Nitin Agrawal Moneycontrol Research
Tata Motors (TTMT) reported extremely disappointing set of numbers for the quarter ended June, marred by higher raw material prices, meagre growth in volumes, higher incentives, and higher foreign exchange (FX) hedge losses. However, reasonable valuations, growth prospects of JLR (Jaguar Land Rover) and the Tata Group’s top management’s focus on domestic business revival warrant investors' attention. Albeit short-term gyrations, we believe that the long-term outlook is positive for the business.
Quarterly result snapshot
JLR posted a meagre volume growth of 3.1 percent (YoY) on the back of lower wholesale volumes. The EBITDA margin was down by 460 bps (YoY) due to higher variable marketing expenses (particularly in the US) and material and operating costs.
On the domestic business front, volumes were down by 13.5 percent (YoY) on account of weak M&HCV (medium & heavy commercial vehicles) volumes that were down 34.8 percent. New launches partially shielded the impact.
Adding to the woes, the company had to absorb foreign exchange hedges losses to the tune of GBP 454 million. However, the management guided that this should reduce going forward.
Why do we still see long-term value in the business? JLR remains strong for long-term Since the acquisition of JLR in 2008, it has posted healthy volume growth of 14 percent (CAGR) over FY08-17, mainly driven by Land Rover. The phenomenal growth came in as the company penetrated into the Chinese market that eventually became the largest market for JLR.
JLR continues to grow volumes at a brisk pace. In FY17, it witnessed a 10 percent growth in wholesale volume riding primarily on strong demand for newly launched Jaguar F-PACE and continued buyers interest for the Land Rover Discovery Sport. Looking at the regional demand, China led the pack with 30 percent growth followed by North America (21 percent). Retail volumes also posted healthy growth of 16 percent.
Strong product pipeline JLR has a strong product pipeline and new launches will strengthen its volume growth. New launches such as Discovery, I-pace and Velar will keep the momentum in volume. This is evident from the waiting period of two months for the new Discovery and three months for Velar.
The company is also focusing on electric vehicles. JLR is planning to launch its first PHEV (Plug-in Hybrid EV) by the end of the calendar year 2017, first BEV (Battery EV) in 2018 and targeting electrification option for at least half of its existing product portfolio.
Turnaround of domestic business TTMT’s market share in commercial vehicle fell to 44.4 percent in FY17 from 59.4 percent in FY12. Over this period, its share in passenger vehicles declined to 5.2 percent from 13.1 percent. The domestic business is in dire need of revival.
The management, in annual report of 2016-17 clearly spelt out that the company needs to work on reviving its domestic business and mentioned that the management is working to improve market share, reduce cost and launch of products on time.
TTMT's Managing Director indicated that the turnaround plan is finalized through which he expects to achieve robust improvement in the bottom-line.
Recent launches in passenger car segment have been received well by the market and we believe that it should continue to do well on the back of a strong product pipeline.
Aggressive capex plan TTMT has earmarked Rs 400 billion towards capacity expansion, technology and new products in FY18. While this will result in negative free cash flow (FCF) in the short-term, the company considers this investment to be important in order to regain its market share in the CV (commercial vehicle) business along with gaining market share in PV (passenger vehicle) business.
Undemanding valuation Based on our Sum-of-the-Parts (SOTP) valuation, we see that while most of the value is coming from the JLR business, improvement in the India business too will be an added kicker.
Our SOTP valuation indicates that the market is assigning an implied EV/EBITDA multiple of 3.3 times (based on FY19 estimates) to the JLR business. However, most of the global players in the same category trade at an average multiple of 4 times. We expect JLR to command a slight premium, on the back of a slew of new launches, focus on energy-efficient products and strong position in the Chinese market. Assigning a multiple of 4.25 times gives us the value of JLR business which is higher than the other parts of TTMT put together. Thus, JLR will continue to remain the biggest value driver for the company.
Our estimates indicate that the stock is currently undervalued by close to 23 percent. We advise investors with a long-term investment horizon to capitalize on the current weakness to build long positions on the premise of growth in JLR business and a probable turnaround in the domestic operations.
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