TATA MOTORS – Equity Valuation

BAVFS – Term Report

IMT- 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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Company Background:

Established in 1945, Tata Motors' presence indeed cuts across the length and breadth of India.
Over 5.9 million Tata vehicles ply on Indian roads, since the first rolled out in 1954. It is the
leader in commercial vehicles in each segment, and among the top three in passenger vehicles
with winning products in the compact, midsize car and utility vehicle segments. The
company is the world's fourth largest truck manufacturer, and the world's second largest bus
manufacturer. The company's 24,000 employees are guided by the vision to be "best in the
manner in which we operate, best in the products we deliver, and best in our value system
and ethics."

The company's manufacturing base in India is spread across Jamshedpur (Jharkhand), Pune
(Maharashtra), Lucknow (Uttar Pradesh), Pantnagar (Uttarakhand) and Dharwad
(Karnataka).

Investor Rationale:

• The auto industry has been performing extremely well and quarter to quarter month to
month, numbers have been pretty robust on consumption and demand.
• Tata Motors has been in continued up trend since February 2010 which is
demonstrated by higher tops and higher bottom. It has given double top breakout on
its daily chart along with above average volumes.
• Underlying demand remains very strong, especially in the CV segment, as economic growth
picks up. Volumes would be driven by new product launches in FY11, robust demand for the
existing product portfolio and ramp-up at Sanand plant for Nano.
• Significant turnaround in JLR performance, backed by revival in key markets, favorable
response to new product launches (Jaguar XJ, Land Rover 2010 models), coupled with cost
saving initiatives.
• Tata Motors’ investments in its subsidiary and associate companies add substantially to the
company’s valuations.

Valuation:

We recommend investment in TATA Motors based on PE / Growth and Free Cash Flows
Method considering the future earnings and cash flow forecasts. We have arrived at a
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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. India’s 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:
India’s 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.

Portor’s 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
JV’s with existing automobile company.
• Supplier’s power: In the relationship between the Industry and the suppliers, the
power axis is tipped in industry’s favour. The industry is comprised of powerful
buyers who are generally able to dictate their terms to the suppliers.
• Buyer’s power: In the relationship between the Industry and the ultimate consumers,
the power axis is tipped in consumer’s favour. This is due to the fairly standardized
nature and the low switching costs associated with selecting from the competing
brands.

TATA Motors’s 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 Company’s 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
is steel which 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 gives
them 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 Company’s 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 year’s 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, using
a 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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Payments under operating leases are recognized in Profit and Loss Account on a straight-line
basis over the term of the lease.

Exchange differences

• Transactions in foreign currencies are recorded at the exchange rates prevailing on the
date of the transaction
• Foreign currency monetary assets and liabilities are translated at year end exchange
rates

Product Warranty Expenses

The estimated liability for product warranties is recorded when products are sold. These
estimates are established using historical information on the nature, frequency and average
cost of warranty claims and management estimates regarding possible future incidence based
on corrective actions on product failures. The timing of outflows will vary as and when
warranty claim will arise - being typically upto five years.

Inventories

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

Employment benefits

The actuarial losses (net) of ` 1722.61 Crores of pension plans of Jaguar Cars Ltd and Land
Rover, UK, have been accounted in “Reserves and Surplus” in the consolidated financial
statements in accordance with IFRS principles and permitted by AS21.

Investments

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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 arm’s length, it’s LIFO. Under
U.S. GAAP, companies can apply LIFO rules to their inventory balances. In periods of rising
commodity 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

21.09
Where, 93

Ke = Cost of
Equity
D = Dividend
Per Share 15
P0 = Current
Market Price 811.65
G = Growth 21.076
Rate 92

Gordon Method:

Gordon
Model
g= 21.07692
d1=
15(1+.210796 18.161
2) 94
k=21.0993
811.7
price 7

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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