Tata Motors (TTM) expects to increase the offering of electric vehicles in the next decade, and management is also offering a new electrical vehicle architecture. As a result, market estimates include double-digit sales growth and positive free cash flow from 2023. Using very conservative assumptions, my DCF model resulted in a valuation that is significantly higher than the current market price. I believe that many market participants have not learnt about the future expectations. I cannot explain how the company trades at the current price mark. I am a buyer.
Tata is a global automotive manufacturer, and the owner of luxury brands Jaguar and Land Rover.
The company sells its products all over the world. In my view, the geographic diversification is quite significant. If one region does not perform, revenue would most likely arrive from other parts of the world, which makes the revenue line quite stable:
I am quite optimistic about the company’s new strategy, which targets the production of modern luxury vehicles and services. More luxury vehicles will most likely enhance the company’s FCF margins in the coming years. In my financial model, I included an increase in the EBITDA and FCF margins from now until 2032.
Besides, it is quite relevant that management is promising to significantly increase the number of battery-powered electric vehicle powertrains. With experts noting that the electric vehicle battery market could grow by more than 33% from 2022 to 2030, Tata will most likely experience significant revenue growth in the coming years:
By the end of the decade, full-BEV powertrains are expected to represent around 60% of total Jaguar Land Rover sales. Source: 2021 Annual Report
Electric Vehicle Battery Market Research Report, Battery Type, Vehicle Technology, End Market and Region – Forecast till 2030: the market size is projected to be worth USD 192.29 Billion by 2030, registering a CAGR of 33.68% during the forecast period (2022 – 2030). Source: GlobeNewswire
Market Estimates Include Positive FCF in 2023 And 2024
Market analysts are quite optimistic about Tata’s revenue growth. They include 14-26% sales growth from 2022 to 2024, and EBITDA margin of 10-14%. In my view, the most interesting period will commence in 2023 when the company is expected to deliver both positive net income and free cash flow.
Given the current valuation of Tata, I don’t think many investors in the market are really aware of the company’s expectations. Please have a look at the numbers below because I took a look at the work of other analysts while doing my forecasts for 2022-2024:
Expansion Of Electrified Models And New Electrical Vehicle Architecture Could Mean A Valuation Of $51
The company’s Reimagine strategy includes the introduction of significant enhancements to the company’s existing vehicle portfolio. In my opinion, if management continues to offer more and more electrified models like the company did in 2020 and 2021, revenue and FCF will most likely trend north. Note the new PHEV models and plug-in hybrid technology:
This included a major expansion of electrified models. From September 2020, we introduced the first PHEV models to Jaguar, with F-PACE and E-PACE both gaining plug-in hybrid technology. We also brought plug-in hybrid technology to the Range Rover Velar, Range Rover Evoque, Land Rover Discovery Sport and Land Rover Defender, for the first time. Source: Annual Report
I am also optimistic about the new electrical vehicle architecture, which the company called Pivi Pro. If customers notice an enhancement in the vehicle experience, I will be expecting a significant increase in revenue. So far, management was quite appreciative about the new software updates and new connectivity opportunities:
Exploiting the speed and capability of our latest electrical vehicle architecture, Pivi Pro is faster, smarter, always connected and future-proof, thanks to software over-the-air updates. Its advanced capability and connectivity delivers a premium in vehicle experience. Source: Annual Report
In my base case scenario, I assumed sales growth of 14-12.5% from 2022 to 2032. Note that the global automotive market is expected to grow at a CAGR of 12.5%, so I believe that my assumptions are quite conservative:
The global automotive powertrain market was valued at US$4187 million in 2021, and is projected to grow at a CAGR of 12.5% during the forecast period 2022-2032. Source: GlobeNewswire.com.
I also used an EBITDA margin of 13% and effective tax rate of 32%, which implied 2032 EBIAT of INR469 billion. Note that my EBITDA margin, operating profit and effective tax rate are pretty much what the company reported in the past. I am not really thinking out of the box here:
My CAPM model includes a beta of 1.5, cost of equity of 13%, and cost of debt around 5%. The WACC stands at somewhere close to 9%. My numbers are close to the figures reported by other investment analysts:
I also assumed a D&A/Sales ratio of close to 3%, change in working capital/Sales of 1.7%, and growing capital expenditures. In my view, my numbers in this case scenario are quite conservative:
Finally, putting everything together, 2032 free cash flow stands at INR292.05 billion, and FCF/Sales would stay between 4.2% and 5%:
The selection of the exit multiple was not easy. Most competitors trade at close to 7x-8x forward EBITDA, so I assumed that the company’s 2032 EV/EBITDA multiple would be close to this mark. I wouldn’t expect investors to use an exit multiple much larger than 8x EBITDA:
So, with a WACC of 9%, exit multiple of 7.1x, and a share count of 765 million, the implied price would be equal to $51. Under the previous assumptions and the current market price, the company looks like a buy:
If we are a bit more fatalistic and use an exit multiple of 4x, the implied enterprise value would stay at INR2,240-INR2,260 billion. The implied price would be equal to $29, which is not far from the current valuation. Let’s say that the market appears a bit fatalistic about the company’s future free cash flow:
Worst Case Scenario Would Include Global Shortage In Semiconductors Supply, Which Would Lead To A Valuation Of $10
I am quite concerned about the supply of semiconductors in the future. If management has to pay a bit more for certain devices, or it doesn’t find enough suppliers, both revenue and EBITDA would decline. As a result, I believe that the company’s fair valuation would decline significantly. In the past, management noted that production capacity could increase in the second half of 2022:
More recently, the automotive industry has been experiencing a global shortage in the supply of semiconductors. We are monitoring the situation closely and working with our suppliers to minimise the impact of the disruption and intend to catch back as much lost production as possible when supply capacity improves in the second half of FY2021/22. Source: Annual Report
There are also many risks coming from new regulatory frameworks. If governments all over the world decide to increase compliance requirements for carbon emissions, the company may be a bit less profitable. As a result, if free cash flow expectations decline, I would expect a decline in the company’s fair value:
The transition away from traditional fossil fuels to more renewable energy sources and the increasing pace of that transition creates particular compliance challenges, in particular tailpipe emissions for automotive companies and wider compliance requirements for carbon emissions produced during manufacturing and other operations. Source: Annual Report
In the worst case scenario, I expect sales growth between 2.5% and 7.5% from 2022 to 2032. If we also include an EBIT margin of 6% and EBITDA margin of 10%, the implied 2032 EBIAT would stand at INR205 billion. Note also that I assumed D&A between INR115 billion and INR200 billion, and conservative changes in working capital from 2022 to 2032. Finally, with a capital expenditures/sales ratio between 6.5% and 8.5%, the free cash flow would grow from close to INR3.805 billion to more than INR75 billion in 2032:
Putting everything together, with a WACC of 9% and exit EBITDA multiple of 5.5x, I obtained 2022 implied enterprise value close to INR1.105 billion, and a target price of $10.
Given my results and the fact that this case scenario is very unlikely, I believe that there is an upside potential in the stock price. With the current market price, I believe that it is more likely that the stock goes up.
With many investors expecting positive FCF from 2023, Tata will also receive significant attention as the number of electric vehicles increases in the next decade. In my view, if management successfully offers a new driving experience thanks to new electrical vehicle architecture, revenue will most likely trend north. I don’t believe that market participants learnt about the company’s expectations because the current valuation of Tata is too cheap. Under conservative assumptions, I obtained a fair price that is significantly higher than the current market price. I will be buying.