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Weak Offering

Though a part of the reputed Tata Group, Tata AutoComp Systems' financials are weak…

The Tata group is planning an initial public offering (IPO) of its auto component manufacturer Tata AutoComp Systems (TACO). The latter has filed its draft red herring prospectus (DRHP) with the Securities and Exchange Board of India (SEBI). According to the DRHP, the company plans to raise Rs750 crore through a combination of fresh issue of shares and sale of stake by promoters. The biggest stake in this company is held by Tata Industries (34.40 per cent). Its other major shareholders include Tata Motors (26 per cent), Tata Capital (24 per cent), Tata Sons (14.25 per cent) and Tata Investment Corporation (1.35 per cent).

TACO manufactures and supplies a variety of components, assemblies and aggregates primarily to original equipment manufacturers (OEMs) in the automobile sector. Some of the notable names include Tata Motors, General Motors India, and Mahindra & Mahindra.

Objectives of the issue
The company plans to use the amount raised through the IPO to expand its business and to repay its loans. As per the DRHP, TACO intends to spend Rs87.67 crore for capacity expansion and modernisation of its existing plant belonging to the interior and plastic division (IPD). Another Rs70.35 crore will be spent on building a manufacturing unit for TACO Composite (TACOCL), one of it subsidiaries. Around Rs284.9 crore will be spent on repayment and prepayment of loans. Currently the company’s outstanding debt amounts to Rs386.09 crore.

Fast-growing industry
The auto component industry’s prospects are closely tied to those of the automobile industry. The Indian auto component industry’s turnover was approximately Rs11,580 crore in FY10 and is expected to grow to Rs22,400 crore by FY15.
Demand from OEMs is estimated to grow at the rate of 17-19 per cent in FY11 and thereafter at a compounded annual growth rate (CAGR) of 15 per cent till FY15. Exports of auto components are estimated to grow over the same period at the rate of 20 per cent.
Total domestic automobile production grew by 25.85 per cent year-on-year in FY10.
Between FY05 and FY10, the domestic consumption of auto components grew at a CAGR of 18 per cent (6 per cent in FY09 and 12 per cent in FY10).
The auto component industry’s current asset base is worth Rs7,000-7,500 crore. According to estimates, it will require investments worth another Rs6,000-6,500 crore by FY15.

Strengths
Backed by Tata Group: TACO is part of the Tata Group of companies. Hence it is expected that it will share the attributes that the Tata Group is known for. Being part of a larger group should also ensure that investors are protected from business malpractices of any kind.
Diversified product portfolio: The company has a diversified product portfolio. It manufactures and supplies products for interiors (door trims, cockpit, dashboard, etc.), exteriors (bumpers, front grills, side mouldings), engine cooling systems, batteries, seating and suspension systems. It meets the requirements of all the major segments such as passenger vehicles, commercial vehicles and tractors.
The company operates its businesses through four subsidiaries and five joint ventures. It has three divisions: IPD (manufactures cockpit, door panel, bumpers), supply chain management (provides logistic support) and TACO Engineering Centre (which develops automotive systems and is also into component design).

Concerns
Fluctuations in raw-material prices: Since it is a manufacturing company, it depends heavily on raw materials like steel, copper, and aluminum. Raw materials account for around 72 per cent of its net sales. Increase in the cost of raw materials has the potential to affect its bottomline.
Customer concentration: The company’s primary customer is Tata Motors. For the six months ended September 30, 2010, it contributed 48 per cent of its total income. The next four largest customers accounted for 21.6 per cent of its total income. Furthermore, as stated in the DRHP as well, TACO will continue to depend on Tata Motors for a substantial portion of its sales. So if Tata Motors faces adverse circumstances, TACO’s prospects will also deteriorate. Furthermore, as Tata Motors has a say in the company’s management, it could potentially influence TACO’s decision making for its own benefit. For instance, it could compel TACO to sell auto components at a lower margin in order to boost its own profits. This could lead to lower profitability for TACO.

Poor margins compared to peers
The company’s close peers include Amtek Auto, Bharat Forge, Motherson Sumi System and Sundaram Fasteners. In FY09, when all the auto ancillary companies were facing the heat due to the slowdown in the auto sector, TACO was able to increase its net sales by 29 per cent. On the other hand, net sales of Amtek Auto, Bharat Forge and Motherson Sumi System declined by 17.93 per cent, 6.28 per cent and 0.63 per cent respectively. Again, on a y-o-y basis TACO posted the highest growth compared to its peers in FY10.
However, if you look at profitability, the company’s net profit margin is the lowest among its peers in FY10. In FY10, Amtek Auto, Bharat Forge, Motherson Sumi and Sundaram Fasteners’ net profit margins were 27 per cent, 22.39 per cent, 13.69 per cent and 12.56 per cent respectively. Tata Auto Comp had a net profit margin of 7 per cent only.

Financials
In FY09, which was a difficult year for the entire auto component industry, TACO suffered a net loss of Rs192.47 crore. But in FY10, its net sales bounced back to Rs938.55 crore. In the last three years, the company’s net sales have grown at a compounded annual rate of 29.96 per cent while its PAT has grown at a CAGR of 9.85 per cent.
But over the past few years the company’s profit margin has been on the decline. From 21.59 per cent in FY06, its net profit margin declined to 7 per cent in FY10.
At the end of FY10, the company’s total debt stood at Rs386 crore and its interest coverage ratio at 1.9. Its average interest coverage ratio over the last five years has been 3.71.
Although TACO is backed by the Tata brand name, the company’s financials are not very sound. While its sales have been on the ascendant, both its profit margin and operating margin have been declining. This raises a question regarding whether the company will be able to provide good returns to its investors. Let the company list, let its fundamentals improve, and only then invest in it.