Telcos Gamble

The hype around this Tata flagships small car ambitions has not matched its performancein the stock markets.

Is this an opportunity or a warning?

Telco, the truck maker, is moving towards becoming Telco the car maker and is hoping to end the millenium with what could well be the companys and the indigenous industrys crowning glory with its yet-to-be-named small car. Its much-publicised new offering, scheduled for launch in November this year and displayed as a prototype at last months Auto Expo, has industry pundits and the doubters stunned. But look away to the stock markets and the picture changes dramatically. The stock, one of the most frequently traded on the markets, has been hitting new lows practically everyday.

 

The general economic slowdown that hit the companys mainstay the commercial vehicle business and apprehensions about the small car project have driven the scrip down. The scrip, which traded at a premium of about 19 per cent to the sensex in the past now trades at a discount of 35 per cent.

To say that the scrip has been hammered would be putting it mildly. From a high of Rs 471.75 in July 1997 the scrip is currently languishing at Rs 227. Most analysts expect the scrip to crash to below Rs 200. Importantly, though, they also prefer to consider this slide a buying opportunity. Is this confidence warranted? Answering that question requires examining the details of the companys small car project, the most important development in its history.

The first and most important issue: how does Telcos small car (which has been given a working name of Mint) compare with other models that are expected from emerging competitors like Daewoo (DArts) and Hyundai (Santro)?

Analysts say, Telcos trump card is that it will be offering a diesel version of the car, something none of the other makers will be offering. A diesel car at a base price of around Rs 250,000 with a 1400 cc-engine at 55 bhp with a fuel economy of 16 km a litre will be hard to beat, they say. And aesthetically, it is comparable to what others plan to offer.

Though some existing models like the Maruti Zen and Fiat Uno may acquire diesel versions, the fact that these cars will have a high import content compared to the totally indigenised Telco car means that they will not be able to match Telcos price.

Telco can also bank on the credibility that a Tata product commands in the market. Coupled with the revamp of its dealer and servicing network, a major influencing factor with customers, this is expected to help the company gain leverage for its cars. Telco intends to start with an initial set-up of dealers and service outlets in the four metros and mini metros. The company could also benefit from possible customer aversion to foreign car collaborations following the imbroglio betwen Premier Automobile and French automobile company Peugeot.

Though all these factors do indicate some advantages for Telco, they cannot entirely erase the threat from government-owned Maruti Udyog, Indias largest and fastest-growing car maker. With a depreciated plant, large volumes in 1996-97 Maruti has notched up a volume of 3.31 lakh cars, an established product line and extensive dealer network, Maruti could easily upgrade its popular 800 model and provide Telco some tough competition. The repeat purchases in case of Marutis indicate strong brand loyalty.

Indeed, Telcos intentions of offering a Zen at the price of a Maruti 800 has pushed Maruti to the limit. The company is now operating at optimal capacities using Japanese management techniques to improve productivity. However, there is a limit to which this can be achieved with the market for small cars expected to expand as a result of all the new launches.

Maruti will have to expand capacities to meet demand and maintain leadership. Of course, the difference between the Indian government and Suzuki over Maruti could jeopardise all expansion and upgradation plans. But a rapprochement could change the competitive equation as well.

If competition is a major issue, the financial viability of the project is an even bigger one. Any venture of this magnitude requires huge capital expenditure and returns take time. And in spite of the inherent strengths of the project, Telco is expected to take a hit on this account.

According to the company, this car project will be viable at 60,000 cars with the plant having a capacity to produce 150,000 vehicles. The company expects to sell 50,000 cars in the first 12 months of production. Though market factors will finally decide how many cars Telco manages to sell, market estimates vary widely.

According to Richard Desouza, analyst, Alchemy Share & Stock Brokers, Telcos projections should not be difficult considering the initial response.

According to a report by Mafatlal Securities, the company will sell 18,000 units in financial year 1999, 75,000 units in

2000 and 112,500 units in 2001. They expect the car project to make operating losses in the first year of operations and losses in terms of PAT for the first two years.

Figures put out by another leading auto analyst point to an interesting trend. According to these projections, had Telco not gone in for the car project in 1998-99, it would have ended up with a net profit of Rs 807.79 crore on sales of Rs 11,234.28 crore.

The car project during the same year is expected to increase Telcos sales to Rs 11,561.30 crore but drag down its net profit to Rs 681.72 crore. He expects the company to sell 15,000 small cars in 1998-99. Effectively, the car project on its own is expected to make a loss. But the picture beyond this is rosy.

For investors, however, the main fear is not that the car project will make losses initially as expected, but the fact that Telcos commercial vehicle business is not seeing good days.

Telco is the second largest private sector company in the country. It is the leader in commercial vehicles with a market share of about 70 per cent. With the automobile industry up against declining volumes from the third quarter 1996-97, Telco should have been the first one to be hit.

However, in 1996-97, Telco belied market expectations to put up one of its best performances. On a total income of Rs 10096.59 crore (Rs 7,735.9 crore in previous year), the company reported a net profit of Rs 762.36 crore (Rs 530 crore).

According to most of the analysts, this performance was impressive prima facie considering the slowdown in the sector.

But a closer look at this performance shows that Telco was actually hit and suffered a continuous decline in actual sales to customers. It only managed to achieve these figures because sales in March 1997 were high, accounting for 13.6 per cent of the companys volumes in 1996-97. This raised doubts that the company may have pushed sales to its dealers rather than actual sales to its customers.

This was borne out by the huge inventory pile-up at the dealers end as well as at the companys plants and stockyards of as much as 50,000 vehicles, one of the highest in recent times. With no cuts in production, this subsequently had its effects on the first half of the current year.

In September 1997, income declined 16 per cent to Rs 3850.17 crore while net profit crashed 35 per cent to Rs 213.93 crore. According to Desouza, These problems are a hangover of the companys response to the recessionary trend in the economy and in the face of declining sales. However, he feels that these things should clear themselves once the company gets its act together and demand picks up atleast at the retail/dealership level.

Things should begin to look up for Telco as production was cut drastically and according to dealers inventory levels in the past four to five months have declined to a more manageable 18,000 to 20,000 vehicles.

Another point of concern is the declining Sumo sales. Against an average of 4,000 Sumos a month in the first half, the company has been able to average around 3,200 Sumos a month in the last couple of months. Sales in December 1997 dipped to 2,160 vehicles compared with 3,919 vehicles for the same period in 1996.

Considering this, the car venture could have advantages for the company. As Rajesh Kothari, analyst, Mafatlal Securities states, The car project will reduce the companys risk profile. The small car project will improve Telcos overall rating since the car business is less sensitive to the general economic cycle compared to the commercial vehicle business. He expects the contribution from commercial vehicles to gross revenues to reduce from 82.09 per cent in 1997-98 to 58.7 per cent in 1998-99.

And finally coming back to the viability of the small car project, what better example than that of Maruti. The premier auto company in the country has faced little or virtually no competition in the past and has performed well.

Currently, Maruti has an operating profit margin of 11 per cent and has achieved a return on capital of 51 per cent.

Maruti Udyog has achieved this with the right product and pricing strategy. Telco seems to have all these in place as well. The big question is whether the consumer takes to the Mint as it has done to Maruti. If that happens then there is no looking back for the company. While analysts expect the price to break Rs 200, investors could benefit if the stock were bought at declines.