Is Tata Motors nearing its bottom?

Tata Motors, India’s largest automaker, is trading at nearly half the price it was only six months ago. On a valuation basis, the stock now trades at 7.7 times its expected FY16 profit numbers, against 24.1 times for car major Maruti Suzuki and 22.6 times for Ashok Leyland, its main competitor in the commercial vehicle segment.

So does it make sense to buy Tata Motors at current levels, given the huge valuation gap with its peers? Nearly 68% of the analysts who track the company say that the stock is a buy, while 8% feel it is a hold and only 24% say it is a sell. But most of the analysts who have a buy now are those who had the same recommendation at the peak of Rs 612 in late January 2015.

A few, however, have changed their stance on the company, the latest being Deutsche Bank. Its report downgraded the stock to a ‘Hold’ based on a greater-than-expected delay in China volume ramp-up (down 33% year-to-date) for Jaguar Land Rover (JLR), likely deterioration in profitability of ex-China markets (US incentives up 50-100 basis points Y-o-Y in July/August), and faster-than-expected model mix deterioration.

Most of the reports on the company are basing their investment rationale on the performance of JLR, as though Indian operations no longer matter. To a large extent, though, it is true as Indian operations have been a drain on its financials, while JLR is in a commanding position on the revenue and margins front.

In FY15, Tata Motors’ JLR operation accounted for 80% of the total revenue, with the remainder coming from all other businesses. At the earnings before interest and tax (EBIT) level, the domestic business incurred a loss, burning a 9% hole in JLR’s profit. However, analysts are hopeful that selectively the domestic business will do well.

Its medium and heavy commercial vehicle business has seen a 16.5% growth in FY15. But that is the only division in domestic market that has done well. Motilal Oswal in its ‘Buy’ report on the company pointed out that the Light Commercial Vehicle (LCV) division which grew at a CAGR (compounded annual growth rate) of 25% till FY13 has fallen by a CAGR of 26% between FY13 and FY15. Tata Motors has lost market share from 62% in FY08 to only 39% in FY15. Motilal Oswal report says that M&M has gained from Tata Motors loss.

The worst performing division is the passenger vehicle segment which operated at a capacity utilisation of only 25 per cent in FY15. Analysts are hopeful that the division will pick up, given the spate of new launches. The company plans to launch two new models every year till 2020. But if the performance of recent launches is any indication, then Tata Motors may need to rethink that business.

The two new supposedly ‘game changer’ models of the company ‘Zest’ and ‘Bolt’ came and went without being noticed. In more than an year of its launch, only 1,458 Zest have been sold, while a mere 433 Bolts have been driven out of showrooms in the six months of its existence.

It is the passenger vehicle business that has not picked up since its initial days of Indigo and Indica. The Tata Motor brand in passenger vehicle needs a big makeover if the division has to make a meaningful contribution to the overall company.

Capital employed in Tata Motors’ domestic business utilises Rs 43,437.64 crore, while the JLR business uses Rs 69,900.25 crore. With 38% of capital employed not providing much return, will the argument again shift to listing its JLR unit to unlock value for its shareholders?

But here too there seems to be a problem, for the time being. Analysts have been comparing JLR’s numbers with those of other European global automobile players like Audi, BMW and Mercedes. Most of the auto majors have been hit by the slowdown in Europe and China. All of these companies are trading at single digit valuation. Their fortunes are largely depended on a revival in China, Europe and the USA.

For Tata Motors, recovery in the Indian economy will not have much of an impact on its performance; it will have to wait for the world economy to pick up. That’s the price of being a global major.

So when should one buy Tata Motors? According to the Motilal Oswal report, the low valuation of the company based on 12-month trailing profits is still near the median level; its minimum price-to-earnings level reached in mid-2011 was 4.3. If global economies, especially China, do not pick up soon, it might test that level again.