Tata Motors Ltd, or TML, is very much in the news recently.
It closed some blocks at its Pune plant. The Jamshedpur unit will go for a third closure this month from today. It went for a day closure on August 1, followed by three block closures from August 8-10. Though the closure from August 16 will reportedly be for two days, it may last for four, according to DNA.
Rating agency CRISIL downgraded the rating of TML to AA- from AA, on weakening of outlook on the business risk profile of Jaguar Land Rover, or JLR.
After posting losses in the December quarter, it returned to profit in the March quarter, but slipped into the red again in the quarter ended June 30, 2019 – Rs 3,680 crores.
TML is India's largest commercial truck producer and owner of the JLR brands. The JLR brands have fallen on hard times due to increased spending for electrified powertrains and autonomous technologies plus a substantial decline in China demand.
Morningstar’s senior equity analyst RICHARD HILGERT shares his views.
- TML Motors is positioned to gain from the continued growth in Indian automotive sales and the expansion of luxury markets in emerging economies, especially China.
- The imperative remains for TML to keep investing in new models across brands and vehicle platforms. The Tata brand also needs to improve on its ability to execute vehicles at world-class quality levels.
- Some JLR products 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.
- A rough road lied ahead but the shares of TML represent compelling value for long-term investors relative to our expectations for cash flow and returns on invested capital.
- Moat: Narrow
- Stewardship Rating: Standard
TML's narrow economic moat rating is driven by the strength and global recognition of its JLR brands. Brand strength enables premium pricing that results in solid margins and healthy economic profits.
Given capital intensity and lengthy product life cycles that a new startup would endure, it is more probable than not that Tata would maintain economic profitability for 10 years. Despite recent JLR losses, the brand still enjoys premium pricing benefiting from its intangible asset moat source. However, for a mass-production luxury automotive brand, it is much more difficult to make the same claim about a 20-year period, during which, as management teams come and go and product turnover opens the possibility of a string of missteps, as is currently the case, the probability rises that the brand could destroy economic value for a period.
Luxury, ultraluxury, and exotic brand automakers do not necessarily have an economic moat just because of brand strength and premium pricing. Even though Bentley (owned by Volkswagen) is globally recognized as an ultraluxury brand that commands a commensurate price, the automaker has experienced inconsistent volume and revenue growth, poor margin performance, profit volatility, and erratic economic profits during the past 10 years.
In contrast, over the same time frame, wide-moat-rated exotic sports carmaker Ferrari has generated stable, consistent revenue growth, wide profit margins, and high returns corresponding with other wide-moat-rated stocks like Hermes, Richemont, and Vuitton. The main difference between the two is Ferrari’s rich Formula One racing heritage and its ability to leverage this heritage with the regular development and sale to select clientele of ultra-exclusive, multi-million-dollar, limited-edition (and sometimes completely unique one-offs), exotic super and hyper cars.
While brands in these segments command high prices and are often purchased to make a personal statement, consumers can still easily switch to one of many competing products. Premium and luxury vehicle consumers can readily choose from brands like Acura, Alfa Romeo, Audi, BMW, Cadillac, Infiniti, Jaguar, Land Rover, Lexus, Lincoln, Mercedes, and Porsche. Ultra-luxury and exotic brands include Aston Martin, Bentley, Bugatti, Ferrari, Koenigsegg, Lamborghini, Maserati (which is shifting to a lower-price higher-volume strategy), McLaren, Pagani, and Rolls-Royce. These vehicle consumers have the financial wherewithal to simply add more cars to their personal fleet if they so desire.
However, based on JLR's ability to price above mass-market models due to its brand strength, we think the luxury brands make a substantial contribution toward building TML’s consolidated economic moat. Using just JLR financials, we estimate that over the past nine years, brand strength has enabled the group to average 6 percentage points of economic profit over an estimated 9.4% weighted average cost of capital.
With new facilities in China, Slovakia, and Brazil, Jaguar Land Rover will have a manufacturing presence in the world's top seven automobile markets.
Global volume growth in luxury segment vehicles is bolstered by an increasing population of upper-middle-class as well as roughly 15 million high-net-worth individuals with investable assets of $1 million or higher. We expect 1%-3% average annual growth in overall global automotive demand, but because of the increase in the world’s wealthy population, we think luxury vehicle segment demand will grow at average annual rate in excess of 3%. We believe JLR will continue to roll out new products that sustain its luxury brand image and premium pricing, supporting our narrow economic moat rating.
On a consolidated basis, TML has generated returns higher than its cost of capital in 8 of the past 10 years. Average 10-year historical economic profit is 6 percentage points above cost of capital. During seven of those years, excess returns were greater than 5%. Tata acquired JLR during its fiscal 2009 in June 2008. Fiscal 2009 and 2010 were the two years in which Tata’s consolidated results did not show an economic profit. In our view, this is an outstanding performance for an automotive manufacturer.
TML's domestic mass-market passenger vehicle and its commercial vehicle operations enjoy substantial growth potential and a low-cost manufacturing base.
The low-cost advantage enjoyed by its Indian business is driven by low labor costs and the local tax structure that favors domestic manufacturers.
Global automobile manufacturers face a steep import duty in India ranging from 60% to 200% based on the price tag which, when coupled with insurance and domestic inland tax of 20%-30%, makes their products an unattractive option for domestic buyers. More than 40% depreciation in the Indian rupee over the past few years has further raised the prices for imported automobiles for the domestic market. This provides a competitive advantage to domestic manufacturers, including Tata Motors.
More global automobile manufacturers may choose to set up manufacturing plants or assembly lines in India, which could give them a level playing field versus domestic manufacturers. Still, it takes at least two years to select a site, apply for government permits, receive various approvals, build a plant, and start vehicle production. Also, immediate market acceptance is not guaranteed and usually requires more than one model.
Tata's efforts to export its small car Nano to Asian countries supports favorable operating leverage in its low-cost India manufacturing base.
Given the time it takes for competitors to establish a presence, and because Tata is already well positioned to benefit from volume growth, we think the company will enjoy a moat from its cost advantage for at least 10 years.
