The commercial vehicles (CV) industry is in the midst of an unprecedented demand surge with an over 35 per cent growth in the first nine months of this fiscal.
Riding this sharp growth curve is Tata Motors, whose CV sales growth at 48 per cent in the April-December 2006 period is running ahead of the overall industry.
The icing on the cake for Tata Motors (TML) is the equally good growth (23 per cent) in its passenger cars business, where the Indica Xeta and Safari Dicor have been driving volumes.
TML is set to put out an impressive report card for the third quarter; the fourth quarter can only be better in terms of sales volumes in both CVs and cars as, traditionally, demand accelerates towards the end of the fiscal.
The market has acknowledged this fact as the TML stock has risen by more than 12 per cent in the last ten trading sessions to Rs 933 now, which is a PEM of about 20 times the annualised second quarter earnings. Investors can consider taking fresh exposures in the stock. However, those considering fresh investments should keep in mind the fact that appreciation from these levels may be slower and over an extended time frame.
Rocketing CV sales
The effective implementation of the Supreme Court ruling on overloading made last year and the continued investment in infrastructure projects, including public investment in road construction, has generated and sustained demand for heavy commercial vehicles.
In light commercial vehicles, the runaway success of the Ace, where the company is not able to produce enough to meet demand, has been a predominant factor driving growth. TML is now seeking to translate Ace's success in foreign markets through its joint venture with a local assembler in Thailand, the second largest market for pick-up trucks in the world. TML is also seeking to leverage its partnership with Fiat to take the Ace to Latin America, where Fiat is an established player.
Good support from cars
While the compact car business is growing impressively, there are some worries in the mid-size entry-level segment where the Indigo and Marina are seeing a fall in volumes. TML is now developing the successor platform to the Indica and the tie-up with Fiat should be of help, especially on the engines front. The joint venture will produce three engines — one diesel and two petrol — developed by Fiat and for use by both partners.
The market is set to become more competitive with the entry of newer models, especially in segments where TML is operating.
The Indica platform will soon near the end of its life cycle and, therefore, the successor and also the so-called `Rs 1 lakh car' become important and will determine the future for the passenger car business.
Dropping margins
Rising input costs of materials such as steel and energy caused a small fall in operating margins in the second quarter to 11.5 per cent compared to 12.05 per cent in the same period last year. The inability to pass on cost increases fully to the market means that the third quarter margins may also be under pressure. Growth in earnings may, therefore, be slower than in revenues in the third and fourth quarters.
However, TML continues to run a successful cost reduction programme and has been efficient in managing inventory and receivables thus easing the pressure on margins.
Risks
A slow down in infrastructure spending which could affect CV offtake remains the biggest risk though there appears no such possibility in the near term. That said, the probability of the growth rate remaining above 30 per cent in the next fiscal appears low; it will most likely moderate to more sustainable levels of around 20 per cent.
For one, the base effect will begin to kick in and two, the slack caused by the overloading ban would be fully absorbed in the next couple of quarters.
Interest rates are an uncertain variable and if they harden further could begin to affect demand for both cars and CVs.
Input cost increases are another variable to watch out for and could exert pressure on margins despite the effective cost reduction programme. The private container trains project of the Railways, flagged off last week, needs close watching; if successful, it could take away some of the business of long-distance road transporters.
While these are medium- to long-term risks, the near-term appears clear and investors can enter the TML stock.