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Tata Motors: Scores an 'Ace' - Views on News from Equitymaster
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Tata Motors: Scores an 'Ace'
Oct 25, 2005

Performance summary
Tata Motors (Telco), the market leader in the commercial vehicle segment, announced its results today. The company's performance during the year is not comparable owing to the merger of Tata Finance and other smaller subsidiaries with itself. The overall performance of the company during the first half has been mixed owing to slower growth in volumes sold. Profitability has been maintained more or less, both at the operating and at the net level.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 41,471 47,813 15.3% 77,211 86,594 12.2%
Expenditure 36,428 42,111 15.6% 68,141 76,088 11.7%
Operating profit (EBDITA) 5,043 5,702 13.1% 9,071 10,506 15.8%
EBDITA margin (%) 12.2% 11.9%   11.7% 12.1%  
Other income 706 580 -17.8% 1,118 1,163 4.0%
Interest (net) 398 461 15.7% 814 971 19.3%
Depreciation 1,068 1,272 19.1% 2,052 2,539 23.7%
Profit before tax 4,283 4,550 6.2% 7,324 8,160 11.4%
Extraordinary item (10) (10)   (10) (20)  
Tax 1,180 1,161 -1.6% 1,977 2,035 2.9%
Profit after tax/(loss) 3,093 3,379 9.2% 5,337 6,105 14.4%
Net profit margin (%) 7.5% 7.1%   6.9% 7.1%  
No. of shares (m) 362 362   362 362  
Diluted earnings per share (Rs)* 34 37   30 34  
Price to earnings ratio (x)         15.4  
(* annualised)            

What is the company's business?
Tata Motors (Telco) is India's largest commercial vehicle (CVs) manufacturer, with a domestic market share of 60% in FY05 and second largest producer of passenger vehicles (18% of domestic demand in FY05). Its plants are located at Pune, Jamshedpur and Lucknow. From a net loss of Rs 5 bn in FY01 to a profit of Rs 12 bn in FY05, the company has come a long way. It has 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. Similarly, company has also acquired a 21% stake in Hispano, a Spanish company, with an option to acquire the rest of the 79%.

What has driven performance in 2QFY06?
Staid volume growth: While the topline in 2QFY06 has grown by 15%, as we mentioned earlier, the merger of Tata Finance and other subsidiaries has distorted the performance. But if one analyses the volume growth during the quarter, while the total units sold in the domestic market grew by 6%, exports grew at a much faster pace of 132% YoY. While the new launches in the LCV segment (Tata Ace) has propelled volumes (47% of total CV volumes in 2QFY06 from 34% in 2QFY05), passenger car sales are lower by 4% in the domestic market. More importantly, the weakness in commercial vehicle (CV) sales is a cause of concern. Though we expected a significantly slower growth in CV sales in FY06 as compared to FY05, the decline is a surprise. But based on our interaction with the company, we believe that volumes are likely to gather steam in the second half. Looking beyond FY06, we expect the sector to grow at around 5% to 6% CAGR in the next three years. While export growth is higher, one has to remember that it is on a lower base and to that extent, the growth is magnified. Telco hopes to derive 25% of its consolidated revenues from international operations (current contribution estimated at around 18%) and the export performance has to be viewed in this context.

Segmental break up...
  Domestic Exports
(units) 2QFY05 2QFY06 change 2QFY05 2QFY06 change
M & HCV 30,515 29,053 -4.8% 1,622 1,876 15.7%
LCV 13,563 21,063 55.3% 3,214 5,981 86.1%
Total CVs 44,078 50,116 13.7% 4,836 7,857 62.5%
UVs 7,652 8,239 7.7% 857 761 -11.2%
Cars 37,515 36,163 -3.6% 639 6,068 849.6%
Total 89,245 94,518 5.9% 6,332 14,686 131.9%

Operating margins sustained: Even as raw material cost to sales is higher by 60 basis points, operating margins of the company is lower only by 30 basis points owing to lower amortisation of product development cost during the quarter. We have estimated improvement in margins in FY06 and beyond (though marginally) on the back of favourable input cost scenario (particularly steel). Also, we are confident of the company meeting its cost reduction programme in the next three years. In the long-term however, we would be comfortable lowering margins, given the increased competitiveness in the passenger car segment and additional promotional expenses.

Cost break-upů
(Rs m) 2QFY05 2QFY06 change 1HFY05 1HFY06 change
Raw materials 28,026 32,611 16.4% 51,354 57,733 12.4%
% sales 67.6% 68.2%   66.5% 66.7%  
Staff cost 2,590 2,742 5.9% 4,951 5,502 11.1%
% sales 6.2% 5.7%   6.4% 6.4%  
Other expenses 5,813 6,700 15.3% 11,836 12,795 8.1%
% sales 14.0% 14.0%   15.3% 14.8%  

Other income affects net profit: Even as operating profit grew at 13% YoY in 2QFY06, profit before tax growth was slower owing to higher interest expense and lower other income. It has to be remembered that other income in 2QFY05 included Rs 285 m as profit on sales of long-term investments, which is one-time in nature. If one were to exclude the same for comparison purpose, net profit growth is higher at 20% in 2QFY06. As compared to the standalone performance, we expect the consolidated profitability to grow at a much stronger rate driven by robust expansion plans of subsidiaries.

Over the last few quarters: The adjacent graph highlights the trend in operating and net margins over the last eleven quarters. After a noticeable improvement in FY04, both have stabilised and have hovered at the current level, even as input costs have shot up. This reflects the benefit of the company's cost restructuring initiative. We have a positive view on operating margins in the next one year for reasons mentioned earlier.

What to expect?
At Rs 521, the stock is trading at a price to earnings multiple of 10.1 times our estimated FY08 consolidated earnings. While we understand the fact that the industry is cyclical in nature, looking at select developing and developed markets, we believe that CV demand is likely to grow at 5% to 6% CAGR over the next three years. Also, we expect strong performance from subsidiaries going forward and there are value unlocking possibilities as well. We had last revisited Telco at Rs 432 in May 2005 with a target price of Rs 690 with a two to three year perspective. We maintain our view.

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