Tata Motors reported fiscal 2017 second-quarter earnings per share of Rs 2.42, a dramatic improvement from the year-ago loss per share of Rs 5.19. Even so, the stock closed 10% lower as the market was expecting Rs 8.59. Tata’s EPS result represented an eye-popping 70% miss.
The unfavorable swing in the British pound was the main driver behind the earnings shortfall, but declines in Indian medium and heavy commercial truck volume and a disappointing margin performance (excluding currency impact) from Jaguar Land Rover were also contributors.
We still view this 4-star-rated stock as attractively valued, currently trading at an 18% discount to our Rs 560 fair value estimate.
We continue to expect Tata Motors to benefit from demand recovery in its domestic market, in which light commercial vehicle units rose 12% and Tata passenger vehicle volume was 28% higher than the same period last year. However, it was disappointing to see medium and heavy commercial vehicle drop 16%, albeit on a difficult comparison in the year-ago period when volume catapulted 36%.
Second-quarter consolidated adjusted EBITDA margin (excluding currency impact and before special items) was 13.4%, versus an adjusted margin of 11.5% reported a year ago. While a nascent recovery is underway in India, and Tata volume has improved, the company's stand-alone EBITDA margin of 3.6% remains well below the historical high of 11.7% set in 2010.
- Fair Value: Rs 560
- Consider Buy: Rs 336
- Consider Sell: Rs 868
- Uncertainty: High
- Economic Moat: Narrow
- Stewardship Rating: Standard
- Growth in India: Tata Motors is the largest commercial vehicle manufacturer in India and gain from an upswing in government spending on infrastructure and the long-term growth potential for light commercial vehicles.
- Global Growth: Jaguar Land Rover will continue to achieve strong international growth. We expect emerging markets to provide significant opportunity.
Investment Thesis
Tata Motors benefits from substantial profitability and returns generated by its premium Jaguar and Land Rover brands. Since fiscal 2009, when Tata acquired the luxury automaker, JLR’s revenue has risen at a compound annual growth rate of 28%, with global volume growing 18%. Over the same period, JLR's EBITDA margin has averaged 12.2% but was 15.7% for fiscal 2016, owing to richer product and market mix driven by new model launches. This drove a respectable 14.5% return on invested capital in fiscal 2014, meaningfully surpassing our 8.5% cost of capital estimate.
Over the past 10 years, competitors have entered the Indian vehicle market and Tata's share has retreated to 13% from a peak of 28% in 2006. The decline is largely due to a drop in passenger vehicle market share. This was driven by Tata taking longer to introduce new models versus its peers, deregulation of diesel prices compromising its diesel range, new competitors entering a rapidly growing market (10% CAGR since 2003), and higher growth in motorcycle sales versus passenger car sales during a period of weak Indian economic conditions. Tata's commercial vehicle share has also declined, but the firm retains an industry-leading 55% of the medium and heavy commercial market. We think the government's $1 trillion infrastructure spending plan has boosted the commercial vehicle market and benefits Tata's India business.
In our view, Tata is positioned to gain from the continued growth in Indian automotive sales and the expansion of luxury markets in emerging economies, especially China. Still, the imperative remains for Tata to keep investing in new models across brands and vehicle platforms. The company also needs to improve on its ability to execute vehicles at world-class quality levels. Quality issues plagued the Nano model, and sales have disappointed. While improving, some JLR products still suffer from perceived poor quality. Growing industry overcapacity and domestic competition, along with capital-intensive operations and the industry's cyclicality, pose serious challenges to Tata's ability to consistently earn returns above its cost of capital.
