Tata Motors 1

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TATA MOTORS Equity Valuation

BAVFS Term ReportIMT- NAGPUR (2009-11)

Name:

Karan Vyas 2009159

Kunal Jain 2009161

Maheep Singh Sangari 2009163

Mansi Walunje 2009164

Mukul Mathur 2009166

Nimit Sharma 2009169

Padamnabham S. Tiwari 2009173

Parth Agnihotri 2009174

N.A.V. Raviratnakar 2009182

Prachir Gupta - 2009185

Section: C2DE

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conclusion that the current share price is undervalued and it has sufficient potential to move

upwards and reach its intrinsic value. Hence, Tata Motors is a good buy for today.

Product Profile:

Industry Analysis:

The automobile industry has always been a barometer for the economic strength of a nation.

It is therefore not surprising that this sector was amongst the worst-hit industrial sectors

during the period of this global meltdown. By contrast, the automotive sector in Asia

experienced growth. China and India were the main drivers of this growth. The domestic car

markets of China and India have remained exceptionally buoyant. The Indian automobile

industry posted a spectacular growth of 32%, powered by improving economic environment,

gradual dissipation of job & business uncertainty, new offerings and good consumer spending

in urban and rural India. Indias economy is expected to accelerate to 9 per cent on strong

consumer demand, a better farm output and global recovery.

Competitive industry scenario:

Monopolistic Competition:

Indias automobile sector is primarily catered by few players namely Maruti Suzuki, Ford,

Hyundai, Honda, Mahindra & Mahindra, Ford, GM, Toyota and Tata. The reasons for few

players in the market are as follows:

A large number of firms,

Products (Automobiles) are differentiated and not seen as perfect substitutes by

consumers,

There is some ability of sellers to set prices as they wish,

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There is free entry to and exit from the market,

There is a heavy reliance on non-price actions to differentiate one's product.

Portors Five forces Model:

Michael Porter identified five forces that influence an industry. These forces are:

Degree of Rivalry: despite the high concentration ratio seen in the automotive sector,

rivalry in the Indian Auto Sector in intense due to the entry of the foreign companies

in the market. The industry rivalry is very high with any product being matched by

the competitors in a few months.

Threat of substitutes: The threat of substitute to the automotive industry is fairly

mild. Numerous other forms are available, but none offer the utility, convenience,

independence and value offered by automobiles. The switching cost associated with

using a different mode of transportation, may be high in terms of personal time,

convenience and utility.

Barriers to entry: The barriers to enter automotive industry are substantial. For a new

company, the start up capital required to establish a manufacturing capacity to achieve

a minimum efficient scale is prohibitive. Although entry to new companies are

substantial, but established companies can enter the market easily by partnership or

JVs with existing automobile company.

Suppliers power: In the relationship between the Industry and the suppliers, the

power axis is tipped in industrys favour. The industry is comprised of powerful

buyers who are generally able to dictate their terms to the suppliers.

Buyers power: In the relationship between the Industry and the ultimate consumers,

the power axis is tipped in consumers favour. This is due to the fairly standardized

nature and the low switching costs associated with selecting from the competing

brands.

TATA Motorss Operation:

Tata Motors posted record consolidated net revenues and profits of Rs. 92,519 crores

($19,376 million) and Rs. 2,571 crores ($538 million) respectively during the current year.

The Companys domestic sales in India for cars and commercial vehicles were 633,862 units

a growth of 34.1%. The sale of Passenger vehicles alone increased by 25.3% to 260,020

units

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Key Strengths of TATA Motors:

Low Cost Producers:

TATA Motors are known for producing low cost economical cars, the most recent and best

example of it could be TATA Nano. One of the major components needed in an automobile

issteelwhich is supplied by the subsidiary of TATA (TATA Steel) which helps in reducing

cost to a major extent. The other factor for this low cost production can be the cheap labour

which they have with them and most of the other raw material they buy in bulk which givesthem economies of scale and hence low cost.

Product Mix:

Tata Motors-owned Jaguar and Land Rover's (JLR) EBITDA margins improved substantially

in Q1FY11 to 15.4% (up 410bps sequentially) supported largely by currency gains

(appreciation of USD v/s GBP), change in product-mix favouring high-end models and

advantageous change in geographical-mix. While some of these factors are likely to stabilize

or even reverse going forward, we expect margins to stay robust on account of better

realisations, improved capacity utilisation levels and continued cost cutting measures.

Today and beyond:

The shift of the Nano manufacturing facilities from Singur in West Bengal to Sanand in

Gujarat has been completed. The new plant in Sanand, Gujarat, has become operational in a

record 14 months time and while this new facility will initially produce 250,000 Nanos per

annum, it will have the capability to expand to 500,000 units per annum. In the interim, Nano

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deliveries had been executed from the Companys facilities in Uttaranchal. The new Sanand

plant will now make it possible to derive scale and optimization of manufacturing processes.

The Nano has been selling extremely well and continues to evoke unprecedented customer

interest across the country.

ACCOUNTING ANALYSIS:

RISK FACTORS ANALYSIS

The following risk factors should be considered to identify red flags when analyzing financial

statements of TATA Motors

(A) Depreciation of Property Plant and Equipment

Companies in the auto components industry are fixed asset intensive, making depreciation a

significant expense for most of these companies.

TATA Motors seems to be providing sufficient depreciation on par with industry standards

without any incidence of extension in reasonable useful lives of assets.

Concern: Companies can boost earnings by extending the depreciable lives of PP&E beyond

their reasonable useful lives.

Indicators: (1) Footnote disclosure of change in depreciable lives of PP&E. (2) Longer

depreciable lives for PP&E than competitors (3) Decline in depreciation expense relative to

gross PP&E.

(B) Inventory Accounting and Analysis

Inventory represents one of the most substantial assets on the balance sheets of automobile

companies and is a leading indicator of financial condition.

At TATA Motors inventories are valued at the lower of cost and net realizable value. Cost of

raw materials and consumables are ascertained on a moving weighted average / monthly

moving weighted average basis, except for Jaguar and Land Rover which is on FIFO basis.

Cost, including variable and fixed overheads, are allocated to work-in-progress and stock-in-

trade determined on full absorption cost basis. Net realizable value is estimated selling price

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in the ordinary course of business less estimated cost of completion and selling expenses. (An

IFRS standard)

Concern: Companies can use inventory accounting to manipulate margins. Rising inventories

are a sign of a business slowdown.

Indicators: (1) Rising inventory levels relative to cost of sales. (2) Changes in inventory

accounting policies.

(C) Provisions for Credit Losses on Receivables

Companies rely upon estimates to calculate the appropriate provision and allowance for

doubtful accounts related to potentially uncollectible accounts receivable.

TATA Motors seems to be providing fully for all the doubtful debtors categorized not

good. Since the information related to age, etc. are not provided being classified, so our

opinion is based on the facts given in the annual reports.

Concern: Companies can overstate earnings by inadequately reserving for potentially

uncollectible receivables.

Indicators: (1) Decline in credit loss expense relative to actual credit losses. (2) A decline in

the provision for credit losses, especially when there does not appear to be an increase in

receivables quality.

(D) Restructuring and Other Special Charges

No restructuring or other such special charges are given in the annual reports, so no concerns

will be present on this account.

Concern: Companies can use one-time charges to manage pro-forma earnings.

Indicators: (1) Recurring and/or significant special charges, adjustments to previous one-time

charges, inclusion of operating costs in restructuring charges.

(E) Warranties

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Companies in the automobile industry generally provide a warranty on their vehicles. The

warranty reserve that a company accrues is an estimate that is generally based on past

warranty claims experience, an assessment of product quality versus prior periods, current

claims, production changes, industry developments and other considerations. As warranties

are generally accrued for each product sold, the level of warranty expense should not

fluctuate greatly versus sales.

Provision for warranty has declined from previous years amount at Jaguar Land Rover

business. Provision for residual risk has been reversed to a large extent (`439.20 crores),

which decreases the overall liability. This liability has arisen due to the acquisition of Jaguar

Land Rover, but decrease to such an extent is alarming. Total provision for warranty has

increased since the last years.

Concern: Since warranty expense is based on estimated future claims, a company can manage

earnings by manipulating future claims estimates.

Indicators: (1) Large reversals of warranties accrued in prior periods. (2) Decline in warranty

expense relative to actual warranty claims paid. (3) Changes in warranty expense as a

percentage of sales and/or decline in warranty reserve relative to sales.

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SIGNIFICANT ACCOUNTING POLICIES

Revenue recognition

The Company recognizes revenue on the sale of products, net of discounts, when the

products are delivered to the dealer / customer or when delivered to the carrier for export

sales, which is when risks and rewards of ownership pass to the dealer / customer.

Sales include income from:

services,

transfer of technology relating to automotive products,

exchange fluctuations relating to export receivables,

export and other recurring and non-recurring incentives from the Government at the

national and state levels

Revenue from sale of vehicles with guaranteed repurchase option / repurchase arrangement:

At the time of sale, the proceeds are recorded as deferred revenue in current liabilities and the

cost of the vehicles are recorded as inventories. The difference between the proceeds and the

guaranteed repurchase amount is recognized in Sales over the term of the arrangement, usinga straight-line method. The difference between the cost of the vehicle and the estimated

auction value is netted off against revenue over the term of the lease.

Revenue from software consultancy on time and materials contracts is recognized based on

certification of time sheet and billed to clients as per the terms of specific contracts.

Dividend from investments is recognized when the right to receive the payment is established

and when no significant uncertainty as to measurability or collectability exists.

Interest income is recognized on the time basis determined by the amount outstanding and the

rate applicable and where no significant uncertainty as to measurability or collectability

exists.

Depreciation and Amortization

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Depreciation is provided on straight line method basis (SLM) over the estimated useful lives

of the assets.

Leasehold Land amortized over the period of the lease

Factory Building 20 to 40 years

Plant and Equipment 9 to 30 years

Computers 3 to 6 years

Vehicles 3 to 10 years

Furniture and Fixtures 3 to 20 years

Technical know-how 2 to 10 years

Developed Technologies 10 years

Software 1 to 8 years

Special tools are amortized on a straight line basis over the lives of the model concerned,

which is 7 to 10 years Capital assets, the ownership of which does not vest with the

Company, other than leased assets, are depreciated over the estimated period of their utility

or five years, whichever is less.

Fixed Assets

Fixed assets are stated at cost of acquisition or construction less accumulated

depreciation / amortization

The product development cost incurred on new vehicle platform, engines,

transmission and new products are recognized as fixed assets

Software not exceeding ` 25,000 and product development costs relating to minor

product enhancements, facelifts and upgrades are charged off to the Profit and Loss

Account as and when incurred

Leases

Finance lease

Assets acquired under finance leases are recognized at the lower of the fair value of the

leased assets at inception and the present value of minimum lease payments.

Operating Lease

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(i) Long term investments are stated at cost less other than temporary diminution in value, if

any.

(ii) Investment in associate companies are accounted as per the Equity method, and

accordingly, the share of post- acquisition reserves of each of the associate companies has

been added to / deducted from the cost of investments.

(iii) Current investments are stated at lower of cost and fair value. Fair value of investments

in mutual funds is determined on a portfolio basis.

Issue expenses / Redemption premium / discount on Foreign Currency Convertible Notes

(FCCN) / Convertible Alternative Reference Securities (CARS) / Non-Convertible

Debentures (NCD)

Issue expenses and premium payable on redemption of FCCN / CARS / NCD as per the

terms of issue, is provided fully in the year of issue by adjusting against the Securities

Premium Account (SPA). Any change in the premium payable, consequent to conversion or

exchange fluctuations is adjusted to the SPA. Discount on redemption of FCCN, if any, will

be recognized on redemption.

Borrowing costs

Fees towards structuring / arrangements and underwriting and other incidental costs incurred

in connection with borrowings are amortized over the period of the loan.

GLOBAL STANDARDS

Inventory:

If one issue has many automotive companies holding IFRS at arms length, its LIFO. Under

U.S. GAAP, companies can apply LIFO rules to their inventory balances. In periods of risingcommodity prices, this accounting method leads to higher recognized costs of sales, and thus

reduces taxable income. However, LIFO accounting is not allowed under IFRS, so companies

will need to recast recorded inventory balances under either weighted average or FIFO rules

for financial reporting purposes.

Research and Development:

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U.S. GAAP requires all costs related to research and development be expensed as incurred,

with few exceptions. IFRS differentiates between researches and development costs,

with development costs capitalized when the technical and economic feasibility of a project

can be demonstrated and further prescribed conditions are satisfy.

FINANCIAL ANALYSIS

Financials of the company have been analysed using ratio analysis technique and key ratios

indicate good financial health of the company. The cash flow analysis also suggests good

cash generated from operations and financing activities. Cash flow from investing activities is

negative, that implies high investment in procurement of assets and hence better utilisation of

funds generated in the other two. The company is having healthy profitability ratios,

turnover ratios and capital ratios. Some of the key ratios are as follows:

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Prospective Analysis and Valuation:

This is done through various techniques like PEG method, Free Cash Flow method and

Gordon Model of valuation. All the methods bring out the same conclusion of the stock being

undervalued and have the potential to move north. It gives us the intrinsic value of the share

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that is higher than the current market price. Hence, we are giving a buy recommendation for

the stock.

Calculation of cost of Equity:

Ke = (D (1 + G ) /

P0) + G Ke

Where,

21.09

93

Ke = Cost of

Equity D = Dividend

Per Share 15P0 = Current

Market Price 811.65G = Growth

Rate

21.076

92

Gordon Method:

Gordon

Model

g= 21.07692d1=

15(1+.210796

2)

18.161

94

k=21.0993

price

811.7

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Past Performance of the Stock

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The stock price has also shown an increasing trend in the past one year from the low levels of

just under Rs.500 to the high levels of touching the Rs.1000 mark. We believe the stock still

has an upward potential due to positive financial position of the company in terms of cash

available, strong future plans and a growing automobile market demand, both for commercial

and passenger vehicles.

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Arguments for investment

1. With new product launches in the coming years, demand is expected to remain strong

for passenger and commercial vehicles both.

2. The company is in good financial health and has healthy prospects for future growth

in income.

3. JLR has seen a major turnaround and is backed by reviving demand for existing

products coupled with positive response for new products and cost saving

successfully being achieved specially for his company.

Key Areas of Concern

1. Rising interest rates and high fuel costs may affect the short term demand for

vehicles.

2. Foreign exchange fluctuations and increase in cost of raw material my put further

pressure on the profit margins.

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ANNEXURES

Table 1 : Balance sheet

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Table 2: Income Statement

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Table 3: Cash Flow Statement

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