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Telco: Robust profit growth

Oct 30, 2002

Tata Engineering (Telco) has posted an impressive performance for the second quarter ended September 2002. Backed by a robust growth in commercial vehicle sales (CVs) and increase in market share in the passenger car segment, both revenues and operating profits have vaulted significantly in 2QFY03 as well in 1HFY03. Operating profits in 1HFY03 have more than doubled.

(Rs m)2QFY022QFY03Change1HFY021HFY03Change
Sales 17,238 21,612 25.4% 31,461 39,090 24.2%
Other Income 137 40 -70.9% 204 109 -46.3%
Expenditure 15,685 18,842 20.1% 28,546 34,248 20.0%
Operating Profit (EBDIT) 1,304 2,770 112.5% 2,343 4,842 106.7%
Operating Profit Margin (%)7.6%12.8%7.4%12.4%
Interest 1,115 831 -25.4% 2,235 1,689 -24.4%
Depreciation 852 900 5.6% 1,747 1,795 2.8%
Profit before Tax (526) 1,079 - (1,435) 1,468 -
Extraordinary item (93) - - (173) - -
Tax - 491 45.5% - 599 -
Profit after Tax/(Loss) (618) 588 - (1,607) 868 -
Net profit margin (%)-3.6%2.7%-5.1%2.2%
No. of Shares (m) 255.9 319.8 255.9 319.8
Earnings per share (Rs)* (9.7) 7.4 (12.6) 5.4
P/E (x) 24.9
(*annualised)

If one were to look at the performance of the company on a quarterly basis, the rise in CV sales has been the single biggest contributor to both volumes and profitability for the company in 2QFY03. The sharp spurt in CV demand is primarily led by recovery in the industrial sector in the current fiscal and higher food grain output in FY02. Our interaction with the company indicates that Telco's market share has increased in 1HFY03 backed by success of new models in the higher tonnage CV segment. With road infrastructure gradually improving, demand for multi-axle vehicles are also on the rise due to economies of scale in operations. Railways are clearly losing competitiveness on account of better road network. The average running cost for a multi-axle vehicle is around Rs 1.2 per km/tonne, which is in line with Railways. This is reflected in hardening of freight rates. Freight rates increased by 10% in 1QFY03 while it was higher by 4% in 2QFY03 thus fuelling growth in CV demand. Telco's CV sales increased by 32% to 32,279 units in 1HFY03.

Telco in 1HFY03...
(Nos)1QFY032QFY031HFY03
M&HCVs 15,254 17,025 32,279
% YoY change49.5%19.7%32.2%
LCVs 7,337 8,651 15,988
% YoY change26.0%22.8%24.2%
UVs 6,744 5,960 12,704
% YoY change8.1%-1.4%3.4%
Cars 11,623 23,536 35,159
% YoY change-9.7%58.8%27.0%
Total unit sales 40,958 55,172 96,130
% YoY change16.6%30.9%24.4%
Source: Company website and our estimates

On the passenger car front, there was slack in volume sales in 1QFY03 due to shut down of the plant for aligning its assembly function for the manufacture of 'Indigo' (the Sedan version that is set for a launch in 4QFY03). However, the company has been able to ramp up production to meet order book and incremental demand in 2QFY03. Car sales (including exports) were higher by 59% to 23,536 units in 2QFY03. The company has extended its market share in the passenger car segment to 23% in 1HFY03 as compared to around 21% in FY02. The company's concerted effort to boost exports has resulting in unit sales touching 607 units in 1HFY03 as compared to just 100 odd units in the same period last year. It needs to be mentioned that exports do not contribute significantly to profitability but adds to the company's visibility abroad.

Telco has also been able to capitalise on the recovery in LCV demand that was led by recovery in consumer durable sector. The numbers are also inflated due to year-on-year effect to a certain extent. On the utility vehicle front, the company has an aged product portfolio and has been losing market share due to competition from Toyota and M&M. However, market share per se has consolidated at 21% levels, according to our estimates.

On the operational front, there has been a marked improvement and is in line our estimates for FY03. This was led by increased capacity utilisation, lower raw material costs, tightening of working capital and savings in employee related expenses. Telco's workforce has reduced by more than 14,000 in the last five years. Raw material costs as a percentage of sales has fallen from 63% in 2QFY02 to 60% in 2QFY03. We expect the company to post operating margins in the range of 12% for FY03.

Interest costs have declined in 1HFY03 sharply on the back of accelerated debt repayment following increased cash flow from operations, which are estimated at Rs 12.3 bn in FY03. Since the rights issue in FY02, Telco has repaid debts to the tune of Rs 5.6 bn till September 2002. Thanks to the ongoing restructuring exercise and revival in CV demand, Telco has posted a net profit of Rs 868 m in 1HFY03 as against a net loss in the same period last year.

The stock currently trades at Rs 135 implying a P/E multiple of 12.8x FY03E earnings. While the company's performance in 1HFY03 is commendable, growth prospects for the remaining quarters are challenging on two counts. For one, as mentioned above, growth in freight rates and volume growth for Telco has declined in 2QFY03 in light of hike in diesel prices and slowdown in the economy. With agricultural output expected to fall in FY03, one will not be surprised if freight rates start weakening from the current levels, thus affecting CV demand in 2HFY03 and in FY04. Also, with increased competition in the passenger car segment, there could be downward pressure on prices in the coming months. So one has to exercise caution for the company's car division. Having said that, we remain optimistic on Telco's growth prospect in the CV segment in the long run.

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