Clouds darken over Tata Motors as trade wars exacerbate JLR woes

Last week, Tata Motors Ltd’s UK subsidiary Jaguar Land Rover Plc (JLR) in its first “Investors Day” spelt out its ongoing strategy to shift towards the new electric mobility platform, reduce the diesel vehicle component in overall sales and drive margins through efficiency. The efforts, however, failed to fire the parent firm’s stock. On the contrary, the Trump-led rumpus about trade wars precipitated the weakness in investor sentiment for Tata Motors Ltd.

Its shares tumbled by 12.6% last week, far harder than the benchmark BSE Auto index and BSE Sensex that retraced by 3.4% and 0.8% respectively. Moreover, the 38% fall in a year makes it the worst performer among listed auto original equipment (OE) makers.

The recent fall reflects equity investors’ speculation that global trade tensions and the resultant tariffs on automobile imports into US will hurt JLR sales. This will be critical as the region accounts for a fifth of its total sales. Moreover, it has been the only region clocking growth within developed markets in FY2018, while the UK and Europe are contracting.

These trade tensions only added to the existing market risks put forth in its Q4FY2018 presentation. There were signals that barring the Asian region’s prospects, market cyclicality could slowdown sales in US. Another risk to sales growth is the shift away from diesel vehicles in Europe and UK along with the Brexit trade barriers. Note that a little over a third of JLR’s sales comprise diesel vehicles. Also, globally, the luxury car market is in a state of flux.

Hopes, therefore, hinge on China to bump sales up in the near term. Indeed, this is the only region where JLR has posted 20% year-on-year growth, for several quarters.

This is not all. There are some inherent balance sheet risks that may weigh on earnings in the next two years. JLR needs capital expenditure towards new technology and product development given the wave of changes in emission norms and fuel use. Its committed capex will comprise 15-16% of its revenue in FY2019. Unfortunately, it comes at a time when margins are at their worst. Note that JLR’s Ebitda (earnings before interest, tax, depreciation and amortization) margin plummeted by 220 basis points (bps) in the quarter gone by (Q4FY2018) to 12.2%, dragging down Tata Motors’ overall margins too. One basis point is one hundredth of a percentage point.

Weak margins and high capex together is not something that JLR can cruise through comfortably. This will translate into negative free cash flows until FY2020 (see chart). Any adverse currency movements will further elevate risks to earnings.

The only silver lining to the cloud is that Tata Motors’ standalone performance that was a drag on consolidated earnings for several years is shining bright on the back of soaring commercial vehicle sales. Yet, its profits earned hardly make a difference in the consolidated books.

Little wonder then that most brokerages, although convinced about JLR’s product line up, have trimmed earnings estimates for the near term. This column had forecast a cut in earnings estimate following job cuts and falling sales in Q42018. Echoing a similar sentiment, a recent report by Motilal Oswal Financial Securities Ltd, while keeping a target price way beyond the current market price of 268, has cut earnings estimate by 7% and 15% for FY2019 and FY2020 respectively.

So, while a meaningful upside to the stock is unlikely in the near term, investors would be watchful of how well Tata Motors steers JLR through the market risks arising out of global trade wars and Brexit and the outcome of its committed capex.