Shares of India’s leading commercial vehicles (CVs) manufacturer, Tata Motors Ltd, have underperformed the Nifty by more than 10% since end-October. Surprisingly, its main competitor, Ashok Leyland Ltd, has outperformed the Nifty by about 24% in the same period. What gives?

Ford had bought the two brands separately for a total of $5.23 billion (Rs20,710 crore). In calendar years 2005 and 2006, the company took impairment charges worth $2.9 billion based on its estimates of declining cash flows from the two brands and because the carrying value of these assets on its books far exceeded their fair value. One of the main reasons for the performance shortfall has been strict labour laws in the UK, where the Jaguar and Land Rover plants are based.

According to reports, Tata Motors has been the preferred bidder because it has the backing of the UK-based labour unions. The markets are naturally concerned that major cost cutting may not be possible without tackling the labour problem.

Needless to say, much would depend on the final acquisition price and the financing structure Tata Motors adopts to fund the purchase. In addition, it’s important to see if the deal includes Ford’s existing distribution network for the brands and what the agreement says about component and engine supplies.

On the positive side, profitability of the two brands has improved lately. Having taken large write-offs in the previous two years, and because of an increase in net product prices and a favourable cost performance, the Jaguar and Land Rover operating segment reported a small profit last quarter.

In the first nine months of the current calendar year, Ford’s premier automotive group (which also includes Volvo Group cars) reported a pre-tax, pre-exceptionals profit of $445 million, an improvement of nearly $1 billion considering that, in the same period last year, the segment reported a loss of $518 million.

A large part of this can possibly be attributed to Jaguar and Land Rover, since Volvo cars had a loss of at least $97 million in the third quarter.

While Ford doesn’t provide a detailed brand-wise break-up of financials, it’s clear that performance of Jaguar and Land Rover has improved this year. Their margins, of course, continue to be in low single digits. Besides, Jaguar has recently introduced its new XF sedan, which also increases the attractiveness of the purchase. Notwithstanding these positive developments lately, an analyst with a foreign brokerage expects Tata Motors’ shares to correct given the large-sized gamble.

As far as Ashok Leyland shares go, if the rumours of a stake/real estate don’t turn out to be true, the stock is considerably expensive.

Having traded at a discount to Tata Motors all along, it’s suddenly now trading at a premium based on its fiscal 2009 price-earnings ratio. Some analysts have assigned a value to Tata Motors’ various subsidiaries, amounting to 20% of its current valuation. Adjusted for this, Ashok Leyland is trading at a considerable premium, for no particular reason.

Its volumes fell 16% last month, led by a 22% fall in its mainstay goods segment. In previous months, Ashok Leyland’s strong passenger bus sales offset part of the decline in the goods segment. However, in November, bus sales were flat owing to a slowdown in orders from state transport corporations. Since government orders can fluctuate, the performance of the passenger bus segment is not a big worry. But falling sales in the goods segment continues to be a concern. Tata Motors did much better last month, reporting flat sales in the medium and heavy CV segment, but any turnaround in sales seems elusive enough.

Chirag Shah of Emkay Research points out in a recent research note that although industry volumes in the medium and heavy CVs segment fell 12.5% between April and September this year, the net tonnage sold was down a mere 2%. This is because of change in product mix, where trucks with higher capacity were sold. Yet, financials of both Tata Motors and Ashok Leyland have been under severe pressure this fiscal, as rising costs have acted as a double whammy. While rising interest costs and increased prudence by banks on lending for CVs have been one of the major causes for the drop in volumes, another factor is how the ban on overloading of trucks has played out for the industry. Initially, the ban led to jump in new vehicle sales and resulted in a high base last year.

This year, the ban hasn’t been enforced as much, and overloading has resumed, causing a drop in potential new vehicle sales.

The positive for the industry is that freight rates have been stable. And soon, the industry will be dealing with a low-base effect (on a year-over-year basis), rather than a high base. But as things stand, the markets are now more interested in external factors rather than the outlook on domestic CV sales.

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