Different lanes
Tata Motors demerger will improve efficiency
The implementation of the decision to reorganise Tata Motors into two independent listed verticals will take 12-15 months. The initial market reaction to the announcement of the demerger was positive, but not very enthusiastic. The conventional wisdom is that such demergers allow “value unlocking”. Investors can better understand where a single and focused business is headed, while managements can also concentrate on the operational dynamics. Hence, markets tend to assign a higher valuation to focused businesses. Paradoxically, this may not have a dramatic effect simply because the company is well-run. It has successfully weathered the ups and downs of Covid and chip shortages in the recent past. It is correct that there are differences between passenger vehicles (PVS) and commercial vehicles (CVS), including understanding and responding to sources of demand, financing models, and managing the respective supply chains. Two dedicated boards, each focused on one segment, may be able to fine-tune operations further. It is also true that each vertical may find it easier to raise funds for a specific project as well.
If one wishes to only take exposure in one segment, one may do so. So there may eventually be some value unlocking. But analysts also point out that Tata Motors has massively outperformed the market with over 140 per cent capital gains in the past 12 months, while the Nifty has risen 25 per cent. This means that any medium-term upside is likely already priced into the valuation. While investors will receive an equal number of shares in both the new companies, the successor companies will be lopsided in terms of comparative turnover and margins. Mainly by virtue of holding the Jaguar Land Rover (JLR) portfolio, the PV segment generates around 79 per cent of consolidated revenues and it has an operating margin of 15-16 per cent. Further, Tata Motors has a 70 per cent domestic market share in the new electric vehicle passenger segment and it is challenging Hyundai for No 2 position in PVS. The CV division has an operating margin of around 7 per cent and contributes only about 21 per cent of consolidated revenues. Volume growth in PVS is also likely to be higher, though Tata Motors is looking at moving into electric buses and other new-age CVS which may boost volumes.
However, while the company would obviously like to gain market share in domestic PVS and CVS, since JLR generates roughly two-thirds of consolidated revenues, its focus is inevitably more global than domestic. If global demand for PVS picks up, JLR should do well and in that case, the PV segment as a whole will do well. The pandemic and the subsequent Ukraine war hit the global auto industry hard since semiconductor supplies dried up. But that also taught auto manufacturers a painful lesson in terms of supply diversification and inventory management. Since the value chain for JLR is also located overseas, Tata Motors is sensitive to fluctuations in global supply-demand for those commodities and it does most of the business in foreign exchange. In sum, while this demerger appears to have little downside, it may also not yield much in the way of immediate upside for investors. However, operationally, it would be expected to increase efficiency over time.