After more than two years of one way ride, optimism towards auto stocks seem to be softening. Or it seems so. Tata Motors, which has risen from Rs 60 levels in mid 2001 to almost Rs 570 in the recent rally, has seen it share price declining by 17% since then. After our detailed third quarter analysis, we look at the recent events and validate our expectations for the year ahead.
First, consider the growth prospects of the commercial vehicle (CV) segment. Initial estimates at the start of FY04, including Tata Motors, for the CV sector ranged between 7%-8%. However, as the year progressed, demand for CV has remained robust and it is likely that the sector could post almost 25% YoY rise in sales. In FY03, the sector saw a 31% growth in sales. Though the CV sector is cyclical in nature and volumes tend to increase at a faster rate during times of turnaround, this is significant by any yardstick. Considering this continued growth in sales, earnings estimates, including ours, were revised upwards for FY04 (we revised our earnings upwards from Rs 6 bn initially to Rs 7.9 bn). This is one of the reasons why Tata Motors was in the limelight in the stock market in the recent past.
Now, FY04 is almost history. What is in store for CV players in FY05? While we believe that the sector is likely to post a much slower growth rate of around 10% in FY05, Ashok Leyland, the second largest player, expects demand to grow 'atleast' by 15%. But we have factored in 10% growth rate for the sector considering the cyclicality of the CV business. The company also expects bus demand to grow by 10% on the back of increased demand from private sector players. With road network improving, demand from private operators have been robust and we expect that to continue. So, where is Tata Motors placed? We expect the company's market share in the domestic CV sector to decline over the long-term considering the expansion of network by Ashok Leyland and competition from MNCs. The Indian CV sector is likely to become fragmented with more players having already entered or firming up plans (Volvo, Eicher, Bajaj Tempo and Mercedes). However, in FY05, we expect Tata Motors to grow in line with the sector i.e. 10% levels.
On the passenger car front, we continue to remain cautious, though volume growth will be higher given the fact that the Rover export will have its full impact in FY05 (the company started exporting in December 2003). We expect the passenger car segment to grow by around 8% with Tata Motors consolidating its market share in Segments 'B' and 'C'.
As far as operating margins are concerned, we expect a scenario where further expansion is likely to be limited if not a decline from the current levels. Just to put things in perspective, in the previous peak of the CV cycle, Tata Motors has an operating margin of 13% in FY97. Despite having reduced employee strength by more than 14,000 and having a tighter control on costs, Tata Motors is likely to post similar operating margins in FY04. We initially expected margins to be higher than this. But it seems that the car segment is eating into its overall margins. Our concern on the operating margin side has got to do with the car business.
The stock currently trades at Rs 473 implying a P/E multiple of 17.4 times and a price to cash flow of 12.0 times. We believe that on the current business basis, the stock seem to be fairly valued. Besides, the company has proposed a fund raising exercise for its overseas acquisition and product development for its passenger car division. While the modalities are yet to be concluded, this could result in additional equity offering and therefore could dilute earnings.
However, what we have not factored into our estimates in the Daewoo acquisition. While full financial details are not available as of now, we expect this to benefit the company in the long term in a significant way. The key factor is that this acquisition will minimize the impact of cyclicality in CV demand in the domestic market. Though we are positive on this move, it could take some years for this acquisition to be restructured. So, caution has to be exercised to that extent.
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