Although things are clearly looking up big-name domestic car companies such as Ford Motor Co. (NYSE: F) and General Motors (NYSE: GM), investors seeking an auto stock with eye-popping growth potential may want to look far away. Very far away, in fact — like about 8,000 miles.

You’d have to go that far to visit Mumbai, where one of my favorite car companies is headquartered. The company’s stock is up more than 60% in 2012, compared with gains of about 10% for GM and 1% for Ford.



What’s more, the stock has delivered 54% annual returns for the past three years. And even though it has so wildly outperformed, I think it could still more than double in the next few years.

#-ad_banner-#The stock I’m talking about is Tata Motors Ltd. (NYSE: TTM). If you’re not all that familiar it, I strongly suggest taking a closer look.

Tata has actually been around a long time, since 1945, though you may not have heard of it until fairly recently. Shares have only been available on the New York Stock Exchange since 2004 (as American Depository Receipts, or ADRs). Today, Tata is India’s largest motor vehicle maker, with total revenue of $32.5 billion in 2011. It’s the world’s fifth-largest medium and heavy commercial truck manufacturer and the world’s second-largest medium and heavy bus manufacturer. Besides India, it has operations in the United Kingdom, Spain, South Korea, South Africa and Thailand.

Most of the company’s press has been related to its no-frills compact car, the Nano, which has come to be known as “The People’s Car” of India since its early 2007 introduction. At the time, it sold for the equivalent of just $2,500 U.S. dollars and now still only costs around $4,200. Despite the Nano’s overall success, though, sales have only been in the range of 8,000-9,200 units per month, noticeably below the 10,000-a-month goal initially set by management and well below the 20,000 a month it hoped to be selling by now. The main problem is the Nano’s reputation, which was hurt early on by problems like a potentially unreliable starter and electrical and exhaust system flaws that increased the risk of fire (a couple cases of this were reported).

However, management has been addressing these issues through recalls, retrofits and design improvements in newer models. So I think monthly sales could soon begin to regularly top 10,000 and gradually approach the 20,000 goal as problem-solving efforts improve the Nano’s reputation. Sales should also spike when Tata enters North America. Indeed, a “Nano America” could be available sometime in 2012 or 2013 for $7,000-$8,000.

Besides the Nano, Tata has a strong line-up of passenger vehicles, such as the Manza and Indigo sedans, the Xenon pickup, the Sumo Victa and Safari utility vehicles and the Vista hatchback. It’s also developing an electric version of the Nano, and in March, unveiled the Megapixel, a four-seat extended-range electric concept car.

The purchase of Jaguar-Land Rover (JLR) in March 2008 for $2.3 billion was an excellent move, since it instantly gave Tata two internationally-recognized marquee brands and immediate entry into the global luxury vehicle market. The JLR division currently accounts for 57% of revenue and about 65% of operating earnings, with the rest coming from the original India-based operations.

Because India’s passenger-car market is still greatly under-penetrated and because Tata has varied domestic and international product lines that it’s continuously working to improve, the company is well-positioned to keep growing quickly. I think analyst projections for earnings per share (EPS) to rise an astounding 40% per year for at least the next few years are feasible. At that rate, EPS would climb from $3.20 in 2011 to $8.78 in 2014.

Risks to Consider: Failure to sufficiently rehab the Nano’s image could hurt, since the Nano accounts for a decent portion — about 6% — of the roughly 140,000 motor vehicles of all types Tata currently sells each month. If the issue isn’t adequately addressed, then competition could erode profits. Renault and Bajaj Auto, for example, have already announced their intention to launch a jointly-produced, ultra-low-cost small car to compete with the Nano starting sometime in 2012.

Action to Take –> Despite the Nano’s issues, I think Tata Motors is an excellent auto stock to own. In India, its biggest market, car ownership rates are still extremely low — only eight per 1,000 people. As the biggest car manufacturer in India, Tata should be able to take good advantage of rapidly increasing demand for cars, which analysts predict will expand by at least 10-12% in 2012 and 2013. Moreover, in the hands of Tata management, the estimated value of the JLR division has soared nearly six-fold to about $14 billion from the $2.5 billion purchase price.

At around $27 a share, Tata is trading for 12 times earnings — noticeably higher than the historical price-to-earnings ratio (P/E) ratio of 8.4. But even if the P/E ratio reverted back to the historical average during the next few years, the stock price could hit almost $74 a share in 2014, assuming EPS reaches $8.78 as projected (8.4 x $8.78 = $73.74). This implies the potential for a gain of more than 170% from current prices.