Identifying the Indian Apple-Part 12
Tata Motors is the cheapest auto stock in the BSE auto index and offers a 50% upside from its current market price of Rs 230. The downside risk to the stock is 25%. %. Investors can choose to buy now and suffer a downside risk if economies and markets worsen or can wait and buy on dips on hopes of the price falling before going up. It is better to buy at Rs 230 and take the downside risk for potential 50% gains.
In this issue of “Identifying the Indian Apple” series, as part of the focus on transport equipment sector, we will analyze Tata Motors, which is the cheapest stock in the BSE auto index.
The transport equipment market in India comprises of OEM’s (Original Equipment Manufacturers) and auto ancillaries. OEM’s include two, three and four wheeler manufacturers and also commercial vehicle manufacturers. Auto ancillary companies cater to both domestic and global OEM’s.
Tata Motors stands out as the cheapest stock in the BSE auto Index
It is ironical that the third largest passenger car maker in India and the owner of one of the most popular luxury cars in the world is trading at valuations lower than some of the auto ancillary companies. There must be a reason why Tata Motors is trading at such low valuations. One reason is that the markets believe that the debt level of the company is too high given its buyout of JLR (Jaguar Land Rover). The other reason is that the company is not doing too well in India, given a weak market and higher competition. The third reason is the market is mistakenly undervaluing the company on fears that may not turn out to come true. Let us look at the reasons one by one. Table 1. shows the forward valuations of stocks in the BSE Auto index. (Two wheeler stocks are not included, as they have been covered in the last issue of “Identifying the Indian Apple”.
Debt levels of Tata Motors
Tata Motors carries total debt of Rs 47,000 crores on its balance sheet. The debt was incurred when the company bought JLR from Ford in 2008 for USD 2.3 billion. Tata Motors had to pump in cash into JLR to make an unprofitable business into a profitable one.
Tata Motors debt in relation to its fy 2012 sales of Rs 165,000 crores is just at around 0.28% of sales. Interest as percentage of total income was at 1.8% for fy 12 and the company made cash profits of Rs 18,000 crores. EBITDA (earnings before interest, tax, depreciation and amortization) was at Rs 23,700 crores. Leaving aside cash levels of Rs 25,700 crores (cash can give a false sense of comfort) the company can easily service and repay its debt at current level of operations going forward. In fact debt levels have pushed up return on equity to 52% in 2012 from – 34% in 2009.
Debt is not an issue for Tata Motors at present and is in fact helping improve the return on equity (ROE).
Indian operations are under pressure
The Indian business of Tata Motors is under pressure as seen by the first quarter performance of financial year 2012-13. India sales fell 9%, EBITDA fell 24% and Profit After Tax fell 48% on a year on year basis. Indian operations as a percentage of total sales, EBIDTA and PAT were at jus 24%, 12% and 9% respectively.
Tata Motors is facing headwinds in India with passenger vehicle and commercial vehicle sales slowing down (below double digit levels for the first four months of fiscal 2012-13). The Indian economy is facing below trend growth on weak monsoons, sticky inflation and interest rates and weak global growth. GDP growth is expected to fall below 6.5% for 2012-13 against initial estimates of 7% and above.
Competition for Tata Motors is also rising with new entrants coming into the country. Volkswagen, Volvo and Nissan are amongst the new entrants who are giving existing players tough fight with world class products.
Indian operations are definitely a drag for the company and is accounting for part of the cheap valuations given by the market to Tata Motors.
Market is valuing Tata Motors on fear rather than facts
Tata Motors at its current market price of Rs 230 is trading at a market capitalization of 0.32x fy 2015 sales and at 3.7x 2015 EPS (Earnings Per Share). The growth assumption for Tata Motors is 14% three years CAGR (Compounded Annual Growth Rate) for sales and 12% CAGR for earnings. The first quarter of 2012-13 showed a 30% year on year sales growth and 16% growth in earnings. This sales and earnings growth is despite poor performance from its Indian operations.
JLR is driving Tata Motors. JLR contributes to 70% of sales and 70% of EBIDTA for Tata Motors. Tata Motors is expected to clock around 16% sales of JLR vehicles in 2012-13. The fact that JLR is growing at much better rate than Tata Motors domestic operations will help the company grow on a consolidate basis.
Markets are worried about the impact of a global economic slowdown on Tata Motors sales. However the fact that China’s volumes grew by 91% in the first quarter of 2012-13 and China’s accounts for 22% of JLR’s global sales is a good sign. China sales have clocked higher volumes despite its economy growing at three year low of 7.6% in the second quarter of 2012. The company is focusing on emerging markets for growth and will most probably achieve around 15% and above (market estimates, company estimates are higher at over 20%) sales for 2012-13 despite weak economic conditions globally.
Is Tata Motors a buy at Rs 230?
The stock at Rs 230 has a market capitalization of Rs 77,800 crores and is trading at a price earnings ratio of 5.2x fy 12 earnings. The market cap to sales ratio based on a three year forward basis is just 0.3 while the PE ratio on a three year forward basis is just 3.7x earnings. The stock is undervalued given its performance, especially in its JLR operations. A lot of pessimism is built in at the current market price.
The upside to the stock is in the form of listing of JLR globally, which will help the company pare its debts and pay for capital expenditure requirement for JLR, which is high. JLR has to pump in money to beef up old products, increase capacity and improve technology.
The downside to the stock is the competition for JLR from established deep pocketed majors such as BMW and Mercedes Benz. Weak economic outlook in the developed world (US, UK and Europe together contribute to over 55% of total volumes) is also a risk for JLR. The high capex requirement for JLR, estimates run into billions of pounds, is another risk for the company.
Net to net, the current valuations are too pessimistic and the company deserves better valuations. The risks are there but the company can tide over the risks and make it more profitable. JLR listing will help as will an improvement in performance in its Indian operation.
The upside to the stock is 50% while downside risk is around 25%. Investors can choose to buy now and suffer a downside risk if economies and markets worsen or can wait and buy on dips on hopes of the price falling before going up. It is better to buy at Rs 230 and take the downside risk for potential 50% gains.
In the next issue of Identifying the Indian Apple series we will look at the rest of the stocks in the BSE auto index.