It Pays to Look Under Tata’s Hood; Indian accounting standards give Tata discretion in accounting for R&D spending.

It Pays to Look Under Tata’s Hood


Nov. 15, 2013 4:30 a.m. ET

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India’s Tata Motors 500570.BY +4.66% is in the big league of global car makers. When it comes to accounting for certain costs, though, it doesn’t play exactly the same way as its peers. India’s largest auto company by market value leapt onto the world stage after buying JaguarLand Rover in 2008. Now that the British luxury car maker makes up roughly 80% of Tata’s revenue, this Indian firm is competing with BMWBMW.XE -0.06% Mercedes-Benz and a host of American and Japanese premium brands. And when compared with some of these peers, Tata looks to be a relative bargain. Although its shares are up more than 20% so far this year, the stock trades at 9.6 times estimated profit for the fiscal year that ends next March. That is at a discount to Daimler, which owns Mercedes, and BMW. Yet Tata’s valuation may be flattered by the way it treats certain costs. This has the effect of boosting its profit—in the near term, at least. Taking that into account, Tata is more expensive than it initially appears. At issue is how Tata treats research and development costs. Tata’s R&D program, at 6% of sales, is higher than the 4% or 5% global car makers typically spend on new products and designs.Indian accounting standards give Tata discretion in accounting for such spending. The company can treat it as an immediate expense that cuts into income. Or it can capitalize the spending, recognizing it over a longer period of time. Tata capitalized roughly 80% of R&D activity last fiscal year. In this, Tata is ahead of Indian counterparts—Indian SUV-maker Mahindra & Mahindra capitalized 44% of its R&D last fiscal year.

Tata’s practice also contrasts with global rivals. American and Japanese car makers expense all their R&D spending, as local accounting rules require. German auto makers, who report under international accounting standards, can capitalize R&D, though this has averaged only a third at BMW the last five years.

To be sure, Tata may need more R&D than BMW and Mahindra. JLR sported outdated models and platforms before 2008, and Tata says it’s treating the British unit as a young company hungry for new designs. The company says it has followed this practice for years, meaning it isn’t changing course.

Still, Tata’s R&D accounting bolsters the bottom line. If all R&D spending were expensed, Tata’s net profit for this fiscal year would fall by two-thirds, estimates Bernstein Research. Tuning the numbers this way decreases earnings by 10% at Daimler. And at BMW, it actually boosts earnings 1% since this car maker amortizes older R&D spending and bears the expense on its income statement.

Adjusting for R&D this way, Tata’s valuation would rise to 28 times this fiscal year’s earnings. Valuations at Daimler and BMW come in at 11.3 times and 10.1 times, respectively, after similar adjustments. Meanwhile, Tata will have to amortize R&D spending once the cars under development hit the market. This will crimp profits down the line.

Investors are revved up about Tata because sales of Jaguars and Land Rovers are growing faster than rivals such as BMW. But they should kick the accounting tires before driving away with the stock.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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