Tata Motors: Facing the Perfect Storm

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December 17, 2008 | SIN Picks | | Author Asif

The shocking terrorist attacks in Mumbai last month that targeted The Taj Mahal Palace hotel amongst various other locations were unlike any other India has experienced in recent years and deeply affected the psyche of a nation. These attacks are going to have a direct impact as well as indirect ramifications for the Tata group of companies. The Taj Mahal hotel belongs to the Indian Hotels Company (BSE: 500850), one of 96 operating companies that constitute the large Tata Sons conglomerate. The hotel not only suffered physical damage caused by the attacks but also from the negative spotlight thrust upon it on an international stage. These inhuman attacks painted a bleak picture of India’s ability to respond to an enemy that is agile and defies the normal rules of engagement. This video footage (some graphic images) of two cops, a shared rifle and a chair against an AK-47 shows just how inadequately prepared India is to respond to both domestic and international threats.

India is likely to see an increase in government spending on defense, intelligence and infrastructure in the months and years to come. The Tata Group of companies that manufacture everything from steel to military vehicles made by Tata Motors (TTM), will most likely benefit from an increase in defense spending, which is currently under 2% of annual GDP. However armored trucks and plans to develop a new platform for Land Rover to win defense orders are probably no more than a drop in Tata Motor’s $9.126 billion annual revenue bucket.

It has been over three years since we first covered Tata Motors (TTM) and a lot has changed both with the world as we know it and with India’s largest automobile company Tata Motors. Back then Tata Motors was a company with a strong balance sheet, double digit domestic and international sales, an exciting small car called the Nano under development and a rapidly growing economy  to service. In contrast the company experienced a 30% decline in overall sales this November when compared to November 2007, a 43% decline in exports, downward revisions of 2008-2009 Indian GDP growth forecasts of 7.5% and a balance sheet that had been riddled with a $1 billion bridge loan to fund the $2.3 billion purchase of Jaguar and Land Rover from Ford Motor (F).

According to the last annual report of Tata Motors, the company spent 64% more on R&D in 2007-2008 when compared to the previous fiscal year. Instead of contributing to revenue and the bottom line, the Nano is putting additional economic strain on Tata Motors. The company had to recently close down its new factory in the eastern state of West Bengal due to protests by farmers and open another in the opposite end of the country in the state of Gujarat (my home state).

With initiatives ranging from a partnership with French car company MDI to create a car that runs on compressed air, a potential partnership with Chrysler to build an electric version of its popular mini-truck called the Ace, integration of its recent acquisitions and the much anticipated launch of the Nano, Tata Motors may be stretching its resources too thin. Both Moody’s and Standard & Poor’s recently downgraded Tata Motor’s debt one notch and have a negative outlook on the company.

While it may look like Tata Motors is facing the perfect storm, the news is not all bad. The Jaguar unit of Ford was not profitable and when Tata Motors decided to acquire Jaguar and Land Rover from Ford, there were concerns about the profitability of the combined unit. Some media reports also suggested that the unit posted a loss of $383 million for the Jan 1, 2008 to June 1, 2008 period. According to this September press release by Tata Motors, Jaguar and Land Rover together delivered earnings before interest and taxes of $688 million in the first six months of 2008. Not only did Tata Motors acquire the two units for a fraction of what Ford paid for them, Ford also funded $600 million in retirement benefits as part of the deal. The redesigned visually stunning Jaguar XF helped push up Jaguar sales by 17% year-over-year in the July to September period.

Another concern amongst investors regarding Tata Motors during the summer and fall had to do with the impact of rising commodity costs on Tata Motors and the propensity of Indian consumers to secure a high interest auto loan. With real estate loans running north of 13% just a few months ago in India, the cost of owning a car once an automobile loan is factored in had increased significantly. A big drop in Tata Motors stock on account of these concerns and a voracious bear market in India that saw the BSE Sensex fall from 21,000 in January 2008 to a low of under 8,500 by November 2008, disrupted Tata Motors plan to convert the $1 billion bridge loan into equity financing through a rights issue. The rights issue was not well received because it was priced almost 28% higher than the price of Tata Motors on the exchanges. The unsubscribed portion of the offering was picked up by Tata Sons and other group companies like Tata Steel.

The Reserve Bank of India dropped its lending rate earlier this month to 6.5%, the third cut since October. With commodity prices off significantly from their summer highs and the cost of borrowing coming down, some of the challenges Tata Motors faced through most of 2008 have self-mitigated.

With operating margins of over 24%, the software services company Tata Consultancy Services (TCS) has been a profit machine for Tata Sons and became the first Indian IT company to reach $4.3 billion in annual revenues in 2007 as discussed in one of my blog posts about TCS.  While Tata Motors is suffering a short-term liquidity crunch, other companies in the group can step up to help Tata Motors in its time of need.

After booking a 64.99% profit in late 2007 on our original 2005 investment, buying back into Tata Motors in March 2008 was a mistake. However selling the position at this point would be bigger mistake as the stock has lost nearly 75% of its value year-to-date and the company is being priced for bankruptcy or a protracted downturn. The current dividend yield is a very juicy 8.1% but could be slashed or suspended to preserve much needed capital. With a viable core business and a promising pipeline of products, I view this setback as a buying opportunity for long-term patient investors and have been periodically buying the stock at these levels for my personal portfolios.

As always, please do your own due diligence and reach your own conclusions.

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