Tata Engg: Hold, trim exposures on uptrend

Recommendation: Hold, trim exposures on uptrend

S. Vaidya Nathan.

IF THE story of diversification and its detrimental impact on shareholders in India is chronicled at any time, Tata Engineering would necessarily figure high on the list.

This is despite the fact that the company's diversification was in a somewhat related area -- cars -- and also one where it had considerable engineering skills.

Despite that, for shareholders there has been nothing but accelerated erosion of value. Though the stock rose to Rs 200-plus levels in 1999-2000, the recovery lasted for a short period. Once the sales numbers started declining, from early 2000, the stock has been on a slide. More downside risk is in store as its businesses are all going through difficult times.

The foray into cars coincided with a downturn in the commercial vehicles business. Had things been well with the latter, the company may perhaps have been able to bear the burden of the car project. It would still have been a draining experience for shareholders, though the magnitude may have been somewhat smaller.

More models, more strain

Over the long term, Tata Engineering may have been in trouble as it would have been difficult for it to operate as a single car company. Making more models would have been that much more expensive in terms of the pressure on resources. There is also no evidence of any single car manufacturer having a good time in any market of consequence.

In any case, Tata Engineering's positioning in the car market is by no stretch of imagination a niche one with even the remote prospect of doing well with one car. In this context, it is no surprise that the company has lined up more offers in the car segments.

A three-box Indica, Magna sedan and a super premium car with technical support from Peugeot are all on the cards over the next three years -- that is, if it sticks to the indicated time schedules. As things now stand, these are likely to be bankrolled in much the same way as Indica was and this could mean more stress on returns to shareholders.

Core business woes

The trends in performance would not have been as much a cause for worry were it not for certain fundamental changes in the core business of medium and heavy commercial vehicles. No doubt, Tata Engineering has faced similar downturns in the past. But those were driven more by the underlying trends in the economy.

In the past few years too -- since 1996 with the exception of 1999-2000 -- the overall trends in the economy have not helped. But more lasting factors appear to be at work now. These assume significance in the light of the fact that the overall GDP growth has stayed in the 5-6.5 per cent range since 1996 -- a level that should have helped sustain demand levels.

Lasting structural changes

That has not been the case. The following appear to be key factors that could keep demand levels for commercial vehicles at lower levels:

The enhanced use of pipelines in the oil sector. Just last month, Gas Authority of India Ltd (GAIL) commissioned a 3,000-km pipeline in the north. This is one of the largest networks and more such pipelines over to criss-cross the country. They have the potential to not only curb future demand but also to take out of commission many subsisting trucks over a period. The use of trucks in the long- and medium-distance transportation of oil products could be reduced to marginal levels as pipelines are a more cost-effective delivery mode. Even select small pipeline networks -- leave alone those of the GAIL kind -- have had an adverse bearing on petro-product truck demands.

The second factor that could cut into the truck market is containerisation. Though it is still a concept at a nascent stage, the increasing use of containers has already cut into demand for trucks. Once port infrastructure improves as does the road network, containerisation can only be expected to pick up pace. All this could mean less demand for trucks of the kind which Tata Engineering now focusses on.

Potent threats, but...

Over the next three to five years, this trend may only accentuate. Coping with markets that are in the throes of a structural change may be tougher than the economic-activity-linked slowdown that Tata Engineering has experienced in the past. But it is not as if trucks would disappear. The nature of demand could change, as trucks may increasingly find a place only in short-haul transportation. As things stand, a few more years of better demand growth than has been the case in the past five years may be required to even absorb existing capacities in the medium and heavy commercial vehicles segment.

Tata Engineering's weakening numbers may also make living through this period of structural change extremely difficult. The losses totted up in the last couple of years and the possibility of more in the next couple of years could strain the balance-sheet in a big way. The fact that car sales volumes are not picking up as expected is also likely to mean that the ``cash break-even'' for the car project, indicated a few months back, could get pushed back.

What all this will mean is Tata Engineering will have to support a big project in a competitive area from resources from a shrinking core business. For all the cost reduction that has been effected by the company, a big splash of red in 2000-01 and 2001-02 appears more or less certain. The sale of some business divisions such as the heavy duty axles and transmission and some real-estate and the proposed sale of a few other ancillary businesses may not generate the kind of cash that could place the company in a comfortable position.

Plugging the gap

Perhaps it is to strengthen its resources base that Tata Engineering has decided to go in for a rights offer. The board of directors is to meet on January 31 to examine the possibility of a rights offer of convertible debenture/non-convertible debentures/quasi-equity related instruments. An equity offer at this stage could act as a further negative to the stock valuation.

For even if the company raises a sizeable sum, there is little else positive as far as the outlook on fundamentals go. An expansion in the equity base may cut into shareholder earnings; of course, that is when there is black in the balance-sheet than the splash of red.

Weak numbers

That the earnings card for 2000-01 would be bad in absolute and relative terms has been becoming clear by the month, since April 2000. For instance, in December, Tata Engineering reported a 54 per cent drop in heavy and commercial vehicle sales, a 14 per cent decline in light commercial vehicles and a 57 per cent decline in cars.

The cars' numbers have got worse by the month. For all the optimism exuded by the Chairman, Mr Ratan Tata, Tata Engineering is likely to fall short of the revised target of 70,000 cars by a long chalk. It sold only 32,560 cars in the first nine months and selling more than this number in three months looks extremely unlikely.

For the April-December 2000 period, car sales fell 12.5 per cent while the industry suffered a 4 per cent decline. Quite clearly, on volumes and market share, Telco has been losing ground. Its weak financials are not going to make it easy to aggressively push the product in the marketplace.

Needed, a surgical cut

What Telco may need at this stage to be in a position to maintain its position to survive and grow in the long term in the light/medium/heavy commercial vehicles is to take the car project burden off its balance-sheet. Realistically, it is difficult to see Tata Engineering pulling off a winner in this line of business over the long term.

Its chances may be better in the light/medium commercial vehicles segment where there may be growth opportunities, and the heavy commercial vehicles segment where Tata Engineering may dominate even if growth rates may not be attractive.

Even if volumes over time get to the 52,000 level seen in 1999-2000, Tata Engineering may be a good cash cow once price increases are absorbed without affecting demand levels. In fiscal 2000-01, equalisation of sales tax rates and high costs on emission compliance also played a role in lower volumes.

The weak position of truck operators and the effect of volatile trends on their operations may also make passing on price increases difficult. Overall, the picture does not look good. For the first six months of 2000-01, Tata Engineering reported revenues of Rs 3,698 crore (1999-2000 first half: Rs 3,650 crore) and losses of Rs 168 crore excluding one-time charges (profit: Rs 0.42 crore). The numbers would get worse by the end of the year.

In this backdrop, investors could consider trimming exposures but wait for the Budget to see if there are any measures that could improve demand/profitability levels. Only shareholders with a penchant for high risk could consider staying invested on the peg that Tata Engineering may get the car business into a joint venture or do an outright sale. The odds on either are pretty low at the moment.