Ram Prasad Sahu Trying times ahead for Tata Motors as it grapples with a large acquisition and a slew of new product launches in a tough macroeconomic environment. Slackening of demand, rising input costs and higher interest rates are not welcome news for the country's largest automobile player, Tata Motors. To maintain its margins, the company was forced to increase prices of its commercial and passenger vehicles over the last five months. In the middle of a massive Rs 10,000 crore expansion plan, a Rs 9,500 crore buyout of Jaguar Land Rover (JLR) and a slew of product launches including the much awaited Nano, the automaker has a mountain to climb. While the JLR acquisition and launch of new products in the domestic market (expected in the second half of this fiscal) have de-risked its product portfolio and will help it to expand its reach over the long term, the short term outlook is rather unappetising. Cost dampener With steel prices moving up nearly 30 per cent from January 2008 to about Rs 40,000 per tonne, there is pressure on suppliers to raise prices of steel that accounts for a majority of input cost of automobiles. Higher prices have meant that the company has had to increase prices in the range of 3-4 per cent on some of its products. With further hikes in the prices of steel imminent over the next couple of weeks, the company will have to look at increasing its prices by about five per cent or absorb part of the costs. With slowing down of industrial growth and high interest rates, a likely drop in sales in the monsoon months, the company will have to balance the need for improving volumes, but at the same time protect its margins. Its success, however, depends on the profitability of its customers. Says Rishab Bagaria, analyst, Pioneer Intermediaries, "With availability of freight robust and freight rates stabilising, higher operational costs have not affected truckers yet." The Tata Motors management believes that demand in the near term could be under pressure due to restrained vehicle finance availability, lower industrial and economic activity and high interest rates. To crank up volumes, the company is likely to give discounts and increase its vehicle finance portfolio, which it manages through its subsidiary, Tata Motors Finance, Tata Finance and on its own books. While the last five months of the FY09 could see a recovery, the near term outlook does not seem too bright. Says Vaishali Jajoo, analyst at Angel Broking, "Rising steel prices means that the company may see a 100-150 bps pressure on its margins over the coming two quarters." While the company may not be able to pass on the entire hike in input costs, increasing volumes on the back on new product launches and discounts will help it to absorb part of the increasing costs. Strength in numbers? Sales of its passenger and commercial vehicles at 5.82 lakh units for FY08 were flat year-on-year (y-o-y). While commercial vehicles sales were up five per cent on the back of improving LCV and bus numbers, it was the passenger vehicles (PV) which put the brakes on volume growth for FY08. Sales in the PV segment were down nearly 5.5 per cent, while the PV industry clocked over 11 per cent growth y-o-y. Due to increasing demand from state transport corporations, bus volumes are robust; it is the truck volumes that are causing the company some concern. A spurt in diesel prices has only added to its misery, as it increases the cost of operations for truckers. Analysts however believe that despite marginal or a flat volume growth in M&HCVs, the sales shift from a 12 tonne capacity to over 25 tonne capacity will result in higher realisations and push up revenues. Says an analyst, "The expected price hikes and product mix is likely to boost sales. The company might be able to maintain 10 per cent EBIDTA margins due to sales of higher tonnage vehicles." Analysts believe that the LCV and bus segments are likely to grow by double digits, while trucks are likely to grow only by single digits in the current fiscal. If FY09 is a problem year for the company due to macroeconomic factors, FY10 will bring with it increasing competition. While the company is expected to hold its own, its stranglehold on the commercial vehicles market with shares of over 60 per cent might be a thing of the past. It will have to contend with competition across segments of its commercial vehicle portfolio due to joint ventures of M&M and ITEC (Rs 2,500 crore investment), Daimler Hero JV (Rs 4,000 crore) and Volvo Eicher JV (over Rs 1,000 crore), which is likely to more than double CV capacity. This is in addition to the Nissan-Ashok Leyland JV for LCVs at an investment of Rs 2,400 crore. While these investments and greenfield ventures will bear fruit a year from now, will new products be able to boost sales for Tata Motors in FY09? Nano and more The company is gearing up to launch several new products/variants both in commercial and passenger vehicles. The Rs 10,000 crore expansion plan includes the launch of 100 new products/variants, streamlining of existing production facilities and setting up four new greenfield units. The four new greenfield units are at Dharwad (Karnataka) in a bus manufacturing JV with Marcopolo (Capacity: 1.5 lakh), Pantnagar (Uttaranchal) to manufacture Ace family of products, Singur (West Bengal) with a capacity of 2.5 lakh units to manufacture the Nano and at Ranjangaon in a JV with Fiat with a capacity of 1 lakh cars and 2.5 lakh units of engines and transmission equipment. Among commercial vehicles, it will launch variants of the Ace, new buses, the World Truck and defence vehicles. On the passenger vehicles side, in addition to the Nano, Tata Motors will launch the new avatars of the Indica and the Indigo. The attention, however, will be the people's car (Nano). Analysts believe that the most optimistic estimate for FY09 would be sales of 30,000 units. With low margins and at these volumes, the launch will not alter its numbers significantly in the current fiscal. Higher volumes and upturn in CV sales could, however, push up sales significantly in FY10. The JLR impact In addition to three manufacturing plants, two design centres, worldwide marketing network and intellectual property and combined sales of three lakh units, the JLR acquisition gives Tata Motors access to two premium brands and product areas it was not present earlier. While the Land Rover will be a fit over the Tata Motors' UV/SUV/crossover offerings in the premium 4x4 (four wheel drive) category and Tata Motors can use the technology to upgrade its SUVs, Jaguar sports cars target the premium end of the car segment and synergies here are less evident. The benefits for JLR are access to emerging markets through Tata Motors and the possibility of low cost outsourcing. While JLR will have to spruce up its sales against more fancied opponents such as BMW, Mercedes and Audi, which are selling over a million units each, the biggest challenge for JLR according to analysts is to meet the CO2 emission norms of the European Union. Bringing down emissions to about 120 gm/km from 250 gm/km in four years and looking at alternative technologies such as hybrid and fuel cell is going to be tough. While analysts believe that Tata Motors has got a good deal in terms of valuations, execution in terms of product innovation and market expansion is a key risk. Questions the company will have to tackle are the component and engine supply arrangements, funding for the annual $700 million R&D budget, which the company needs to roll out new products and meet emission norms, and the pension deficit. The Tata Motors management says that it has entered into long-term arrangements for the supply of parts. The $700 million investments that Tata Motors will have to pump in every year into JLR, is also a concern. While Tata Motors will raise debt and equity to fund the acquisition and short term capital requirements and will be sitting on a comfortable debt- equity ratio of 1 post equity dilution, further fund requirements from JLR could put a strain on its balance sheet. Tata Motors, however, believes that JLR's products, marketing and cost reduction measures would enable it to be a self-sustaining outfit. The pension deficit, analysts argue, is likely to aggravate given the state of the equity markets. Ford had to cough up $600 million to make good the deficit as part of the deal with Tata Motors. The next valuation date has been fixed for April 2009. On the operational front, the JLR management is confident that improving numbers coupled with good demand in emerging markets such as China and Russia, in which the company has a strong customer base, will result in sales growth. JLR has seen its numbers improve with sales moving up by 50 per cent to $15 billion over the last five years, while its gross profit margins improved from 12 per cent in CY05 to about 18 per cent in CY2007. Its EBIDT has turned positive in CY 2007 at $620 million after negative EBIDTA in 2005 and 2006 at $1.9 billion and $2.1 billion, respectively. For the latest quarter (Q1CY08), the company notched up sales of $410 million though these numbers were inflated on account of dealer stocking of the Jaguar XF prior to its launch in March and non-cash adjustments. Hence, one will have to track the JLR numbers for the next two quarters to get a handle on sustainability of performance. With key product launches in the pipeline, what would be the impact on Tata Motors' consolidated numbers? Subsidiary boost Strong performance by its six subsidiaries helped Tata Motors maintain its profitability for FY08. While standalone EBIDTA was down 6.6 per cent y-o-y, consolidated EBIDTA was up 7 per cent. The going has been good so far, but future revenues and earnings will be driven by JLR and new products from the Tata Motors stable. While JLR's operational parameters are likely to improve over time, what it brings is size in revenues and will contribute over 63 per cent of the combined Tata Motors estimated turnover for FY09 at over Rs 100,000 crore. To part fund JLR's acquisition, Tata Motors is coming out with three unlinked simultaneous rights issue of Rs 7,200 crore and this is likely to lead to an equity dilution of about 45 per cent. At the current price of Rs 488, the stock is available at 9 times its fully diluted estimated FY09 consolidated EPS of Rs 56. While these valuations are not expensive, investors are better off waiting till December to gauge JLR's progress towards profitability and performance of Tata Motors' core CV business before committing their investments in this stock.