alongside our clients, we primarily earn performance fee once client returns exceed 10% annualized).

Our investment philosophy and principles are discussed in more detail on our website www.fortunaadvisors.in

We are happy to discuss our specific investment theses (including work in progress cases). Please let us know if you are open to having a discussion with us.

In this article we analyze Maruti Suzuki India’s Decision to Buy Production Facilities in Gujarat, held under Suzuki Motor Gujarat (its fellow subsidiary)

Maruti Suzuki has been the one brand almost everyone who grew up in India in the 1980s loves. And for good reason. Maruti made the dream of owning a car possible for millions of Indians. 

And now when it is time for the next growth phase, there is a debate on how its proposed actions are placed vis-à-vis the interests of minority shareholders.

The debate is not on the consideration to be paid, the strategic reasons or the timeline. The issue being discussed by proxy firms and the analysts is the mode of consideration, that is, how should Maruti Suzuki India Limited pay for the plant.

Let us summarize the context quickly. 

Maruti Suzuki India Limited (MSIL) entered into a related party transaction in 2014-15 with its Parent, Suzuki Motor Corporation Japan (SMC). The related party transaction outlined the investment by SMC into a production facility of upto 7,50,000 cars per annum. MSIL leased its land in Gujarat for the plant. SMC was to invest in the production facility from its own balance sheet, to manufacture and supply vehicles on an exclusive basis to MSIL, on no-profit, no-loss basis. MSIL signed up to market the entire production from the plant.

The Contract Manufacturing Agreement (CMA) was approved by majority of the minority shareholders of MSIL in 2015, after much discussion and debate. 

Since then, a lot has changed in the market.

For starters, the entry level segment has degrown. This has been the traditional strength of MSIL. MSIL’s annual report for FY2022-23 outlines sub 2% year-on-year growth in this segment till 2030.

Alongside, the premium segments, including the SUV segment, have grown. MSIL’s annual report outlines 6% plus year-on-year growth in this segment till 2030.

Clearly, Indians are buying more premium cars, with this trend likely to continue.

Another clear trend is towards lower carbon emissions – ethanol blending in petrol engines, CNG, hybrid electric, and electric vehicles. This will mean multiple powertrains will coexist in the coming decade as the transition to electric vehicles plays out. MSIL has estimated that only 15-20% of its annual production will be electric vehicles in 2030. 

In recent years, MSIL has lagged competition in the transition to EVs, impacting its overall market share. However, this may start reversing as MSIL readies to launch its EV in H1 FY25.

The changed market context has made the production facility under Suzuki Motor Gujarat (SMG) more relevant for MSIL. The SMG plant in Gujarat is focused on the more premium, and newly launched successful models under MSIL. Its relevance for MSIL has grown steadily as evident from the table below:

Rs. Cr.	FY16-17	FY17-18	FY18-19	FY19-20	FY20-21	FY21-22	FY22-23
Purchase of Goods from SMG by MSIL	681	5,087	9,043	14,294	13,974	21,210	28,345

Source: Maruti Suzuki Annual Reports

View from a corporate finance perspective – 

Suzuki Motor Corporation (SMC Japan) invested in the production facility at its 100% subsidiary Suzuki Motor Gujarat Pvt. Ltd. The table below outlines its investments:

Rs. Cr.	FY14-15	FY15-16	FY16-17	FY17-18	FY18-19	FY19-20	FY20-21	FY21-22
Share Capital	100	3,200	5,810	8,580	8,680	12,590	12,680	12,730

Source: RoC Filings of Suzuki Motor Gujarat Pvt. Ltd.

Had MSIL made these investments from its own cash flow, it would have lost out on the interest income from such cash on its balance sheet. By not investing in building the production plant at Gujarat, MSIL gained interest income at the treasury rate of investments. Not a small sum over these years.

At the same time, since the contract manufacturing agreement specifies the sale by SMG to MSIL will be on cost basis, there have been little, if any, profits booked at SMG. This is outlined in the table below:

Summary Financials Suzuki Motor Gujarat Rs. Cr.	FY14-15	FY15-16	FY16-17	FY17-18	FY18-19	FY19-20	FY20-21	FY21-22
Net Worth	102	3,210	5,986	8,687	8,791	12,688	12,733	12,757
Net Fixed Assets	0	3	2,334	2,941	6,211	7,111	7,355	11,218
Cash Balances	102	2,648	3,816	5,815	2,792	3,557	3,522	2,734
Revenues	0	0	719	6,617	11,399	16,969	15,850	24,440
PAT	2	8	178	104	104	101	46	23

Source: RoC Filings of Suzuki Motor Gujarat Pvt. Ltd.

View from a strategic perspective – 

The decision by MSIL Board to buy out the production facility at SMG at Net Book Value is a long term positive for MSIL shareholders. This will ensure the important and future ready production facility comes directly under MSIL. MSIL be better prepared to respond to a changed market reality.

The negative still remains as another Battery Unit (under the name of TDS Lithium Ion Battery Gujarat Ltd., formerly known as Automotive Electronics Power Pvt. Ltd.) remains under the ownership of Suzuki Motor Corporation Japan. 

MSIL has over Rs. 45,000 Cr. in cash available to directly pay for the SMG plant. That will be a simple transaction to execute. 

If, however, the MSIL Board decides to pay the consideration as stock (thereby issuing equity on preferential basis to the Promoter SMC Japan), the short term market messaging will likely be negative. This will imply dilution for the minority shareholders, and enabling the Promoter SMC Japan to retain further upside from the growth in MSIL equity value in the future. In our calculations, if the consideration were paid as stock and not as cash, post the preferential allotment, SMC Japan’s stake will increase from the current 56.48% to about 58.32%.

For Minority Shareholders of MSIL, it is the long term picture that is more relevant. The production facility is ready, brings 750,000 units capacity directly under MSIL, at net book value. 

The Minority Shareholders with a long term strategic view on MSIL should benefit from this transaction, irrespective of how the consideration payout is structured.

 

 

View of Gurvinder Juneja, Principal Officer, Fortuna Investment Advisors

A SEBI Registered Equity Focused PMS 

DISCLAIMER: Invested in MSIL. This is not a recommendation to buy or sell. Please do independent analysis before taking any decision related to investments.