While Q1 results were in line with estimates, gains from new models/FX should step up in coming quarters, with weakening of pound boosting margins
Tata Motors’ (TAMO) Q1FY17 results commentary reflects a stable to improving outlook for the global car business, to be driven by the ramp-up of new models and a weaker GBP. We are cautious on the global pricing scenario but have been positively surprised by the response to new products. Moreover, a lower GBP has raised expectations of higher margins in the medium term, leading to a re-rating of the stock. We now increase our target price by 31% to R500 on account of: (i) an increase in FY17/18e EPS by 7-8%; and (ii) a 20% increase in valuation to 4x FY18e EV/Ebitda (vs. 3.3x earlier). However, at current valuation (4.1x FY18e), these positives are likely factored. Hold.
Q1FY17: robust mix and a weaker GBP offset by hedging/revaluation losses
Consolidated revenue at R659 bn (+10% y-o-y) was 3% higher than our forecast but headline Ebitda at R76 bn (-31% y-o-y) was 12% lower due to FX-related revaluation losses. Jaguar Land Rover (JLR) revenue, Ebitda and margin were at £5.5 bn y-o-y (+9% y-o-y), £672 m (-18% y-o-y) and 12.3%, respectively. The company reported that adjusting for hedging losses, JLR margin was at 14%.
Growth moderation in global markets vs new model momentum: US/EU/China Auto teams are expecting varying degrees of demand moderation. While TAMO could outperform due to its launch pipeline, there remains demand/pricing-related uncertainty in these geographies.
Currency could more than offset any negative volume impact in the near term: TAMO is positively affected by GBP depreciation as its UK-based car business accounts for 75%/100% of revenue/PAT. We calculate that a 10% depreciation in the GBP/USD leads to a 25-30% increase in the earnings of the UK operations. This gets offset by: (i) negative translation impact (TAMO’s reporting currency is INR); and (ii) aggressive hedging, resulting in a smaller immediate impact on the P/L. Adjusting for these, we calculate that a 10% depreciation in the GBP/USD leads to a 15-20% increase in TAMO’s EPS. We currently assume GBP/USD of 1.15 by Dec-16. Deutsche Bank expects the GBP to remain weak in the medium term. This should support a re-rating of TAMO.
Our target price (R500) is based on 4XFY18E EV/Ebitda; risks: Our target valuation for TAMO is in line with its five-year average. Upside risk: better-than-expected volume/FX. Downside risk: a slowdown in key markets.
Key changes to our forecasts
We are increasing our Ebitda forecasts slightly to incorporate better margins. The 7-8% increase in PAT forecasts is on account of the flow-through of Ebitda and strong ramp-up in the China JV operations, which are accounted for under the equity method.
The increase in target price reflects a re-rating of the stock: While we have been positive on Tata Motors’ new product momentum, we were wary of the deterioration in its mix. We believed that the company’s entry into lower-priced segments, coupled with pricing pressures in key markets such as the US and China, could keep margins volatile. However, we have been surprised by the strong response to the new models. In addition, the recent depreciation of the GBP (10% in three months) and Deutsche Bank’s outlook of a further weakening should support the margin trajectory of the company. The stock has already re-rated on account of the above-mentioned factors and we believe that this could sustain in the medium term. Hence, we now value the stock at its five-year average of 4x FY18e EV/Ebitda (vs. 3.3x earlier). This leads to a 31% increase in the target price to R500.
Results vs our forecasts: Consolidated revenue came in at R659 bn (+9% y-o-y, +3% vs. Deutsche Bank estimate), Ebitda at R76 bn (-31% y-o-y, -12% vs. Deutsche Bank estimate) and Ebitda margin at 11.6% (Deutsche Bank estimate at 13.5%). Adjusting for FX losses, Ebitda was at R85 bn, largely in line with expectations.
Valuation: We value Tata Motors at R500/share based on: (i) R495/share for the Automotive business at 4x FY18e EV/Ebitda; and (ii) R5/share for the vehicle financing business in India. Our multiple for the Automotive business is in line with its past five-year average. The implied PE of 8x FY18e is at a slight discount to its five-year average of 9x. Tata Motors’ stock has re-rated significantly over the past six months due to a positive volume momentum in its global business and the depreciation in the GBP, which improves the outlook for margins. While we believe that Tata Motors’ strong model launch pipeline should enable it to grow faster than the market, we remain cognisant of the risks of growth moderation in key markets such as Europe, the US and China.