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Volume driven business - Views on News from Equitymaster
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  • Sep 30, 1999

    Volume driven business

      These are heady days for stockholders of Tata Engineering and Locomotive Company Limited (Telco). Their company is witnessing a boom in sales of commercial vehicles (CV), its bread and butter business. Its small car, Indica, has been a raving hit among the Indian masses. And, a mammoth restructuring exercise has been undertaken to convert the highly leveraged automobile company into an auto design and assembly major. The bottomline - the stock has gained 73 percent since 1st April 1999.

      Telco is India's largest CV manufacturer with a 65.5 percent market share in heavy commercial vehicles (HCVs), 63.7 percent share in light commercial vehicles (LCVs) and 26.2 percent share in utility vehicles. In the car segment, it has already staked claim to 6.5 percent of the market, within months of the launch of its maiden product.

      India's CV sector is recovering from one of its worst ever downturns. During this period, Telco's CV sales fell from a high of 167,051 units in FY97 to 92,254 units in FY99, a fall of over 44 percent. Given the highly leveraged nature of its operations, Telco was one of the worst hit companies in the sector. As a result, its profits fell from a high of Rs 7.63 bn to Rs 0.98 bn during the period.

      However, during this period, something very exciting was brewing at the company - its small car.

      Telco's small car, Indica, has generated the kind of enthusiasm that has never been witnessed before. While the masses admired it for being an 'Indian' product, the investors went gaga over the cost efficiency of the project - the total cost per car (approximately Rs 110,000 per car) was the lowest amongst all the new entrants in the Indian market. While other players, like Hyundai, were grappling to get orders for 10,000 cars, the Indica managed a fantastical 115,000. The company, which is operating at full capacity levels of 5,000 cars per month, has decided to start a second shift to meet demand. The interest in the product is apparent. However, the downside is that the car project will contribute to the bottomline only in FY02, once it achieves the breakeven volume of 100,000 vehicles. Moreover, with competition hotting up, margins are likely to be thinner than expected, thus prolonging the breakeven period.

      Telco's prospects, however, even for the near term, have improved dramatically. This is mainly due to a strong recovery in the demand for HCVs, which between April and July 1999 grew by 53 percent (YoY). Telco's sales of HCVs jumped 64.4 percent during the same period. Despite all the enthusiasm about its car, Telco will continue to make a bulk of its profits from its CVs division.

      Another reason for the increased interest in the company's stock is due to the restructuring exercise that has been initiated by the management. As part of this exercise, Telco has already hived off its construction equipment division into a separate company. It further plans to spin off its engine, machine tool, transmission, forge shop and foundries divisions into joint ventures with global leaders, generating free cash flows to the tune of Rs 15 bn. This inflow of funds will help in reducing its debt burden, beefing up its research and development (design) facilities as well as its assembly operations. As a consequence of this move, the company is expected to dramatically improve its bottomline and also the quality of its products in order to meet the Euro II emission norms (some already do).

      However, concerns remain. The company has been consistently losing market share in the utility segment to arch rival Mahindra & Mahindra. Also, demand for LCVs continues to languish, stroking fears of a short lived economic recovery. Finally, if fears of a sub normal monsoon were to be confirmed, the company could once again plunge into a crisis in which it has to grapple with lower volumes and still lower margins.

      Sentiment, however, continues to be cheerful. The market buzz has now shifted to how the company's 'midi' car, which is still in the development stage, is going to revolutionise the mid car segment.

      While new product launches keep the market sentiment upbeat, a vibrant CV sector will ensure that the company's bottomline does not fail to cheer investors.



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