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Tata Motors: More challenges on the anvil - Views on News from Equitymaster

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Tata Motors: More challenges on the anvil

May 22, 2006

Performance summary
Tata Motors (Telco) is well on its path to de-risk its business from the volatility in demand for commercial vehicles (CVs). While the standalone revenues increased by 18% YoY in FY06, on a consolidated basis, the growth was higher at over 21% YoY. Despite input costs increasing and the launch of new models, the company was able to maintain operating margins during the fiscal, which was commendable. But for the issues with respect to production in the first quarter of the year, the company's performance would have been better.

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 53,389 68,828 28.9% 174,191 206,022 18.3%
Expenditure 46,983 59,899 27.5% 152,480 180,225 18.2%
Operating profit (EBDITA) 6,406 8,928 39.4% 21,711 25,797 18.8%
EBDITA margin (%) 12.0% 13.0%   12.5% 12.5%  
Other income 557 156 -72.0% 2,327 3,593 54.4%
Interest 574 803 39.9% 2,208 2,965 34.3%
Depreciation 1,628 1,892 16.2% 5,173 5,947 15.0%
Profit before tax 4,760 6,389 34.2% 16,658 20,477 22.9%
Extraordinary item (108) 87 - (139) 57 -
Tax 771 1,895 145.8% 4,150 5,245 26.4%
Profit after tax/(loss) 3,882 4,581 18.0% 12,370 15,289 23.6%
Net profit margin (%) 7.3% 6.7%   7.1% 7.4%  
No. of shares (m)       362 383  
Diluted earnings per share (Rs)         39.9  
Price to earnings ratio (x)         21.1  

What is the company's business?
Tata Motors (Telco) is India's largest commercial vehicle (M/HCVs and LCVs) manufacturer, with a market share of 62% in FY06 (FY04 - 59%) and second largest producer of passenger vehicles. Its plants are located at Pune, Jamshedpur and Lucknow. From a net loss of Rs 5 bn in FY01 to a profit of Rs 15 bn in FY06, the company has come a long way. It recently acquired the CV division of South Korean auto major Daewoo and this is likely to help the company to augment growth in the higher tonnage CVs, an area that holds considerable promise in the future.

What influenced performance in FY06?
CVs - A mixed bag: While the overall auto sector witnessed an 8.4% YoY growth in volumes (to 1.5 m units) during FY06, it was much slower than the 19% YoY growth that was witnessed in FY05. The company attributed the same to the changes in emission norms, heavy monsoons, increase in interest rates and higher fuel prices. While the domestic CV sector saw a 10% YoY growth in volumes, excluding the sale of 'Ace' (Telco's LCV model), the actual growth was staid at around 1% YoY. As far as the passenger car segment is concerned, industry volumes stood at 1.1 m units, representing an 8% YoY growth.

While this was the industry growth rate, Telco saw a 14% YoY rise in total volume sales, largely influenced by 'Ace'. The company attributed to the sluggishness in CV sales (excluding 'Ace') to supply-chain constraints in 1QFY06, which was rectified. In our view, the growth in CV sales was considerably slower in the first nine months of the fiscal, which gained momentum in the last quarter (after the Supreme Court ruling with respect to overloading of trucks).

As far as 'Ace' is concerned, since its launch in May 2006, Tata Motors has sold 30,000 units (14% of the company's CV sales and 7% of total volumes in FY06). Given the fact that the company was unable to meet demand, it is already in the process of doubling its capacity. Despite the supply-related constraints, Telco has increased its market share in the M/HCV segment from 61.6% in 4QFY05 to 62.2% in 4QFY06. While Telco's market share increased in the mid-sized cars segment (Tata Indigo), on the entry-level and utility vehicles (UVs) front, the company lost market share. We expect Telco to gain market share in FY07 in light of the launch of the petrol car in the entry-level segment. On a standalone basis, the company's topline growth was around 8% YoY higher as compared to our estimates.

Key subsidiary performance…
(YoY growth Sales growth PAT growth
Tata Daewoo (Korea) 39.0% 113.0%
Tata Technologies 202.0% 51.0%
HVTL 0.0% 11.0%
HVAL 0.0% 8.0%

As we go forward, it is pertinent to analyse Tata Motors on a consolidated basis. The Daewoo acquisition (mid-2004) is progressing well with the company gaining market share in Korea in the HCV segment and a new product was launched in the MCV segment recently (14% market share within three months of the launch). In FY06, Tata Novus (a Daewoo model) was launched in India, which is expected to consolidate the company's market share in India. As far as Telcon is concerned (engaged in engineering equipment manufacturing), Hitachi increased its stake in the company to 40% during the year. We expect very strong performance by Telcon over the next three years. The performance of HV Axles and HV Transmissions is influenced by Telco's performance (as key suppliers of components) and both these companies are ramping up capacities to meet demand going forward.

Superb show at the operating level: Despite raw material costs going up (not just steel) and many new model launches, Telco managed to maitain operating margins at the standalone level. This was owing to the company's cost savings initiatives. As compared to the budgeted cost savings of Rs 3 bn in FY06, the company managed to cut costs to the extent of Rs 4.7 bn, which is commendable. With raw material prices softening, we have a positive bias on the margins front. At the consolidated level, operating margins increased on account of the improved performance by the Korean subsidiary.

Consolidated results…
(Rs m) FY05 FY06 Change
Net sales 195,328 237,182 21.4%
Expenditure 170,363 206,643 21.3%
Operating profit (EBDITA) 24,966 30,539 22.3%
EBDITA margin (%) 14.3% 14.8%  
Other income 1,339 2,436 81.8%
Interest 1,697 2,460 45.0%
Depreciation 5,981 6,951 16.2%
Profit before tax 18,627 23,564 26.5%
Extraordinary item (184) (99) -46.1%
Tax 4,906 6,400 30.4%
Profit after tax 13,537 17,065 26.1%
Minority interest 85 223 162.9%
Profit from associated companies 401 439 9.5%
Net profit 13,853 17,281 24.7%
Net profit margin (%) 8.0% 8.4%  
No. of shares (m) 362 383  
Diluted earnings per share (Rs)   45.1  
Price to earnings ratio (x)   18.7  

Net profit lower than our estimates: While our standalone net profit estimates were in line with the company's performance, we were more optimistic about the company's ability to turnaround subsidiaries at the consolidated level. To that extent, the company's actual net profit was lower than our estimates. Nevertheless, as we had mentioned earlier, in the next three to five years, we expect the subsidiaries to drive earnings.

What to expect?
At Rs 844, the stock is trading at a price to earnings multiple of 18.7 times its FY06 earnings. If we take a three year view, while the company aims to save additional Rs 6.5 bn through restructuring at the domestic level, we believe that Telco's market share in the car segment will remain under pressure, which will partly compensate for the cost savings. While the company aims to outperform the CV industry in the future, the bus segment is likely to drive volumes. Currently, international business accounts for 16% of overall revenues, which the company expects to increase to 25% by FY10. Amidst these positive, we remain concerned about oil prices and interest rates going up. We will update the research report soon, with our view on the stock.

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