Analysing Tata Elxsi with Tanushree Banerjee

India is readying itself for the new age industrial revolution. Instead of a paradigm shift in the physical manufacturing process, this revolution will focus on the customer end with Automobiles and Technology.

As far as automobiles go, the industry can be broken into two essential components; power and software.

The government is already big on EVs, trying to move away from traditional fuel sources and incentivising the Lithium-ion battery tech necessary in EV production. Lithium-ion is currently the most popularly known and well-researched source of non-combustible energy for vehicle engines. Budget 2023-24 saw importing machinery and equipment necessary to manufacture lithium-ion batteries become exempt from taxation. The import of lithium-ion cells also gets taxed at a lower rate of 5% customs duty.

A major difference between Internal Combustion Engines (ICE) used in traditional vehicles and Electric Motors used in EVs is the dependence on software. While ICE vehicles use mechanical parts to control the power generation and output, EVs require the transmission of orders through software built into the vehicle to control the vehicle’s speed.

So, not just the manufacturers of EVs but the supporting industries could benefit in the coming times.

Now, take this potential industry and add a dash of “Desh ka Namak Company”, and you get Tata Elxsi. The Indian conglomerate titan has stood the test of time and loyalty without losing itself to obsolescence.

But just a renowned name does not a good company make. What really makes Tata Elxsi tick? Is it worth taking a “ride on”? Don’t ask me; ask Tanushree Banerjee, co-head of research at Equitymaster, as she breaks down her take on Tata Elxsi.

How to pick stocks like Tanushree Banerjee

Tata Elxsi was an Equitymaster recommendation from April 15, 2020, to March 25, 2022. To approach these recommendation-worthy stocks, Tanushree analyses businesses through various metrics that are as follows:

India’s Revival Prism

This prism is based on the assumption that “Every listed Indian company will have the chance to capitalise on the extremely favourable ecosystem that India will offer over the next few decades, as it emerges as one the most competent and globally recognised hub of corporate activity.”

But this revival that Tanushree sees will be a net positive average. What this means is that there will be some stocks that underperform or even destroy investor wealth through this period of growth. The point is to pick the potential performers as the economy gives them room to grow.

Financial History

Another metric that Tanushree applies to her stock-picking process is financial history. This information allows her to gauge a company’s ability to generate cash across cycles. This takes newly listed companies with non-existent financial backgrounds out of the question.

Thus, by applying this metric, the number of stocks that she has to go through is also effectively reduced to only mid-cap and large-cap companies.

Risk Analysis

Whenever it comes to picking an investment instrument, the concept of risk is accompanied. So, Tanushree applies another filter, wherein she does not pick stocks that have the potential to turn profitable or companies that have flawed balance sheets and could be exposed to liquidity threats.

These companies, according to Tanushree, are “the hotspots of return-free risks”. This means that the companies have risks associated with them, as any company does, and their returns are uncertain. Investing in such stocks exposes the investors to innate threats associated with the company while presenting no concrete evidence towards returns either.

The risk tied into these stocks are too great when compared to their valuation and are, thus, avoided by Tanushree.

Potential for Upside

Now, based on the above metrics, the selection pool is limited to mid-cap and large-cap companies, as mentioned above. So, a problem that follows this echelon of stocks is these stocks reaching their peak. A peaked stock means that there is little to no room for capital appreciation as the company does not necessarily have any upside remaining.

But this is not the case. Based on data from Aswath Damodaran’s blog, the number of listed stocks in India makes up 8.6% of the total listed stocks globally. However, the total market capitalisation of listed companies in India makes up only 3.5% of the global market capitalisation. This means that even the largest companies still have room to grow.

Sure, this growth can be accounted to small and mid-cap companies too, but large-cap companies would not be left out of this growth spurt. So you could still go for the larger companies without having to worry about your investments stagnating, as the company growth stalls near its peak.

Indian Tech Sector Analysis

Now, these are pretty generic filters to apply to the stock selection process, so to get specific, Tanushree applied some prevalent macro trends. This is what she observed:

1. The government, trade bodies, and policymakers were focusing on certain types of technologies. These bodies were facilitating the ecosystem necessary for the development and integration of these technologies. These included AI, blockchain, green energy technologies (like tech for EVs), data security technologies, etc.

2. Due to these developments, there was a massive potential for disruptive businesses in these sectors. If businesses played their cards well, they could turn out to be massive compounders in these up-and-coming industries.

3. India had a lot of legroom to grow in software-based technology, as multiple businesses like healthcare, utilities, and automotive integrated IoT into their processes. Indian investment in tech is also poised to grow as automobiles shift more towards EVs and autonomous vehicles.

As a result, Indian tech spending was set to grow 10x to reach $120 billion by 2030.

Now, while EVs and autonomous vehicles were still recent developments, there were still millions of lines of code being written for these vehicles. Global players were definitely vouching for Indian coders, as a report by Business Standard stated that 35% of the code for over 100 million lines of codes for driverless cars was being written by Indian Techies.

Tanushree had a bit of an upper hand in these regards as she had a watchlist of stocks engaged in these fields, and one stock (Tata Elxsi) stood out in this list, through her various filters. To top it off, Madhukar Dev, the ex-managing director of Tata Elxsi, said these words that struck a tone with Tanushree:
“Design for Tata Elxsi is not about looks. We visualise products that don’t exist.”

While no one believed in Madhukar Dev, such was the case with Steve Jobs when he said, “Design is not just what it looks like and feels like. Design is how it works.”

This made Tanushree wonder if Madhukar Dev’s passion to “marry tech with design” would lead to Tata Elxsi creating fortunes similar to Apple’s. So the obvious next question was…

Could Tata Elxsi be the Next Apple?

To be able to answer the question, the company needed to be understood better. Tata Elxsi is set up in Bengaluru and houses a 6,000-strong workforce. The company’s primary revenue sources are Europe (55%), the US (30%), and the rest from Asia, including India.

Based on operations, 90% of Tata Elxsi’s revenues came from designing products for transportation, broadcast & communications, and the healthcare sectors. The company provides services in the fields of big data analysis, cloud, mobility, virtual reality, and AI.

Now, this business was not some secret trend that other companies did not know about. Other big tech players were also capturing their share in the market. So what set Tata Elxsi apart?

Factors that made Tata Elxsi a Good choice

These were the reasons that set Tata Elxsi apart from the rest of the tech crowd:

1. Design-Centred Operations: Tech-based products run the risk of turning obsolete very quickly. Thus, software alone cannot help these businesses. Thus, companies engaged in tech need to focus on design to create customer stickiness.
Apple is the tried and tested example of the wonders design does for tech companies. For Tata Elxsi, this was going to pose as an opportunity to beat the competition by creating products that left a lasting impression on its customers.

2. Focus on R&D for Innovation: Tata Elxsi has a dedicated and effective Research and Development team, which was evident on the 2018 Investor Day. When driverless cars were still something of a far-fetched idea for India, Tata Elxsi had already created a prototype to show analysts on its investor day.

3. Strong Order Book: Owing to its preparedness and pre-emptive development, Tata Elxsi had already garnered a healthy order book from various automotive industries as well as businesses in other industries.

These non-automative businesses included but were not limited to pharmaceuticals, FMCG, electronics, and consumer durables.

4. Stability of Revenues: Thanks to an order book from clients belonging to varied industries, Tata Elxsi’s revenue had the benefit of diversification. This meant that in case of a sudden, unprecedented slowdown in any of the industries that Elxsi catered to, it would not suddenly have its revenue base shaken.

These facts were further fortified by the company’s margins which looked like this:

Now one thing that is important to note is that investing alone does not ensure returns. Investors need to understand that while companies might satisfy their initial buy parameters, they should remain aware and exit certain stocks at the right time.

A share triggering an exit response does not necessarily mean that the business is bad or not worthy of following; timely entries and exits are what ensure the actual realisation of returns. So here’s why Tanushree suggested exiting an investment.

Tata Elxsi: From Good Buy to Goodbye

Here are the reasons why a stock might not be suitable to hold, even when it initially satisfies the investors metrics, and why Tata Elxsi moved to a sell recommendation.

1. Tailwinds cease to exist as a result of regulatory/policy changes.
2. Sharp rise in valuation multiple that reduces the compounding rate.

As far as Tata Elxsi was concerned, during the 2 years that it had been recommended by Tanushree, it had already turned into close to a ten bagger. The valuation had grown from ₹733 to ₹8,441.

This steep rise in valuation led Tanushree to believe that such a growth would not be sustainable in the future, which is why she recommended investors to sell their holdings, to lock in an absolute appreciation of 1051%.

The Bottom Line

While this article focused on Tata Elxsi individually, the stock was more so an example than a specific use case. Tanushree’s fatigue test could serve to be one of the multiple filters that investors use before getting to the right stock for them, with some tweaks, of course.

Tata Elxsi sits in a sensitive spot where the “future prospects” often make the industry like a gold mine. Stock Gurus will inflate certain stocks with a phrase like “The future is bullish for (insert random industry here)” without necessarily providing concrete reasoning for their selection or a replicable process.

While recommendations are a method to go about selecting stocks, it should be a blind buy under any circumstance, and investors should be able to conduct their due diligence before pulling any triggers.

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