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.
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.
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.
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