I am a small investor in the KSE. The recent speculative hype attracted me to the stock market but did not force me to opt for mere speculation. Before investing my lifetime fortunes, I carried out a detailed analysis of available investment options, including holding lengthy discussions with various analysts. My efforts led me to choose Pak Suzuki as my core investment. Why?
Given Pak Suzuki's size and its clear tilt towards low price vehicles, it is uniquely positioned to benefit from the ongoing boom in the auto sector sparked by the prevailing low interest rate environment.
The effective control of the Japanese management over Pak Suzuki's affairs was another comforting factor for me.
Anyway, this investment was made owing to stock fundamentals and with the hope that the company would use my wealth in an effective manner. And I expected to benefit from the dividend returns from the company. My due diligence proved absolutely right as the company reported an 85% improvement in its earnings on the back of a 68% improvement in sales.
However, against this massive jump in earnings, the cash dividend of R3/share that was declared for the year was the same as was declared last year. This represented a substantial fall in profits paid out by the firm to 9%, the lowest amongst all the Pakistani car companies.
Like me, most investors at KSE bought these shares on the back of strong earnings growth expectations and a proportionate increase in dividends.
Since the company failed to achieve the latter objective, the stock price came down significantly and the share has consistently traded at a significant discount in terms of multiples.
Instead of blaming my brokers or myself for this unfortunate fall, I decided to undertake another due diligence to determine where my analysis went wrong. Initially I was under the impression that investors were not very optimistic regarding the company's future or as a result of the government's long drawn out threat of action in the sector.
However, the continuous delays from the government in this respect forced me to look for other reasons as well.
I went to my computer and started searching for comparable companies. After a few hours I got hold of a comparable company. It was none other than Pak Suzuki's own sister concern in India. So I compared the two Suzuki Motor Corporation owned companies in Pakistan and India.
Pak Suzuki controls over 50% of the Pakistani car market and is 73% owned by the Suzuki Motor Corporation, while Maruti Udyog, which is 54% owned by the Suzuki Motor Corporation, controls over 50% of the Indian car market.
However, while Pak Suzuki is trading at a price that is 3 times its expected earnings for 2004, Maruti Udyog is trading at a significantly higher 25 times its projected earnings.
I found the two firms to be very similar in a lot of ways. Both have the same parent company ie Suzuki Motor Corporation. Both control over 50% of their respective markets, with most of their focus concentrated on the smaller end of the market with their 800cc and 1000cc offerings and both are in the process of expanding capacity in order to contend with the strong demand for their products in FY04.
However, I also found that they also differ in a number of ways, in that while Pak Suzuki has a production capacity of 60,000units per annum, Maruti Udyog has a production capacity of 320,000units per annum.
In terms of operational efficiency as well, I found that the two companies are quite different, with Pak Suzuki generating net profits of nearly R32,000/unit in FY03 versus Maruti's R5,000/unit as a result of Net Margins of 9% and 2% respectively.
However, I noted that Maruti has since managed to improve its margins, resulting in profits per unit rising to R15,000 for the period April 1 to December 31, 2003.
Further analysis also showed the two companies to be quite different with regard to the portion of profits that are paid out as dividends, with Maruti paying out a 29% of its profits in cash dividends against Pak Suzuki's minuscule 9%.
While I agree that in the past Pak Suzuki has indicated that it prefers to follow a conservative dividend paying policy, choosing to target absolute dividend values rather than payout ratios, however in my opinion, the company seems to have taken this policy to an extreme.
Thus even though Pak Suzuki earns a higher profit per unit than Maruti Udyog, it pays out a substantially smaller portion of its profits in dividends than the Indian company and indeed much less than the other Pakistani assemblers as well.
I do understand that decisions regarding the amount of cash dividends to be paid have to be made keeping in view the company's cash balances.
However, I found that both companies had very strong cash reserves of R6bn for Pak Suzuki, versus R13bn for Maruti at the end of FY03.
According to my calculations paying out 40% of its profits would have resulted in a cash outflow of only R629mn from Pak Suzuki's cash reserves.
Given that the company is currently expanding its capacity at a cost of R1.3bn, I feel that the company could have easily paid out the higher dividend. If however, the company had a reason for holding on to excess reserves of cash, I feel it should have disclosed this reason at least to its shareholders.
What infuriates me further, is that even though Pak Suzuki is generally expected to perform strongly in the future, returns to shareholders, as measured by return on equity, are likely to drop slightly since it seems highly unlikely that the company would be able to earn similar returns on the additional cash that it is retaining in its operations.
In comparison, Maruti is expected to maintain a steady return based in part on its higher payout rate and the massive improvements that are taking place in the company on the back of the high level of technical maturity the company is undergoing apparently on the back of Suzuki Corporation's high level of interest.
This may have something to do with the fact that Maruti is quoted as being Suzuki's largest production company outside Japan.
In my opinion, Pak Suzuki management's' decision also seems to have affected the company's stock price quite drastically.
Given the strong growth and higher profit per unit, it would not be unreasonable to assume that the stock would trade at a higher price than Maruti.
Unfortunately however, we find that this does not seem to be the case. Maybe it is the government's constant interference in the sector or the very small size of Pak Suzuki's share float of about 11 mn shares at R134/share versus Maruti's much larger float of about 78mn shares trading at R698/share that are causes of the relatively lower valuation.
However, given Pak Suzuki's profitability we would expect it to trade higher that the multiple 3 of its projected earnings that it current trades at versus the Karachi Stock Exchange's multiple of 12, than Maruti that trades at a multiple of 25x versus the Mumbai Stock Exchanges multiple of 16x.
Given this strange situation, I have reached two possible options for the company. It can either buy back the 27% of its outstanding shares not owned by the Suzuki Motor Corporation at a reasonable price and thus spare small investors like me a lot of suffering, or it can split its stock and increase the size of its free float and thus make its shares more liquid.
In this regard, I would therefore like to request the SECP to intervene, on the basis that the company is obviously discriminating against its minority shareholders and it is also promoting speculative investing. I have heard time and again that the SECP would like to see investments being made on a long-term fundamental basis rather than on a short-term speculative basis.
However, in my opinion, it is actions like these that prevent investors from taking a long-term view and in fact actually promotes taking a short-term speculative view of investing.
Moreover, the management of Pak Suzuki should either disclose its investment plans for the cash that they have retained in FY03 or announce at interim dividend along with the company's first quarter FY04 results.
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Company Price EPS FY03 DPS FY03 Payout Ratio
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Dewan Farooque 34.9 1.9 1.0 53%
Motors
Honda Atlas 91.6 8.2 3.5 43%
Cars
Indus Motors 115.5 16.0 7.0 44%
Pak Suzuki 134.0 32.0 3.0 9%
Motors
Maruti Lid o 535.0 5.1 1.5 29%
Motors -India
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2002A 2003A 2004F 2005F
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Pak Suzuki Motors
ROE 37% 47% 38% 35%
Incremental ROE 102% 51% 18% 34%
Maruti Udyog Motors
ROE 4% 5% 13% 13%
Incremental ROE -3184% 9% 96% 13%
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