Tata Motors, India’s largest automaker by stock market value, has outstanding exposure to foreign currency borrowings in the form of foreign currency convertible bonds (FCCBs). These instruments, which are expected to mature over the next few years, have been affected by large fluctuations in the foreign exchange (FX) market.
“We have not hedged these instruments and had to take some significant valuation in mark-to-market losses in our quarterly results that we have published in the last two to three quarters, like many of the other companies in India,” said C Ramakrishnan, chief financial officer (CFO) at Tata Motors to Asiamoney PLUS in a telephone interview on March 19.
“Some of it has been recouped with the rupee strengthening a little bit over the last two to three months. Depending on whether these bonds get converted or not, some of these losses may or may not happen,” added the Mumbai-based CFO.
A convertible bond is a fixed income instrument that can be converted into a predetermined amount of the company’s equity at certain times during its life, usually at the discretion of the bondholder.
The auto company’s domestic operations post-tax profit plummeted by 57.6% to INR1.38 billion (US$27.4 million) in the fiscal third quarter ending December 31, 2011. This is due to rising input costs, higher marketing spends and competition in passenger car segment, coupled with depreciation of rupee and booking of mark-to-market losses of INR1 billion.
Tata Motors issued two five-year convertible bonds – one maturing in July 2012 worth US$490 million and the other in 2014 worth US$375 million – for capital expenditure (capex) purposes. The latter has a callable option this October, which could be exercised says Ramakrishnan.
“The bonds which are maturing a couple of years later are very much in the money and the share price – after the issuance of the bond – has been on the increase and has been doing quite well. So we expect those bonds to be converted,” declared Ramakrishnan. “The bond that is maturing in July of this year, they’re almost at conversion breakeven price with the improvement in share price performance in recent months.”
However, Tata Motors, has taken some precautionary steps to minimise FX risks and has opted to hedge another portion of foreign currency borrowings – its syndicated loans – which are maturing in the next few years.
“Depending on our outlook, our net dollar positions and on the period of the exposure, we do take some percentage of cover going forward with increasingly lesser percentage beyond time,” said Ramakrishnan. “But more during next one, two or three quarters, we will cover slightly higher percentage of our exposure on a net basis.”
The company has two outstanding US dollar-denominated syndicated loans that were issued in two tranches with values of US$200 million and US$300 million and are due in 2016 and 2018 respectively.
Despite the weakening rupee trend, Tata Motors experienced a jump in net profits “mainly triggered by improvement in the performance of the Jaguar Land Rover” and a handsome gain in exports as impact of currency falls.
“In terms of trade exposure, 90% of our sales are in India and 10% are exports. All of our costs are in rupees and we hardly import any components for our vehicles,” noted Ramakrishnan. “So we are always foreign exchange positive in terms of our trade flows – our exports are always much higher than our imports. So on the trade side, we will benefit on the stronger dollar and weakening rupee.”
The rupee declined 11.6% year-on-year to 50.2344 per dollar in Mumbai on March 19, according to data from Bloomberg. The rupee dropped 0.7% last week. One-month implied volatility, a measure of exchange-rate swings used to price options, fell 25 basis points (bp) to 9.5%.
Tata Motors strong brand name and resilient performance amid increasing market volatility means it has not been restricted in terms of access to funding.
But the company highlighted that its main concern has been the tightening of liquidity and the high cost of borrowing in the marketplace. This will have an adverse impact on customers’ access to funding.
“I don’t think I would call funding constraints a concern on our growth at this stage. Both capital markets and institutional lenders both have been fairly open to providing us funding that we need,” said Ramakrishnan. “Car purchases have been affected by the inflation concern and anti-inflationary mechanisms like high interest rates.”
Moreover, the auto giant recently increased prices of its passenger vehicles, including the Nano, by up to INR35,000 due to the hike in excise duty in India’s budget for 2012-13. Finance minister Pranab Mukherjee had proposed to raise excise duty from 10% to 12%.
This could potentially dissuade buyers.
“Whatever the excise levied, we normally pass down the related changes to the market, which is what we have done,” said Ramakrishnan. “There may be some impact in the market some softening, but normally March is a busy month for sales in India.”
As a result, Tata Motors’ shares were down 2.4% on March 20, hit as well by profit-taking after the stock hit a record high on Friday (March 16).
Despite the central bank raising interest rates to curb inflationary pressures, Tata Motors still see buoyant demand for its commercial vehicles.
“Commercial vehicles are bought for commercial operations like business investment for a transport operator. They will be affected more by the liquidity and availability of money rather than the relative cost,” said Ramakrishnan.
The Reserve Bank of India (RBI) recently took steps to improve liquidity in the banking system. On March 9 it unexpectedly announced a cut in the cash reserve ratio (CRR) – the share of deposits that banks must hold with it./ The cut was a much a sharper-than-expected 75bp and is estimated to have released INR480 billion of liquidity into the banking system.
In addition, Ramakrishnan believes that interest rates have peaked and the market will see a moderation in due time, which should help support the business.
Standard Chartered said it expects the central bank to reduce interest rates by 75bp in 2012-13, lower than its prior forecast of cuts totalling 150bp, citing higher crude oil prices and a domestic excise duty hike.
Tata Motors, which spends approximately US$800 million annually on capex, has no plans to tap capital markets for funding this year. Capex is expected to be met using its free cash flow, which is normally placed in low-risk instruments like money market deposits.
The auto manufacturer will look to invest around INR8-10 billion over the next two to three years on a plant in Dharwad, Karnataka. This additional plant in Dharwad, with a capacity of around 90,000 units annually, will exclusively manufacture the Tata Ace Zip and Magic Iris, which fall into the family of light commercial vehicles (LCVs).There have been rumours in the media that Tata Motors may acquire bankrupt Swedish carmaker, Saab Automobile’s assets for US$350 million. Saab Automobile, owned by Dutch company Swedish Automobile, filed for bankruptcy in December, nine months after halting production due to a lack of funds.