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Auto: Who’s cashing in?

Nov 19, 2004

With product lifecycles shrinking and an extremely demanding consumer to cater to, auto majors all across the world are facing great strain on their financial resources. On the one hand, while aggressive price wars has meant that growth in topline will be hard to come by, the race to bring out contemporary models on the other hand, is forcing companies to pump more cash back into operations. But where is this cash going to come from? Rudimentary finance tells us that you either tap the capital market or sweat your assets more so that you generate more cash from your operations. With the former option fraught with the risk of sending your capital structure haywire, little wonder that companies and investors alike pay so much of attention to that all important criteria of cash from operations.

The scene is no different in India as well. As demand for four-wheeler grows and as competition intensifies, companies will have to pump out more cash from their operations. Infact, already in the passenger car arena, new models have become the order of the day and the Indian companies have been pitted against multinationals with deep pockets. In such a scenario, do they possess enough financial resources? Moreover, among the many companies that are vying for investor’s money, which one would be the most suited from a long-term? Although definite answers to both these questions cannot be given, one can at least make a small judgment by looking into the cash flow patterns of these companies over the last 3 years.

The table below shows cash from operations (after accounting for working capital changes) that four leading auto companies have generated over the last three years.

Cash from operations (A) (Rs m) FY02 FY03 FY04 Total
Ashok Leyland 4,166 4,372 4,185 12,723
M&M 4,792 5,131 8,629 18,552
Maruti 8,015 (688) 18,303 25,630
Tata Motors 2,714 14,158 21,139 38,012
Revenues (B) (Rs m) FY02 FY03 FY04 Total
Ashok Leyland 26,966 31,257 39,796 98,019
M&M 38,865 44,526 58,292 141,684
Maruti 70,677 72,535 93,456 236,668
Tata Motors 75,027 90,977 132,232 298,236
(A/B) FY02 FY03 FY04 Total
Ashok Leyland 15.4% 14.0% 10.5% 13.0%
M&M 12.3% 11.5% 14.8% 13.1%
Maruti 11.3% -0.9% 19.6% 10.8%
Tata Motors 3.6% 15.6% 16.0% 12.7%

As is evident from the table below, while Ashok Leyland has generated higher cash from operations vis-à-vis its revenues over a three-year period, it is the decline in the third year that has raised concerns. More so due to the fact that the year was one of the best for the four-wheeler industry in a long time and all the other three players witnessed their best performance in this year. While a one year too short-term to judge a company’s performance, the fact that Ashok Leyland’s balance sheet size is much smaller to archrival Tata Motors will not hold it in good stead over the longer term unless it improves its market share considerably.

Tata Motors, on the other hand, had a small hiccup in FY02 on account of teething problems of its passenger car division but has recovered smartly since then. It has generated enough cash in the remaining two years to keep its expansion plans afloat. Apart from robustness in CV sales, passenger car division also delivered a stellar performance and as a consequence cash from operation registered a sharp rise. Having said that, the importance of the CV division to the overall cash flows cannot be understated.

M&M, the other auto company that is dependent on more than one segment has the best overall cash flows relative to its revenues over the three-year period. This is despite the fact that the tractor sales had remained rather subdued for the first two years. However, its success largely revolved around ‘Scorpio’ its offering in the UV segment and hence unless the company comes out with similar successful offerings, strength in cash flows is likely to diminish going forward. Besides, the robust cash flow is also on account of reduction in debtor days, which increased between FY01-FY02 in light of higher credit sales of tractors.

FY04 saw the sales of passenger cars jump by a strong 30% over previous year and not surprisingly, Maruti, which accounts for more than half of all the passenger cars sold in the country, came into its own and generated its best cash flows ever. But as FY03 showed, the company is vulnerable to slowdown in the auto industry and hence, prone to occasional hiccups. But the company does possess one of the widest range of models to choose from and with car demand in the country expected to grow at a robust pace, the company with its strong cash flows is likely to take the maximum advantage of it.

Having looked at the cash flow patterns of the four auto companies, it is clear that company that derives its revenues from more than one segment is relatively better placed than other companies. However, in both the cases, the success largely revolved around just one segment, HCVs in the case of Tata Motors and UVs (read Scorpio) in the case of M&M. Therefore, should one place faith in the product development abilities of auto companies or invest in a company that is dependent on one segment or one market but does have a wide range of models to choose from?

The decision depends on the risk profile of the investors. Buying auto stocks tend to be very rewarding when the industry is in doldrums. During these periods, one can buy a mix of both (i.e. one segment company and a multi-segment auto company). But during the peak or close to the peak, one would be better off by investing in a diversified product company.

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