Passenger and commercial vehicle manufacturer Tata Motors Ltd had little choice but to alter its fund-raising plan to buy the Jaguar and Land Rover (JLR) brands. Its earlier plan, announced on 28 May, involved issuing equity and equity-linked instruments worth Rs9,800 crore. The company had said this would dilute its equity base by up to 35% in the current fiscal year and another 12% in three to five years, adding up to 51%.
This was when Tata Motors’ stock traded at Rs635. Ahead of the company’s review meeting on Wednesday, the stock had fallen by a third to Rs425. Mint’s calculations show that if the company had stuck to its original plan, the equity dilution would have been as high 77% in three-five years, with the majority equity issuance happening in the current fiscal year.
An auto analyst with a foreign brokerage firm says it was this prospect of a very high dilution that led to the sharp fall in Tata Motors’ shares. The company’s announcement of the large equity issue in May has worked as a double-edged sword.
The news about equity dilution first drove down prices, which in turn led to fears about further dilution and the cycle kept repeating itself. According to the analyst, the markets had factored in a dilution of as high as 70%.
With the company now reducing its dependence on equity issuance by Rs3,000 crore, the dilution would be roughly 46-53%, based on the current share price. It will now sell some of its investments to raise part of the funds required to finance the JLR acquisition.
It’s interesting that this information hasn’t led to a rally in Tata Motors’ shares. Although the stock opened strongly on Thursday, it closed the day 2.1% lower at Rs416, faring only slightly better than the broad market, which fell 3%.
One reason for the lack of enthusiasm could be the fact that the dilution is still high at about 50% in the current year. This assumes that the company will go ahead with its overseas issue worth Rs2,600 crore, for which it got shareholders’ approval.
And, no one expects JLR to add 50% to Tata Motors’ profits anytime in the near future and make good the drop in earnings per share because of the dilution.
The other more important reason is that the uncertainty relating to the pricing of the equity issuances remains. With the markets showing no signs of recovery, it could well turn out that Tata Motors would eventually have to issue more shares to raise the same amount of capital.
To add to all this, it hasn’t been completely open about the financial details of JLR. The market is still divided on whether it is profitable, leave alone other details such as cash flows. The car maker’s cash flows are likely to be negative due to recurring high research and development expenses, and this is likely to necessitate further fund raising at a future date.
The only way to stem the fall in its share price would be clarity on the equity issuances’ pricing and timeline on one hand, and financial details of JLR on the other.
Stick to defensive stocks as investment demand slows
Just before the crash in the markets, the sectors that had run up the most and were the most richly valued were all linked to investment demand. These included the capital goods sector, the power sector and the real estate companies. Much store had been set on the bulging order books of the engineering companies and the visibility of their revenues. At the macro-level, the story was that while higher interest rates had derailed the consumer durables and auto sectors, investment demand had picked up the baton.
It was a very plausible scenario. Unfortunately, the numbers contained in the “Economic Outlook for 2008-09”, released recently by the Prime Minister’s economic advisory council, tell a rather different story. The saga started in 2001-02, when total investment or total gross domestic capital formation contributed a negative 0.7 percentage point to that year’s gross domestic product, or GDP, (at market prices) growth rate of 5.22%. Consumption was the great driver of growth that year, with domestic final consumption expenditure contributing 4.57 percentage points to GDP growth. Investment demand bounced back the next year and contributed much more to GDP growth than consumption, but much of that was inventory growth and investment in fixed capital contributed a mere 1.57 percentage points of that year’s miserable GDP growth of 3.77%.
See: Shared growth
Investment in fixed capital became the largest contributor to growth in 2004-05, when it contributed 4.66 percentage points to the overall growth rate of 8.28%. Consumption contributed 3.93 percentage points that year. Interestingly, the contribution of investment in fixed capital to growth peaked in 2005-06, at 4.73 percentage points, and it has been going down since then. Last fiscal year, it was clearly consumption that was the most important driver.
More importantly, the council believes that, of the 7.7% growth that it envisages for 2008-09, consumption will contribute 5.09 percentage points, while total investment demand (including inventories) will contribute 3.62 percentage points.
That’s quite a sharp deceleration from the 4.51 percentage points that investment demand contributed to GDP growth last fiscal. That should be another reason for sticking to defensive stocks and leave sectors such as capital goods and power alone.
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