On Indian Wheels

10 mins. to read
On Indian Wheels

Sticking with my Indian theme, I’d like to make the case for a global automotive powerhouse that combines Western technology and branding with Eastern management and ambition. And it’s not often that you get the chance to back British manufacturing with an option on the recovery of a vast Asian market. I’m talking about Tata Motors.

You can either buy Tata’s Motors shares on the Mumbai Stock Exchange (BOM:500570) or the (Indian) National Stock Exchange (NSE:TATAMOTORS), which is also located in Mumbai, denominated, of course, in Indian Rupees. Or, you can buy their US Dollar denominated ADRs on the New York market (NYSE:TTM).

But why invest in motor cars? Isn’t this a horribly 20th Century sector? A mature market; capital intensive; an environmental threat; a technological dead-end.

Not so. The global automotive industry is at an inflexion point which offers huge opportunities.

First, production technology has improved massively in recent years thanks to robots, CAD-CAM and the rest. This facilitates enhanced customisation (cars of different colours, engine sizes and specification share the same production line). And it has also reduced unit costs in real terms.

Second, thanks to better engine technology and materials, cars are becoming cleaner, more fuel efficient, and safer. Fatality rates on the roads have been falling globally, though there are still shocking discrepancies between developed and developing countries.

Third, manufacturers have worked with component suppliers to design cars to be more easily recyclable when they are scrapped.

Fourth, alternative fuel technology is gaining momentum, though perhaps slower than expected. Hybrid cars now comprise a significant market segment in Japan, though in India they are still marginal.

Fifth, self-driving cars, while still science fiction for most of us, are in an advanced stage of development. We are assured that the main technological challenges have already been resolved – it’s the legal and behavioural issues that still need to be overcome. (I must admit that, on my recent trip to India, most cars seemed that they were self-driving – though I didn’t witness any prangs at all!).

And sixth, fundamentally, the global market for new cars is still growing; even though the market is mature in the technical sense that most purchases are in order to replace an existing model. According to a KPMG report[i] published earlier this year, global vehicle sales will pass the emblematic 100 million unit mark by 2017 and will continue to rise until the end of this decade.

Most of this increasing demand is coming from large emerging markets, especially China, India and Brazil. China’s car market overtook that of the USA in 2009, growing at an average of 14% over the last five years, though last year growth was down to a mere 10% – at nearly 23.5 million units per annum.

And let’s not forget that the USA is still a huge car market where growth has been robust of late. The UK market has also been resurgent.

On the production side, China is by far the biggest player with over 22 million units, whereas India and Brazil are comparative laggards, with around 3.8 million cars produced each per annum.

Now the global automotive industry is highly concentrated. There are only 30 groups worldwide which manufacture more than 500,000 cars per year; and though there may be some further consolidation, the existing order is not likely to be overturned. KPMG predicted that the top 10 manufacturers will still all be from the developed economies in 2020. And German manufacturers will continue to dominate at the premium end. The main changes in market position that KPMG envisaged in the near-term were threefold.

First, KPMG predicted that Volkswagen would steal the number one mass market spot from Toyota during 2016. Recent events may have put that call in doubt.

Second, they predicted that India’s Tata Motors will continue to rise up the league – not just because it produces budget cars for Asian markets, but because it has positioned itself as a manufacturer of quality cars and SUVs through its strategic acquisition of the UK’s Jaguar Land Rover (JLR) in 2008.

Third, Hyundai’s continued rise in market share was predicted to stall.

Now Tata Motors is a conglomerate within a conglomerate, being part of the massive Tata Group, which was founded as long ago as 1868 by the great Jamsetji Tata as a trading company. The Group now controls 32 listed companies (plus many more private ones) which had a combined market capitalisation last year of more than US$140 billion. Activities range across steel, telecommunications, chemicals, automotive, consumer products, services, hotels and much more. Note that 58% of the group’s revenues are generated outside India.

Jamsetji Tata came from Mumbai’s Parsi Zoroastrian community. Originally from Persia (Iran), the Parses migrated to Western India in the 10th century, escaping persecution. Under British rule they contributed to the growth of Mumbai as India’s pre-eminent financial and commercial hub. A wealthy and talented minority community renowned for their philanthropy, they have always looked beyond India for cultural inspiration and commercial opportunity. Famous Parses include the eminent conductor Zubin Mehta and the legendary singer Freddie Mercury.

In India, Tata’s name is everywhere. Indians are born in Tata hospitals, live in apartments girded with Tata steel and cook with electricity supplied by Tata Power. Their highways throng with Tata trucks.

Tata Group’s current supremo, Cyrus P Mistry (not a member of the Tata family, but a fellow Parsi), is also Chairman of Tata Motors Limited. Dr Ralph Speth, the German CEO of JLR, sits on the Tata Motors board.

Founded in 1944, Tata Motors is India’s largest automobile company, with consolidated total revenues of nearly US$39 billion last year and a current market capitalisation of around US$20 billion. With over 66,500 employees worldwide, it’s a regional leader in commercial vehicles and a global player in passenger vehicles, with leading products across all segments.

Within India, Tata Motors is the dominant player in commercial vehicles. Last year, Tata Motors sold 432,600 commercial vehicles – that’s a market share within India of 54.1%. But its 587,946 passenger vehicles sales accounted for just 5.8% of the Indian car market. Now add the 429,861 vehicles sold by JLR last year (of which 79,307 Jaguars and 350,554 Land Rovers). In 2013 it ranked 19[ii] out of the 30 automotive majors by production volume.

Present in 175 countries, Tata Motors’ cars, buses and trucks are marketed worldwide. The company has six manufacturing bases in India as well as in the UK (JLR in Solihull and Wolverhampton), South Korea (Tata Daewoo), Thailand, South Africa and Indonesia.

Tata Motors’ leading edge in research and development, not least in engine technology is evident. Last year, they launched the lightweight, fuel-efficient REVOTRON 1.2T, a turbocharged intercooled fuel injection petrol engine[iii] for the Indian market. Tata Motors employs over 4,500 technicians at its Engineering Research Centre in India, established in 1966. R&D centres are located in India, South Korea, Italy, and the UK. In March this year, Tata Motors opened the National Automotive Innovation Centre at the University of Warwick.

Tata Motors is now emerging from a difficult period in the domestic Indian car market. Over 2013-14, it fell to fourth place behind Maruti-Suzuki, Hyundai and Mahindra. This was partly due to a contraction in demand and partly due to Tata’s focus on the small car segment like the award-winning Tata Nano, as against the more rapidly growing SUV segment[iv]. This has now been addressed with the launch of the Vista, a premium hatchback and the Zest, a compact-sized sedan. These classy models display renewed commitment to comfort and aesthetics and appeal to India’s growing middle class.

The domestic Indian car market was subdued last year by rising inflation and high interest rates, as finance companies tightened lending criteria. But the entire economic weather has brightened since the election of the pro-business Modi government in May 2014.

JLR is, dare one say, the Jewel in the Crown. Last year, more than 80% of Tata Motors’ revenues were generated by JLR, and over 100% of its profits. Without JLR, Tata Motors would have lost money. And while the Indian domestic business is recovering, JLR is soaring.

JLR, of course, manufactures out of the UK, though it has established a production facility in China where it manufactures the Land Rover Evoque. It also has plans to manufacture in Brazil. And it is building a new engine plant for Jaguar cars at Wolverhampton. Under Tata’s stewardship, JLR spent US$2.2 billion on R&D last year. New models, like Land Rover’s Discovery XXV Special Edition, the Jaguar XE sports saloon and Jaguar’s F-Type Coupé range, continue to impress. Tata’s reputation for taking a long-term perspective seems to be paying off at JLR.

Partly thanks to new models, JLR posted record unit sales over the year to 30 September. On 14 October JLR reported September 2015 retail sales of 47,634 vehicles (10,394 Jaguars and 37,240 Land Rovers), up 3% from a record September 2014 performance. In fact, the company sold 349,412 vehicles in the first nine months of 2015.

JLR’s regional performance year-to-date shows 21% growth in Europe, 18% in North America and 15% in the UK, with Overseas down 12%. In fact, sales in China are down 29% this year!

Unfortunately, JLR had an estimated 5,800 vehicles stored at the port of Tianjin at the time of the explosion and fire last August. Many of these vehicles were destroyed or damaged. There is thus likely to be an exceptional charge for Q2 FY2016.

On the basis of most recent figures, Tata Motors’ consolidated sales are down slightly this year though net earnings and EPS are up. Recent squalls in China have not helped, despite the improvement of conditions in its core market, India.

The automotive industry is sensitive to a downturn in the global economy overall, especially at the luxury end. It is fiercely competitive and vulnerable to supply chain disruptions. However, the environment is currently favourable. The global economy is still growing, with consumer confidence improving.

Be aware that Tata Motors’ ownership structure is complex. Currently 42.66% of its shares are held by Tata family and Group entities, 48.1% by Indian and foreign institutions, and just 9.33% by private investors (Indian and foreign). 21.25% of the shares are held in the form of ADRs on the New York market. Each ADR represents five underlying shares.

There are two share classes: Ordinary (one vote per share) and Ordinary Shares with Differential Voting Rights (one vote for every ten shares)[v]. You can assume that shares available to non-Indians have reduced voting rights.

The ADRs are probably the more cautious option. However, for those who can stomach the additional FX risk, the one year Sterling-Rupee chart shows the Rupee trading fairly stably between 92 and 105 to the Pound.

How have the shares/ADRs performed? Not great this year. The ADR price hit US$50 in early February but is now down to around US$29 with the current price-earnings ratio of 8.8 looking modest. What happened?

First, the Bombay index fell from grace after all-time-highs in January. Second, conglomerate risk kicked in. Many analysts believe that the market over-reacted to the poor reception of the new Tata Nano on the Indian domestic car market this summer – even though that model represents a tiny fraction of the company’s global sales, 80% or more of which, remember, are generated by JLR.

Tata Motors is well placed to benefit from both the huge potential of India’s growing domestic car market and the growth in demand for SUVs and luxury cars (JLR) in the developed world. But this is not for the faint-hearted investor. You need to believe in India Inc. – a theme to which I shall return soon.

If ever Tata were to spin off JLR and list it separately in London we would see that Tata and JLR shares would respond very differently to domestic Indian news flow. In the meantime, you can regard this stock as a kind of hedged exposure to the global automotive market.

[i] KPMG Global Automotive Executive Survey, 2015.

[ii] World Motor Vehicle Production: World Ranking of Manufacturers Year 2013

[iii] Annual Report, 2013-2014, page 23/218.

[iv] http://www.ft.com/cms/s/0/0b6f9226-9adf-11e2-b982-00144feabdc0.html#axzz3RFEMCp8Y

[v] See : http://www.tatamotors.com/investors/shareholder-information/shareholding-pattern.php#

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