Tata Motors reported fiscal 2017 second-quarter EPS of Rs 0.26, a dramatic decline from the year-ago EPS of Rs 8.62. Even so, the stock closed 7% lower as the market was expecting Rs 0.77. Tata’s EPS result represented an eye-popping 65% miss. Significantly higher launch costs for the new Land Rover Discovery and lower volume across all regions except North America and China, made for disappointing margin performance from Jaguar Land Rover, or JLR, while Tata medium and heavy domestic commercial truck volume declined 8%.
FAIR VALUE ESTIMATE: Rs 570
February 2017: Solely due to the time value of money component of our Discounted Cash Flow (DCF) model, we have raised our FVE to Rs 570 from Rs 560. However, we view this stock as reasonably valued, currently trading just into 3-star rated territory on a 15% discount to our new Rs 570 fair value estimate.
September 2016: The FVE was raised to Rs 560 per share from Rs 550, mainly to reflect the time value of money component in our DCF model. Our FVE assumptions include revenue growth of 6%, well below the trailing 10-year average revenue growth rate of 27%, while the five-year adjusted EBITDA margin forecast is roughly 15%, nearly 300 basis points better than the trailing 10-year average of approximately 12%. We take into consideration margin expansion from the Indian business as the domestic market rebounds plus improved JLR volume and profitability due to the launch of new models and new facilities in China and South America.
ECONOMIC MOAT: Narrow
The Narrow Economic Moat rating is driven by the strength and global recognition of its Jaguar and Land Rover brands. Brand strength enables premium pricing that results in solid margins and healthy economic profits. The low-cost advantage enjoyed by its Indian business is driven by low labor costs and the local tax structure that favors domestic manufacturers. In our opinion, given capital intensity and lengthy product life cycles that a new startup would endure, it is more probable than not that Tata Motors would maintain economic profitability for 10 years.
However, for a mass-production luxury automotive brand, it is much more difficult to make the same claim about a 20-year period, during which, as management teams come and go and product turnover opens the possibility of a string of missteps, the probability rises that the brand could sustain irreparable damage and the cost advantage erodes.
With new facilities in China and in Brazil, Jaguar Land Rover will have a manufacturing presence in the world's top seven automobile markets. Global volume growth in luxury segment vehicles is bolstered by an increasing population of upper-middle-class as well as roughly 15 million high-net-worth individuals with investable assets of $1 million or higher. We expect 1%-3% average annual growth in overall global automotive demand, but because of the increase in the world’s wealthy population, we think luxury vehicle segment demand will grow at average annual rate in excess of 3%. We believe JLR will continue to roll out new products that sustain its luxury brand image and premium pricing, supporting our narrow economic moat rating.
