Tata Motors: BUY. Tata Motors: Switching to the fast lane

The Tata Motors stock has dropped by over one-third since our earlier recommendation in April this year at ₹535.

Disappointing results in both the March 2015 and June 2015 quarters and concerns over China, a major market for Jaguar Land Rover (JLR), have contributed to the pessimism. But the challenges are short term.

For one, JLR volumes in the coming quarters are expected to get a leg-up from the many launches lined up. Secondly, having begun local production in China under a joint venture recently, the company is faced with some teething issues. But this is expected to be resolved in the next two to three quarters.

Besides, with domestic commercial vehicle and passenger car sales looking up, the outlook for the India business too is promising. Hence, investors with a perspective of at least one to two years can use the fall in price as an opportunity to buy the stock.

The stock now trades at a reasonable PE of 10 times its trailing 12-month consolidated earnings and about seven times its estimated earnings for 2015-16. This is in line with its historic average.

Tata Motors has posted lacklustre results in the last two quarters. For the quarter ended March 2015, consolidated profits dropped by 56 per cent to ₹1,717 crore over March 2014. In the latest June 2015 quarter, consolidated net profits halved to ₹2,769 crore compared with the same period in 2014.

Among other reasons that affected the consolidated numbers are unfavourable forex movements at JLR and weak JLR volume growth. Retail volume growth for JLR vehicles at best remained flat in both these periods compared with the corresponding previous quarters.

Poor offtake in China was a big contributor to the lacklustre volumes. In the last two quarters, China volumes have shrunk to about 19 per cent of JLR’s global sales compared with 24-28 per cent a year ago.

The general economic slowdown in China was only a part of the reason for the run down performance. JLR’s sharp volume drop in China was due to teething problems in its joint venture for local production there.

Slow ramp-up in the production of Ranger Rover Evoque at this plant and lower imports of the newly-launched Discover Sport — in view of the plans to shortly begin its local production — affected volume growth. Running out of the older XF and XJ in view of the expected launch of the newer models didn’t help either.

But China is expected to do better in the months to come, as local production is ramped up.

Secondly, in view of the economic slowdown in China, the company has also made some price corrections for the Evoque and realigned prices of the Jaguar XE, which is to be introduced shortly in China.

JLR is also rejigging its marketing and sales organisation in China to push up sales. While the low capacity utilisation, price corrections and marketing efforts may exert pressure on the margin in the near term, higher operating leverage, as the ramp-up happens, and improved sales will help mitigate the margin dilution to an extent.

JLR’s volumes in China and in the rest of the geographies will receive a boost from upcoming launches as well; the new Jaguar XF, the new Range Rover Evoque and the refreshed Jaguar XJ will be introduced shortly.

The new XE was also launched in many markets only in May 2015 and is yet to see a full quarter of sales. Apart from the China factor, marketing efforts towards these launches all over the globe may dent margin a bit in the next one or two quarters.

But higher realisations from the better product mix as a result of launches will help mitigate the impact. JLR’s operating margin now stands at about 16-17 per cent. With the domestic auto industry reviving, Tata Motors is on a strong wicket in its India operations. At the standalone level (Indian operations), the company turned EBITDA positive in the March 2015 quarter, after five quarters in the red. The good run has continued into the June 2015 quarter as well.

The company’s domestic medium and heavy commercial sales grew 21 per cent in the June 2015 quarter over the same period last year. Aided by launches such as the Zest, Bolt and the Gen X Nano, its passenger vehicle volumes grew 27 per cent. Lower inflation and interest rates, along with a pick-up in the economy, is expected to aid domestic auto sales in the months to come.