Faltering Indian Automaker May Be A Future Defense Giant

| About: Tata Motors (TTM)


Tata Motors is India's largest automaker and a Fortune 500 company.

Jaguar Land Rover's outstanding performance has kept parent Tata Motors in the black despite disappointing sales figures from the main business.

The company's defense arm is India's largest defense company.

The newly-raised FDI limit and demand from the global south will work in Tata's favor in the long run.

(Quick note At the time of writing, 1 USD ≈ 60 INR.)

The Tata Group is one of India's oldest and most storied conglomerates. Founded in 1868 by Jamsetji Tata, the group has a combined market cap of INR 785 billion and over a hundred companies under its umbrella. Its largest members crowd the Bombay ticker under the letter 'T': Tata Chemicals, Tata Communications, Tata Consultancy Services, Tata Global Beverages, Tata Motors, Tata Power, Tata Steel, Tata Teleservices, Titan, and Taj Hotels.

If this is reminiscent of a keiretsu, it's not wholly unjustified. The Group's holding company is Tata Sons, which controls the brand and is majority-owned by charitable trusts endowed through the generations by various members of the Tata business family. Tata is run backwards, in a sense: instead of throwing the occasional CSR bone to mollify critics, it operates the entire business to fund its philanthropic mission. The Chairman of Tata Sons, Cyrus Mistry, is the ex-officio Chairman of the Group and its businesses.

Tata is also known for acting like a Berkshire Hathaway, with a difference. Instead of seeking out and assimilating great businesses, it incubates them in-house as autonomous entities, cross-financing them from the established parts.

Accessible by Car

Tata has historically been interested in being a global business, eager to learn and expand. Nearly sixty percent of the group's revenues originate from outside India. This article is about Tata Motors (NYSE:TTM), which is a Fortune 500 company in its own right and the second-largest company in the group by market cap.

Probably best known outside India for its diminutive Nano, Tata Motors manufactures a wide range of vehicles in India and is the parent company of Jaguar Land Rover in the UK, Tata Hispano (a bus and coach manufacturer) in Spain, and Tata Daewoo (the commercial heavy vehicle arm of Daewoo) in S. Korea. It is the largest auto company in India and the second-largest bus manufacturer in the world.

My thesis is built around Tata Motor Defence Solutions (TMDS), its defense arm, which is the country's largest defense company and has supplied the Indian Army with rugged buses and trucks since 1956. I believe the recent increase in the FDI limit in defense to 49% plays to Tata's strengths and positions it to benefit enormously in the long run.

Thesis: Defense

The Group already has INR 80 billion in back-orders and is aiming to increase its defense revenues from INR 17 billion to INR 24 billion in 2014. TMDS accounts for forty percent of Tata's defense revenue and 75 percent of India's internal security market.

Notably, Tata Motors is one of the four companies invited to compete for a $10 billion project to supply Future Infantry Combat Vehicles (FICV) to the Indian Army.

As with any Tata venture, intra-group synergies will play a key role in differentiating it. Tata Advanced Systems has JVs in place with Sikorsky, Lockheed Martin, and Israel's Elta. Tata Power was closely involved with India's guided missile program and built the command-and-control systems for the indigenous Arihant submarine platform. Even Tata Consultancy and Titan have a contribution to make, with their expertise in IT and precision manufacturing, respectively.

This project is part of a larger shift in India's defense industry.

India's anxiety around defense FDI is driven by a core contradiction - India has one of the largest defense procurement budgets, and not much of its key hardware sourced is domestically. Import dependence in a crucial sector is always cause for concern, and doubly so when it's defense. Enabling deep private-sector expertise at home will be important to the Indian defense establishment for the next decade or so, and that will provide a test bed for the development of low-cost defense technologies.

There are dozens of countries that are in an even tougher bind. They neither have the capability to develop the systems they need, nor, unlike India, the funds to buy from American or European companies.

This is Tata's opportunity to squander. While developing on Indian defense cues, Tata Motors has the ability to transform itself into a major defense player in the global south. The market for advanced hardware in Africa and S. America has been seriously underserved, and Tata can fill the gap that exists between expensive western-built weaponry and second-hand Soviet hardware of dubious origin.

There is, of course, bound to be serious competition from other Indian defense majors and from companies in China and Russia, but Tata's operational flexibility and experience in building local alliances and brands leads me to believe it has the potential to make serious money in this market.

The downside

The defense contracts and global customer base mentioned above will play out in the long run, but for now, Tata Motors is not entirely comfortable. The company saw sales of both passenger (-36%) and commercial vehicles (-29%) fall in FY 2014, with further weakness to come with an erratic monsoon. It says something about Tata's predominance that this still leaves it with a 55% market share in commercial vehicles.

The passenger vehicle numbers are especially troubling, since they managed to push Tata down to the fourth rank in passenger vehicle sales in India, behind Hyundai, Suzuki, and Mahindra. With only a thousand Nano units sold in May, Tata is caught between pouring more money into a non-performing marque or aborting a highly visible project, with all the investor confidence implications it brings. Fortunately, with a low debt/equity ratio and Group's war chest behind it, cash will not be a problem for Tata Motors for the foreseeable future.

Meanwhile, Jaguar Land Rover is doing swimmingly and achieved a record-breaking sales volume in FY 2014. JLR now produces 90% of the automaker's global profits and has returned yearly dividends of around INR 15 billion to the parent company. It is essentially keeping the company afloat at this point.

Tata's share price is up 30% year-to-date, but there are headwinds ahead, and while JLR's results may carry it through weakness in the short term, it does need to recover credibly in its standalone business at home to remain attractive.

Tata is busy promoting Revotron, its first indigenously-built petrol engine, which early reviews characterize as "smooth" and "effortless". The company will hope its new Zest and Bold lines carrying this new engine manage to revive consumer interest in the brand. It is reported that Cyrus Mistry has taken a personal interest in the smallest details of the new cars.

In summation

If Zest and Bold perform, they may lift Tata's brand image out of the muck across the board and give a boost to the rest of its offerings as well. The post-monsoon figures at the end of Q3 will be telling.

In either case, Tata Motors remains on my radar for its enviable liquidity, its ownership of global luxury brands, its continued strength in India's commercial vehicles sector, and its future as the arsenal of poorer democracies.

Figuring out Indian figures

Should you wish to dig into Tata's Indian filings (or indeed, any economic figures from India) you may run into the terms "lakh" and "crore". A lakh (or lac) is a hundred thousand, and a crore is ten million.

One consequence of this is that numbers in India may be grouped differently than in the west. For example, India's 2012 population of 1,236,344,631 would be written as 123,63,44,631 (one hundred and twenty-three crore, sixty-three lakh, forty-four thousand, six hundred and thirty-one).

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in TTM over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.