Description

Tata Motors is one of the largest automakers in India by volume, with a leading market position in commercial vehicles, and a leading global luxury automaker through its ownership of Jaguar Land Rover (JLR). Shares are down almost 50% in dollar terms since the start of 2018 due to weak profitability and volumes at JLR.

Thesis: buy Tata and get JLR for free

Tata’s ROE and FCF are expected to bottom in 2018. We estimate that the Indian standalone business is worth ~$9.0bn and JLR is worth ~$12.5bn versus the current market value of $8.1bn. In other words, you are paying a fair price for Tata and getting JLR for free. At our fair value of $21.5bn, there is 165% upside. This equates to 6x 2019F EV/EBITDA and 4x 2021F EV/EBITDA, both material discounts to Indian and luxury peers.

Meanwhile, the country cycles look constructive. Liquidity is easing in India and China and cyclical stocks have bottomed. An uptick in the China credit impulse foreshadows a bottoming in Chinese auto sales, and Chinese auto manufacturers have stabilized in anticipation of this upswing. A number of EM automakers appear to be breaking out and auto suppliers have bottomed.

Jaguar and Land Rover are iconic brands that are fixable

Three quarters of Tata’s revenue and profit are generated by JLR. Since Tata purchased JLR from near-bankruptcy in 2008, volumes have grown 3x, but missteps in China and runaway spending hit volumes and margins. However, JLR is not structurally broken, and has an opportunity to be more profitable given its stable of high-ASP and high-margin SUV’s such as the Range Rover. We believe there are several strategic paths to reviving the two brands, while several SUV launches on a new aluminum platform in 2020-21 should boost margins in the near-term. Volume and margins are expected to rebound over the next three years.

Given the importance of JLR to the overall company as well as management’s prior turnaround success, we are confident the ship can be righted. Tata Group has made tough decisions regarding floundering acquisitions in the past, placing ailing British steelmaker Corus into a joint venture with ThyssenKrupp last year. In spite of current performance, the two iconic brands have substantial value. Tata Sons has been an aggressive buyer of Tata Motors stock at these levels earlier this year.

Turnaround 1.0 -- Tata India

Challenges:

1. Few product introductions

2. Weak market activation

3. Margin pressure

4. Complex organizational structure

5. Introduction of new emissions standards

Solutions:

1. Sales enhancement through intense customer and topline focus

2. Rationalization of the supplier base and optimization of manufacturing operations

3. Organizational restructuring to improve direction and decision-making, including reduction of managerial layers from 13 to 5

Result: profitable growth despite challenging conditions

Turnaround 2.0 -- JLR

Challenges:

1. Excess manufacturing capacity

2. Pricing and inventory missteps in China have led to sales declines

3. Profligate R&D and spending have led to low margins despite high ASP’s

Solutions (so far):

1. Appointed Adrian Mardell as “Transformation Director”

2. 10% headcount reduction

3. Cut costs by $3.2bn over the next 18 months

Potential result: profitable, aspirational luxury brand valued at higher multiple

Catalyst

1. Turnaround plan gains traction

2. Uptick in Chinese auto sales

3. Sale or partnership for JLR