After the industry analysis of the automobile sector, I am moving on to the valuation of individual companies. To start with, we have the stock in the eye of a corporate governance controversy, Tata Motors. Tata Motors competes in the passenger and commercial sub-sectors of the automobile sector, giving three-wheelers and two-wheelers a miss. In the passenger vehicles segment, Tata Motors has been steadily losing market share, struggling to stay above a 5% market share threshold. In the commercial vehicles market too, the company has witnessed declining market shares in all the categories. In the spare parts market, Tata Motors is the only automobile OEM which has not been growing its sales.
Historical and Forecasts
Let us consider the trends in the total revenue, total expenses and the net profit margin.
The data up to 2016 is taken from the annual reports and refers to the financial year data. Revenues can be seen to be showing a healthy increase each year, although for 2016 the growth is slightly lower than the previous years. I have forecast it to continue to grow based on a linear trend based on the previous five years. Hence, total revenue from operations grow from around 2.8 lakh crores in 2016 to around 5.8 lakh crores by 2026. The average rate of excise duty was calculated based on the previous five years and this was applied to the 2017 revenue, and so on for every year the average excise duty rate of the past five years was assumed to apply to the total revenue from operations. This makes the excise duty forecast for 2026 around 10,000 crores. A linear trend when applied to the other income from 2012 to 2016 raises it from 982 crores in 2016 to 1636 crores in 2026. The net income and the depreciation have been taken from the income statement for the calculation of the free cash flow to equity (FCFE). Despite the slow growth of the net income, the significant increases in the depreciation lead to the FCFE having a healthy growth rate over the years.
An analysis of the expenses shows that it has been increasing at a faster rate than the revenues. While the total revenues grew only at a CAGR of 14% from 2012 to 2016, certain items of the expenses grew at a much faster rate, bringing the profit margins down drastically. Notable among these were employee cost (24%), depreciation (32%), product development (26%) and exceptional items (26%). Together, these dragged the profit after tax down by a CAGR of 5% from 2012 to 2016. Since I have forecast the expenses to increase based on a linear trend, the net profit margin continues its downward trajectory in to the future, hitting 2.3% by 2026.
On the balance sheet too I forecast all items based on a linear trend, except the reserves, which are calculated as the difference between the total assets and the liabilities except the reserves. On the liabilities side, the largest contributors are long term borrowings, trade payables and reserves. The have shown increases of 17%, 15% and 25% respectively on a CAGR basis between 2012 and 2016. The total liabilities are forecast to increase from 2.7 lakh crores to 5.9 lakh crores from 2016 to 2016. On the asset side, there are no single large contributors, with each item contributing less than 20% of the total. From the balance sheet I obtain the change in working capital, net borrowing and capital expenditures to calculate the free cash flow to equity. Due to the linear trend forecast adopted, these cease to vary after a few years.
The Valuation
Finally, the FCFE grows to 36365 crores in 2026 from 1888 crores in 2016. These are split between the ordinary shares and the DVRs ('A' Ordinary shares) based on the number of shares of each projected, again based on a linear trend. To find the value due to the FCFEs in the forecast period from 2017 to 2026, these are discounted based on the cost of equity calculated based on the CAPM model. A risk free rate of 6.5% based on the yield of the 10 year Government of India bond is taken. For the country risk premium, two values for India have been calculated by professor Aswath Damodaran of the New York University Stern School of Business. One of these (7.39%) is based on the Sovereign CDS and the other (8.82%) is based on the local currency sovereign rating provided by a rating agency. I find the former more palatable since the ratings agencies have taken flak for giving excellent ratings to the securitization products that brought the U.S. economy down in 2008. The beta for both types of shares have been taken from online sources. These are 1.41 for the ordinary shares and 1.75 for the DVRs. Together, these yield a cost of equity of 16.92% for the ordinary shares and 19.43% for the DVRs. The terminal growth rate for the FCFEs is assumed to be 5% since the economy is expected to change its growth rate from around 6% in 2016 to around 3% by 2060, but until 2035, grows at over 5%. The automobile sector's contribution to the economy is thus assumed not to change much since it keeps pace with the economic growth.
The Price
Together, this set of assumptions yields a valuation of ₹ 440 for the ordinary share and ₹ 346 for the DVR. Hence at over ₹ 500, the TATAMOTORS scrip seems overpriced significantly, whereas the DVR at at around ₹ 320 seems fairly priced.
A sensitivity analysis based on slightly different values of the terminal growth rate (TG) and the equity risk premium (RP) can be found below.
It can be seen that in no instance does the ordinary share's price begin to approach its current price of around ₹ 510 and that the range of prices for the DVRs includes its current price of around ₹ 320.
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