the tata group

The executive chairman of Tata Sons said recently, "we have moved away from fixing to focus on growth".  I have not dug deep into the context behind the statement. What I know is that just physical growth will not contribute to value. That has to be accompanied with consistent excess returns. Value creation to shareholders is the primary focus for managers of any business. Their duty is only towards their owners; everything else is incidental. But the chairman knows better than we do. 

The Tata group sells from salt to trucks, covering the entire gamut of consumption. There are 17 companies listed on the stock markets, and have a total market capitalization of Rs.10,401 b ($148 b). In addition to these companies, there are many private organizations - including not-for-profit - set up to serve the society. With more than 700,000 people, the group is probably the largest private employer in India. That is commendable. 

This post analyzes only the publicly traded entities within the group. These 17 companies have total revenues of Rs.6,496 b and total earnings of Rs.560 b (March 2018). That implies the group is priced at an earnings multiple of 18.55. Although price-sales multiple is not the best measure - enterprise value to sales is better - 1.60x seems quite interesting.

Yet when we look a little closely, we can note some peculiarities. Consider this: Just one company makes about 70% of the group's market value. With Rs.7,185 b market cap, TCS stands singular. It is a little hard to believe that the rest of the group - 16 publicly traded companies - are only 30% of value, and are collectively worth only Rs.3,216 b.

One of the most important measures of how well a company is managed is the return on capital, and TCS stands out with stellar performance. It also generates large amounts of free cash flows. Titan also has superior return on capital over the past decade. But then market's inconsistency in pricing equities is evident: TCS contributes (Rs.258 b) over 45% of the total earnings of the group and Titan (Rs.11 b) only 2%, and yet, TCS is priced 27x and Titan 81x earnings. This is not to say that only earnings matter for pricing stocks; what I mean to say is that Titan is richly priced as of now considering its growth prospects and return on capital.

Tata Motors revenues for 2018 were Rs.2,954 b (over 45% of total group revenues) and earnings were Rs.89 b (over 15%); similarly, Tata Steel too had significant revenues and earnings for 2018; but both are priced less than 6x their earnings. For Tata Steel it is understandable because it is in the cyclical business, and its average earnings over the decade have not been impressive, and we are never certain about timing of commodity cycle. For Tata Motors, the situation is different; having had some good times through Jaguar, Land Rover in the past few years, with slowdown in JLR business in its key markets, the business is faltering. A large amount of capital is required for its ambitious electric vehicles project, and it is not coming through easily. We are not sure if those revenues, earnings, and more importantly, free cash flows are going to be large enough to price its equity. At the moment, though, Tata Motors is worth just Rs.519 b. 

If return on capital is less than cost of capital over a long period of time, it is not possible to have free cash flows. No excess returns, no free cash flows. Tata Steel and Tata Power have failed in this test. Tata Communications is worth Rs.147 b, and its performance has not been impressive either. Tata Chemicals showing has been deteriorating over the past decade.

Tata Global Beverages and Tata Coffee, both, have not had decent growth. Their return on capital has not been good. Tata Global is priced at 24x earnings (Rs.119 b), and Tata Coffee at 14x earnings (Rs.15 b). They may well have potential going forward.

Voltas growth numbers haven't been good, but it is priced about 30 times earnings. We haven't got much to say about Indian Hotels which is priced rather rich and is worth Rs.165 b now. Trent has low return on capital and free cash flows over the past decade.

Tata Elxsi and Tata Metaliks are performing well, but aren't big enough to make meaningful contribution to the group; yet. Tata Sponge and Nelco are collectively priced only Rs.15 b, and aren't the best performers.

For 2018, TCS, Tata Motors, and Tata Steel contributed about 85% of the total group revenues and earnings. In July 2017, I noted what would happen if TCS falters and JLR slows down. Well a little over a year, and TCS is doing fine, but JLR is actually faltering.

Yes, the Chairman is right, the group needs growth. But growth requires capital for reinvestment, and more importantly, for growth to create value, it has to show excess returns. Superior return on capital and free cash flows.

Tata group, no doubt, is a significant contributor to the Indian economy and society. It intends well and means well. With the change in focus, we are confident that the group will emerge stronger than before. 

adag, and market inefficiency

reliance power

Reliance Power operates power plants and is also involved in distribution of electricity. In early January 2008, Reliance Power came out with an initial public offering primarily to fund its power projects across the country. In February 2008 the stock got listed, opened at a high of over Rs.500 per share, but closed the day at just over Rs.370. This was the largest IPO at the time which collected over Rs.115 b through issue of 260 m shares. During February and March 2008, the stock price saw a high of Rs.599.90 (BSE) and a low of Rs.303 (NSE). 

To make up for the loss, the company issued bonus shares to all the minority - that excludes promoters - shareholders in the ratio of 3:5. That makes the high price adjusted to bonus to Rs.375 and low price to Rs.189, and the market capitalization of the business to Rs.905 b (high) and Rs.457 b (low) in 2008. As of now, the stock is trading at Rs.10.75 and the market cap is Rs.30 b. That's a colossal loss. The promoters own 75% of the business, and over 80% their shares are pledged. 

It was generous of the chairman to give bonus shares to the shareholders when it was clearly not required. If the shareholders thought the business was good enough at Rs.450 per share, they would have got their expected rate of return, never mind the blip in the stock price. That the issue price was too high was something investors had to check for themselves. Even the timing of IPO wasn't considered right which had the makings of the global recession. However, the long term fall in stock price is not attributed to these events, but the business itself.

reliance infrastructure

Reliance Infrastructure is involved in power plants, metro rails, airports, bridges, and toll roads. The company acquired BSES in 2002 and sold its transmission business in Mumbai in 2018. In January 2008, its stock traded at Rs.2,485.75; that was nearly Rs.600 b for all equity. Now the stock price is Rs.112.30 and the market value of equity is Rs.29 b. Down 95%. The promoters own about 48% of the business, and over 80% of their shares are pledged. 

reliance communications

Reliance Communications emerged from transfer of telecommunications business from Reliance Industries on a going concern basis, and it shares were listed in early 2006. In January 2008, the stock was priced nearly Rs.800, and the equity was priced over Rs.1,500 b. It is trading less than Rs.6 per share now, and the equity is worth Rs.15 b. Down 99%. The company has filed for bankruptcy this month as there have been too many hiccups in its attempts to sell assets to repay its enormous debt. The promoters own about 53% of the business, and 30% of their shares are pledged. 

reliance capital

Reliance Capital is a financial service company operating in asset management, mutual funds, stock broking, wealth management, insurance, and finance. In January 2008, the stock was trading at Rs.2,762.60, and as I write this post in February 2019 it is quoting at Rs.136.50. The market value of its equity has fallen 95% from Rs.678 b to Rs.35 b. The promoters own about 52% of the business, and 75% of their shares are pledged.

reliance naval 
Reliance Naval & Engineering is into shipbuilding business. After Reliance Infrastructure acquired 17.66% stake in Pipavav Shipyard in March 2015 for $130 m, it came out with an open offer, and the ownership now stands at about 30%. The company operates as a part of the ADAG group.  In August 2010, the stock was trading at Rs.116.20 and in December 2015, at Rs.100.25. The market cap has changed from Rs.77 b to just over Rs.6 b. Down over 90%. All of promoters shares have been pledged.

reliance home finance
Reliance Capital owns 48% of Reliance Home Finance, and the total promoter holding is 75%. As it was spun out of Reliance Capital in September 2017, each share held in Reliance Capital got a share in Reliance Home Finance. The stock price has fallen from Rs.107.20 (September 2017) to Rs.24.30. That's reduction in market cap of 77%. The company is worth about Rs.12 b now.

reliance nippon life
Reliance Nippon Life Asset Management is owned by Reliance Capital (43%). In January 2018, the stock price was Rs.318.30. As of now, it is 50% down and the market cap of the company is Rs.96 b.

The promoters ownership has proportionately fallen to Rs. 115 b as of February 2019.

Like we noted the long term fall in stock prices is not attributed to any macro events, but the businesses themselves. For whatever reasons many of the businesses have been dealing with unmanageable debt, and as is their wont, the markets have also punished those that should not have been.

Nevertheless, such a steep fall in stock prices appears to be unwarranted, and this might be an opportunity for investors having faith in the management. A decade and more, these businesses should come out of their problems and emerge good. But then again such contrary views require bold moves, and also depend upon the opportunity costs. 

tata motors, and jaguar, land rover

The market value of Tata Motors equity was Rs.575.954 b as of yesterday. As I write this post, while markets are still open, it is down to Rs.472.066 b. That is an 18% fall. 

The company has two types of shares: 2,887.348 m ordinary common shares and 508.502 m differential voting rights shares. The DVR shareholders are entitled to one vote for every 10 such shares held and dividends of 5% more than that are entitled to the ordinary common. However in the absence of any dividends distributed to the ordinary, there will be no dividends for the DVR shareholders. 

In June 2008, Tata Motors completed its acquisition of Jaguar Land Rover business from Ford Motor Company at a net consideration of $2.3 b in an all-cash transaction. The acquisition was on a cash-free, debt-free basis, but, Ford contributed $600 m towards the pension plans. In November 2008, Tata Motors market cap was at a low of Rs.65 b (less than $1.5 b at the 2008 exchange rate). That itself should have made the consideration over the top. But the chairman had said it was a momentous time for all at Tata Motors. Another Tata company, Tata Steel, had just acquired Corus for $12 b (608 pence per share against the original offer of 455 pence) in 2007. So the group was in an acquisition binge.

But then in 2008, JLR was losing money. Surprisingly, Ford had failed to monetize JLR. The financial crisis and subsequent recession meant demand for luxury cars (Jaguar) and SUVs (Land Rover) was slowing down. Confidence in the credit market was the lowest. Borrowers struggled for credit, and lenders were worried about defaults. The combination was unusual because Tata Motors was in the mass segment and JLR in the premium segment, and the synergy seemed to be out of place. For the first financial year after acquisition (March 2009), Tata Motors posted a net loss of Rs.25 b. The company also ended up with debt of Rs.219 b. 

Raising cash was a priority for Tata Motors. The sale of 1.3% holding in Tata Steel to the parent, Tata Sons, for Rs.4.85 b and a rights issue of Rs.41 b was not much compared to the capital needed. A turnaround in JLR was what was required.

And what Ford could not do for years, Tata Motors did in two years. Earnings for 2011 were Rs.92 b; for 2012, Rs.135 b; and for 2013, Rs.98 b. The catch was that Tata Motors local business wasn't doing well. In fact, it posted huge losses in 2015 and 2017.

JLR was turned around all right. But there was a cost to it. A good business is one which earns a high rate of return on its capital employed, and does it consistently. In this respect, we don't think Tata Motors standalone has been doing well. Tata Motors consolidated earned about 15% on equity for 2018. But then that was largely due to contributions from JLR as we have seen. Both revenues and earnings from JLR have been disproportionately large compared to the consolidated numbers. Whether it will continue in future is a question.

Tata Motors has poured in billions of dollars in JLR since acquisition. Yesterday when it released its 3rd quarter results (December 2018), the markets had a surprise. The company said that the carrying value of its capitalized investments were brought down by 3.1 b euros ($3.5 b). When the assets are not expected to bring enough cash flows to justify their carrying values, they are brought down to the level equal to the present value of future cash flows, and such impairment is taken to the income statement. This is a non-cash adjustment that does not affect the statement of cash flows. Yet, the indication is the JLR business may not do as well in future. One of the primary reasons has been slow down in China which was its biggest market. Tata Motors reported Rs.269.61 b loss for the quarter. JLR reported a net loss of 3.1 euros implying no profits even before this one-time impairment loss. The standalone business reported a profit of Rs.6.18 b.

JLR has announced plans to come out with electric vehicles on all models. It will require a lot of capital for investment though. Tata Motors domestic business is doing better than before. Time will tell whether each business will be able to justify the capital invested. For that to happen they will have to show high return on capital and generate large free cash flows on a consistent basis. We hope that the group will be able to wither the past and come out on better terms.

the purchasing power, and its parity

The long term purchasing power of an individual depends upon two things: earning capability and inflation. The time value of money tells us that a dollar today is worth more than a dollar earned a year hence. There are at least 2 reasons for that: inflation rate and uncertainty. If you want to borrow a dollar from your friend, your lender friend will look for compensation in terms of inflation. If you go and ask money from the market, however, the lenders will look for compensation in terms of both inflation and uncertainty. They will perceive present as sacrosanct, and future as uncertain. And because their money is only going to come in future, they will seek compensation for that. Consequently, the interest rate implied on the debt will include 2 elements: Inflation rate and a premium for default which represents uncertainty risk. 

Inflation is an implicit tax on every person's cash flows. If $100 is kept under a mattress for a year, and inflation rate during the year is 5%, the purchasing power of $100 is reduced to $95. That is why mattress is not a great idea, and it is important for the investor to at least make returns equal to the inflation rate. This will keep the real returns (the purchasing power) in tact.

The same rule applies to the exchange rates under the purchasing power parity. The exchange rates of currencies are determined by markets based upon their demand and supply. Both demand and supply depend upon a variety of factors. As of now the Indian rupee is trading at about Rs.71.50 per dollar. By end of 2017, it was Rs.63.84. These are of course determined by the free market. 

However in the long run, fundamentals of the country will take precedence, and the exchange rates will settle based upon those factors. Under the purchasing power parity, the exchange rates are influenced, therefore determined, by the long term inflation rates in the two countries. For instance, let us begin with the 2017 exchange rate of Rs 63.84 per dollar. If the long term inflation rates of the US and India are going to be 2% and 6% respectively, in the next 5 years the exchange rate should settle at Rs.77.38. That represents the rupee depreciating about 4% each year against the dollar. 

As of now, the US is the biggest economy with a GDP of $20 t, and China is behind with $12 t. India's GDP is $2.6 t. But when we apply purchasing power parity to the GDP, the numbers change drastically. China becomes number one with $26 t GDP, then the US ($20 t), and India comes third with $9.5 t. That is because instead of using market rates, we apply inflation-adjusted rates to the currencies. 

The purchasing power parity theory compares the two currencies using a basket of goods and services, and concludes that the cost of an item in country A should be the same in country B in real terms. And the real values are calculated after removing inflation components attributed to them. The idea is to include a variety of goods and services, instead of one or two items, that are representative of the economy. 

If the price of a pizza is $10 in the US and Rs.500 in India, the PPP exchange rate would be Rs.50 per dollar, considering both pizzas of equal quality. While market exchange rates are also influenced by factors not fundamental to the economy, such as perceptions and bias, PPP rates are considered more intrinsic. 

As easy way to calculate the PPP rates between the two countries is to look at their PPP and nominal GDP. Here's how it is done: We know that India's GDP is about $2.6 t. At the prevailing exchange rate of about Rs.70, that is Rs.182 t. We also know that in terms of PPP it is $9.5 t. That means the implied PPP exchange rate is Rs.19.16. In 2017, it was about Rs.17.74; in 1990, it was Rs.5.76; that implies over 27 years the inflation differential has been about 4.25% which appears to be fair. 

One thing comes out clear: The market exchange rates are not useful all the time.