An Interesting Play on the Auto Industry

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Tata Motors (NYSE: TTM) has been manufacturing automobiles in India since 1954, however over the past several years they have become a major player in the global automaker landscape.  So far in 2013, shares of the company have fallen by over 23% at a time when most other stocks seem to be making new highs daily.  The main reason for the decline is the news that India’s auto sales are now projected to fall in 2013 for the first time in a decade.  With a great market share and an expanding range of vehicles, is this a good time to get into Tata at a bargain, or should investors wait out the economic slowdown in India before jumping in?

<img alt="" src="http://g.fool.com/editorial/images/30357/ttm-3-month_large.png" />

Tata has historically been a manufacturer of commercial vehicles; however its recent notoriety has come from its passenger vehicle division.  For those who are not too familiar with Tata’s lineup, they currently produce 14 models of passenger vehicles, including the Nano, which catapulted Tata to relevance. 

The Nano: Game Changer

<img alt="" height="240" src="http://g.fool.com/editorial/images/30357/tata-nano_large.jpg" width="330" />

Introduced in 2008, the Nano was the least expensive production car in the world at under $3,000 U.S.  The current base price for the Nano is around 150,000 rupees, or about $2,750.  Tata intended for the Nano to do for the Indian middle class what the Ford (NYSE: F) Model T did for the middle class of the United States when it was introduced.  Although sales of the Nano were slow at first, the increase in emphasis on affordable passenger cars has been a success, as evidenced by Tata’s revenues, and the company has a nice 25.2% market share of all four-wheeled vehicles sold in India.

<img alt="" height="255" src="http://g.fool.com/editorial/images/30357/tata-revenues_large.png" width="424" />

In my humble opinion, since the Nano is still the cheapest new car available in India, Tata is in a great position to capture new market share despite the slowing new vehicle sales in India.  The slowdown is due to a combination of an economic slowdown in India combined with high loan interest rates.  In an environment like this, the lowest cost options usually win.  This is the same reason that Wal-Mart was one of the best performers during the U.S. financial crisis.

Growth

Tata has grown tremendously over the past decade, largely as a result of acquisitions, in addition to the success of their own passenger car division.  The most notable of these, especially for U.S. investors, is Tata’s acquisition of the Jaguar and Land Rover brands from Ford in 2008.  Since taking over the brands, Jaguar Land Rover (the subsidiary’s name) has produces such new vehicles as the Range Rover Evoque and Jaguar F-Type.

Cheapest Cars in the United States??

Tata also plans to grow by focusing on expanding its international operations in new markets all over the world, including the United States, where Tata would love to become a major player.  A few months ago, Tata announced that it was redesigning the Nano for the U.S. market, and plans on selling it within three years. 

Although by upgrading the Nano to meet U.S. standards will mean a significantly higher price tag then it has in India, the Nano will still be very inexpensive.  Changes that must be made, such as emission controls, safety features, and conveniences such as power steering, traction control, and a bigger engine should bring the Nano’s base price to around $8,000.  This would make the Nano America’s cheapest car by a large margin, as the next cheapest new car is the $11,750 Nissan Versa.

How to Play the Auto Sector

The right automaker for your portfolio depends on your risk level, as well as what direction you think consumer spending habits are heading.  Tata is a fantastic choice if you believe (as I do) that the decline in India’s auto sales is temporary and that the increase in middle-class spending will continue.  I also think that Tata is a great investment before the U.S. version of the Nano is released, which I believe will be a great success here. 

Valuation and Alternatives

Tata is a relatively high-risk way to play the sector, and its low valuation of less than 9 times forward earnings is evidence of this. 

If you want a safer, more traditional approach to the auto industry, Toyota (NYSE: TM) may be the way to go.  The largest automaker in the world, Toyota makes a great product and is a very stable company, and shares trade at a premium valuation of 15.1 times forward earnings.  As stated before, Toyota is possibly the safest way to play the auto industry, and should provide shareholders with nice, steady returns over the next few years.

If you want a little more risk/reward, Ford may be worth a look.  Ford trades at just 8.7 times forward earnings, and has also had a pullback lately, down about 12% from its highs.  With earnings projected to grow by 11% annually going forward, Ford could produce great returns, if they are able to sustain their turnaround since the crisis of a few years ago.  Ford is actually the best dividend payer of the group, yielding over 3%, as opposed to around 1.4% for the other two companies mentioned.

Conclusion

Whichever way you decide to invest, I think the auto industry in general has several growth years ahead of it.  That said, I think Tata has the most potential of the group, especially if they successfully capture some of the low-end new vehicle market in the United States.


Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus