Tata Motors - "A trade-off between domestic margins and global volumes" ::LKP

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Domestic business disappoints, while JLR saves the game again

Tata Motors consolidated sales was up by 26% yoy in Q2 FY12, led by strong sales performance on the JLR business. JLR volumes grew by 23.3% yoy to 68000 units, while EBITDA margins were at 14.92%a decline of 170 bps yoy. Standalone sales were up by 13% yoy and 9% qoq, as volumes grew by 4%, driven by LCV segment as PV segment continued to decline.Consolidated margins came in at 12.5% while standalone margins sunk to 7.2%, lowest in the recent past. Adverse product mix, high RM costs, higher incentives on the PV side, declining PV business and  few price hikes led to margins in domestic business to fall. In the quarter, the company incurred forex losses to the tune of Rs4390mn, in totality out of which Rs 2490mn came in the domestic business.This was due to adverse GBP/$ and INR/$ movements. Excluding these losses, adjusted standalone PAT was down by just 8% yoy and flattish qoq, while consolidated adjusted PAT was up 10.6% yoy.

JLR volumes to remain buoyant on Evoque and emerging economies

JLR sold ~130,000 units in the first half of the year driven by China and other developing countries like Brazil, Russia and Middle East. Contribution from China has gone up from 9.7% in Q2 FY11 to 16% in Q2 FY12 and the absolute volumes have doubled in the same period. With the launch of Evoque which has still order bookings close to 20,000 has started showing its impact in the volumes of JLR (wholesale volumes of 7772 units in Q2). With Evoque expected to form 15-20% of volumes in FY13E, we expect a strong growth in JLR volumes going forward. Traction happening in the emerging markets and steady performance in the US will be able to offset any weakness in the European continent and UK. Application of smaller diesel engines in Jaguar vehicles will also lead to volume improvement, for e.g. Jaguar XF model launched in July is receiving a good response. We expect JLR to report 269K units in FY12E and 303K in F 2013E.

Domestic LCV volumes to remain strong while PVs may continue to disappoint

On the domestic front, CV sales are expected to hold up in the rest of the year as well. In difficult operating environment especially in South India, MHCV sales were up 5% in H1 FY12, while LCV sales were up by 23% in the same period. Going forward, we expect MHCV sales to hold up on issues in South Indian markets getting resolved. On the LCV front, the demand for Tata Ace family is expected to remain robust.Increasing capacities for Tata Ace at Dharwad facility will keep pace with the rising demand for the model.However, with macro environment getting worsened for PV industry, Tata Motors with a relatively aged and a weak product portfolio will continue to underperform. This may pull down the domestic volumes. Nano also has been unsuccessful and is not meeting company’s expectations. We expect MHCV/LCV/PV to grow by 6.5%/16%/-12.1% in FY 12E and 7%/12%/9.5% in FY 13E respectively.

Domestic margins to be a drag on the stock

Deceleration of domestic margins to 7.2% may not be the bottoming out of domestic margins as indicated by the management. Higher raw material costs, higher incentives on PVs and lower utilization of PV capacities have resulted in such margins.Going forward, management has cautioned us for pressure on domestic margin performance. We believe that Tata Motors cannot improve the PV capacity utilization rates as PV demand is expected to report a negative growth this year. Some positive impact of RM costs softening may be seen in the ensuing quarters, but they won’t be enough if there is absence of operating leverage from PVs. Ramp up of capacities on LCV side at Dharwad will also support margins as capacity utilization goes up (Ace manufacturing facilities function at more than 100% capacity utilization).

On JLR side, rising Evoque volumes may spoil the product mix, but, China which is having extremely high realizations may take care of that. Also, Evoque will be priced differentially depending upon the geographies and may not result into the expected margin distortion. Higher utilization of capacities with growing volumes will offer operating leverage. Hence, we are maintaining our margins on JLR business at 13.7%/14.3% in FY 12E/FY 13E. Due to the concerns at domestic business, we are slightly cutting down our margin estimates in domestic markets to 8.3%/8.5% in FY 12E/13E. Hence, our consol margins now lie at 11.7%/12.2% respectively for FY 12E/FY 13E post cutting them by 60/40 bps respectively.

Outlook and valuation

Though we have cut our margin estimates for domestic business, we are maintaining the same for JLR and are estimating higher volume growth for JLR. The net impact of this has led us to increase our target price for Tata Motors to Rs 195, from our previous target of Rs172, which got achieved recently. However, from current levels of Rs181, we see a limited upside of 8%. We arrive at our target price by deriving a value of Rs 84 for domestic business, Rs131 for JLR and Rs19 for other subsidiaries .