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This should have been a smooth summer-earnings season for India's favorite Japanese brands, MarutiSuzuki and Hero Honda. Instead, it has brought an unexpected twist over a fairly routine matter: Royalty payments.
Both companies rely on technology, like engines and transmissions, developed by Suzuki Motor and Honda Motor. For this, they pay royalties that are among the companies' biggest expenses.
That much isn't a surprise, but investors and analysts were caught off guard by Maruti's disclosure that its royalty payments rose sharply as a proportion of sales. That, plus higher raw material costs drove a 20% on-year drop in Maruti's profits for the quarter, despite a 27% sales rise.
Two factors explain the jump in royalties: Maruti's product mix has been changing to include more sophisticated engines in its cars. Also, India's central bank lifted a long-standing cap on those payments. That restriction -- a legacy of New Delhi's past efforts to strictly regulate capital movement into and out of the country -- had kept the payments limited to 5% of local sales. On several of its newer models, Maruti was paying the maximum permissible, says Edelweiss Securities.
All eyes have turned to motorcycle-maker Hero Honda, which reports its results Thursday. Its royalty payments have been rising faster than sales lately. They reached $90.2 million in the year ended March 2010.
The hand-wringing now -- Hero Honda's shares are down 5.6% in the three days since Maruti's disclosure -- is over whether a similar royalty-jump will appear in Thursday's results. Like Maruti, Hero Honda's been changing its product mix to maintain a lead in India's increasingly competitive market and appeal to consumers with more cash to spend.
The impact could be significant. Goldman Sachs estimates that each percentage-point increase in royalty costs, as a portion of sales, will knock 6% off of Hero Honda's earnings.
For both companies, this makes life difficult at an already tough time. Sales in India are growing fast, but new entrants are also rushing into the market, making it hard to pass along rising costs - whether royalties or pricier steel and rubber.
But the issue could linger. Hero Honda has no research and development facility of its own. Instead, it depends entirely on the Japanese for its new technology. Maruti is developing its own R&D center, but that will take more than two years to become operational. Until then, it will continue to buy technology from Suzuki.
Analysts, who were caught flat-footed by Maruti's disclosure, are disgruntled with management's lack of transparency on the issue. The question now is if Hero Honda will be under their glare next.
Source: Heard on the Street: Will Hero Honda be Humbled by Royalty? - WSJ.com
Both companies rely on technology, like engines and transmissions, developed by Suzuki Motor and Honda Motor. For this, they pay royalties that are among the companies' biggest expenses.
That much isn't a surprise, but investors and analysts were caught off guard by Maruti's disclosure that its royalty payments rose sharply as a proportion of sales. That, plus higher raw material costs drove a 20% on-year drop in Maruti's profits for the quarter, despite a 27% sales rise.
Two factors explain the jump in royalties: Maruti's product mix has been changing to include more sophisticated engines in its cars. Also, India's central bank lifted a long-standing cap on those payments. That restriction -- a legacy of New Delhi's past efforts to strictly regulate capital movement into and out of the country -- had kept the payments limited to 5% of local sales. On several of its newer models, Maruti was paying the maximum permissible, says Edelweiss Securities.
All eyes have turned to motorcycle-maker Hero Honda, which reports its results Thursday. Its royalty payments have been rising faster than sales lately. They reached $90.2 million in the year ended March 2010.
The hand-wringing now -- Hero Honda's shares are down 5.6% in the three days since Maruti's disclosure -- is over whether a similar royalty-jump will appear in Thursday's results. Like Maruti, Hero Honda's been changing its product mix to maintain a lead in India's increasingly competitive market and appeal to consumers with more cash to spend.
The impact could be significant. Goldman Sachs estimates that each percentage-point increase in royalty costs, as a portion of sales, will knock 6% off of Hero Honda's earnings.
For both companies, this makes life difficult at an already tough time. Sales in India are growing fast, but new entrants are also rushing into the market, making it hard to pass along rising costs - whether royalties or pricier steel and rubber.
But the issue could linger. Hero Honda has no research and development facility of its own. Instead, it depends entirely on the Japanese for its new technology. Maruti is developing its own R&D center, but that will take more than two years to become operational. Until then, it will continue to buy technology from Suzuki.
Analysts, who were caught flat-footed by Maruti's disclosure, are disgruntled with management's lack of transparency on the issue. The question now is if Hero Honda will be under their glare next.
Source: Heard on the Street: Will Hero Honda be Humbled by Royalty? - WSJ.com
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