Tata Motors on JLR cruise

JLR continues to shine on improving margins, but rising raw material costs and interest rates could dampen India show.

Though the Tata Motors’ stock has corrected 12 per cent (in line with the markets) since end-December due to domestic macroeconomic headwinds, the company continues to impress with strong financials. The latter is backed by rising sales of its UK-based subsidiary Jaguar Land Rover (JLR), steady commercial vehicle numbers and strong cash flows.

Thanks to the turnaround in JLR’s performance, the stock has been the best performer in the large cap auto segment, with returns of 65 per cent since January 2010 compared to BSE Auto’s 22 per cent and a measly 8.36 per cent for the Sensex.
 

IMPROVING PROSPECTS
In Rs crore	FY10	FY11E	FY12E
Net sales	92,519	117,461	135,858
% chg y-o-y	30.40	27.00	15.70
Ebitda	8,614	16,509	18,672
% chg y-o-y	292	91.7	13.1
Adj. PAT	1,526	8,434	9,924
% chg y-o-y	LTP	452.70	17.70
P/E (x)	–	9.10	7.80
All figures are on consolidated basis                         LTP is Loss to profit Source: Analyst reports, Bloomberg

While the overall demand has been steady so far, the company is facing tough challenges on account of stiff competition in the domestic passenger vehicles segment and rising raw material costs at the operational level. Hardening interest rates and fuel costs could be dampeners, especially for the commercial vehicle (CV) purchases, which is almost entirely on credit.

Strong CV, JLR performance On the back of good volumes in the December quarter from the domestic CV segment (up 21 per cent year-on-year) and those of JLR (up 6 per cent), Tata Motors recorded a 22 per cent growth in its consolidated sales to Rs 31,685 crore. JLR sales were driven by a strong showing in China (72 per cent up, 11 per cent of overall sales), Russia (up 24 per cent) and North America (up 16 per cent). While supply constraints limited the growth of medium & heavy (M&H) CV sales (up 17.5 per cent), light commercial vehicle sales grew a healthy 24.5 per cent. Notably, the new emission norms for M&HCVs, which came into effect from October 1, 2010, has not had any significant impact on the sales unlike in the past, believes the management.

While rising interest rates are a major concern, the company believes the freight rates are healthy, which should support volume growth. So far, fleet operators seem to have the pricing power and have been able to pass on the multiple fuel price rise over the last quarter and this is reflected in the Indian Road Freight Rate Index, which is up 2.03 per cent in January 2011.

Rising competition 
The domestic passenger vehicle segment is a problem area, reporting a mere 5 per cent increase in volumes due to intensifying competition and inventory issues. While Tata Motors’ small-car segment (Nano, Indica) registered a drop of 8.2 per cent, the mid-size car segment (Indigo, Manza) grew 15 per cent. Tata Aria’s launch in October 2010 helped utility vehicle (UV) sales move up 45 per cent in the quarter.

With Nano available across the country from January 2011 (the small car had sales of 6,700 units in January 2011, PV segment grew a strong 14 per cent year-on-year), the company is hoping the car, which does not have any direct competition, will average 10,000 units a month and help it to regain part of the lost share. While the CV sales will be driven by the existing product line, volumes for JLR could see an uptick with the launch of Range Rover Evoque in the next five months.

Margin concerns
Earnings before interest, depreciation, tax and amortisation (Ebidta) margins for the consolidated entity grew yearly (340 basis points) as well as sequentially (70 bps) to 15.2 per cent on account of higher profitability at JLR, which registered its fifth straight quarter of higher profits. However, a rise in raw material costs dented margins, which fell from 12.9 per cent to 10.4 per cent at the standalone entity.

While volume growth, pricing power, a favourable product mix and lack of discounts helped to improve operating margins at JLR, price rise taken on October 1 for the standalone entity weren’t enough to neutralise the commodity inflation, especially in steel and rubber. The management believes the price rise taken on January 1, (1-1.5 per cent) should help to maintain margins at the current levels for the March 2011 quarter. Given the rising competition, the company is likely to focus on cutting costs rather than increase prices.

The consolidated entity reported a net profit of Rs 2,400 crore (80 per cent of which came from JLR) on the back of improving realisations, higher margins (up 760 basis points to 17.4 per cent) and favourable exchange rate movement. While the going so far has been good with JLR generating $400 million of cash profit every quarter, the company needs to sustain this (volume growth, profits) in the coming quarters. That’s because, any fall in revenues could peg back profits, given the annual capex and product development expenses estimated at $1-1.2 billion.

Valuations
Analysts have pegged the sum-of-the-parts valuations for Tata Motors’ standalone operations and its subsidiaries upwards of Rs 1,400-Rs 1,500, which points to upsides of 16-24 per cent from the current levels of Rs 1,209 over the next one year.