TATA MOTORS - IS IT A CONTRARIAN BUY?

about 5 months ago
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Tata Motors did not disappoint. As expected, its earnings for Q2FY20 were dismal but more disappointing than expected. Its Jaguar Land Rover (JLR) sales have been going down since July 2018 and for four consecutive quarters, it has been posting a loss.

Expectations were set for only a loss as it was common knowledge that its JLR sales were down and given the slump in the domestic market, loss was a given.

For Q1FY20, JLR (including China) reported a 12% (YoY) decline in retail sales at 128,615 units and wholesale was down 10% at 118,550 units. Net revenue showed a 8% fall and it posted a loss of £402 million.

On the domestic market front, the picture was actually worse in terms of decline in sales. Retail sales fell 13% and wholesale dropped 20.5%. Net revenue was down 20% at Rs.13,352 crore and net loss was at Rs.97 crore, which is much lower than JLR.

Thus on a consolidated front, for Q1FY20, Tata Motors posted a huge loss of Rs.3698 crore, much more than analyst’s expectations of around Rs.2500 crore. The magnitude of the loss comes into perspective when you look at its loss for Q1FY19 loss of Rs.1117 crore and loss of Rs.1902 crore in Q4FY19. Consolidated revenue was down 8% (YoY) at Rs.61,467 crore.

The consistent fall in JLR sales is the biggest reason for this huge loss as its contribution to total revenue stands at 75% and its loss alone stood at Rs.2391 crore. The company has listed the following reasons for the drop in JLR sales:

The Cons:

  • Industry volumes down in most regions
  • Lower revenue resulting from the weaker market conditions
  • Additional plant shutdown time and delays in WL TP certification resulting from Brexit contingency planning also contributed to the lower sales and profits.
  • JLR continues to capitalise about 80% of R&D expenditure while others capitalise around 30-40%
  • Its net fixed asset to sales ratio stood at 50% in FY19 v/s 32-35% of its peers 
  • Higher proportion of capitalisation despite huge write-offs means risk perception or probability of further write-offs has risen
  • Warranty and provision ratio of JLR at 9-year high 

The Pros:

  • China sales rose in June compared with the prior month
  • The company had record sales in the UK, up 3% (YoY)
  • Free cash flow was negative £719 million after £795 million of investment spending in the quarter - this represented a £954 million improvement (YoY).
  • £756 million of favourable working capital
  • Positive impact of its £2.5 billion profit and cash improvement programme - £100 million of cost-savings and £300 million reduction to previously planned investment in the quarter, taking the total savings to date to £1.7B.
  • Sales of all-electric Jaguar I-PACE and the new Range Rover Evoque up YoY, which partially offset the impact of weaker market conditions on other models.

Looking ahead, the management seems to be very optimistic, reiterating that its financial results will improve over the balance of the year and continues to target a 3%- 4% EBIT margin for the full year with continued investment resulting in negative but improving cash flows. The company is confident of returning to profits in current fiscal itself, which means the next two quarters have to show positive JLR earnings. All hopes on pinned on the ongoing major transformation for JLR through simplified business, delivering on our product strategy and adapting to the tough market environment. New product launches is what it expects to get JLR out of the rut.

What this means is that when the China sales started dropping, the company was caught completely unawares, with no Plan B in place. It did not know the way ahead but now with one year of dealing with falling sales, looks like it has found its bearings and seems to have finally got a grip on the situation.

Last year, shareholders were so miffed with this consistent loss making saga that they had demanded that the company divest stake in JLR.  Tata Motors put all speculation to rest saying that it will do no such thing and was confident that with its focus on improving operational excellence and investing in innovative products and technology, JLR will soon get out of the woods and stay competitive globally.

So is JLR a big mistake and does Tata Motors need to get out of it? No way! The company has finally reworked itself to deal with the new challenges and major cost cutting and other operational changes.  As the Economist says, “Jaguar may need to rethink what sort of cars it makes but Range Rover is among the most profitable brands in the business and updated models arriving in the next few years will give the firm a boost. If it can get through the next year, then concentrate on expensive suvs, JLR should get back on track.”

While many brokerages are putting out a “sell” call you can try being contrarian as the management remains optimistic that its various steps will get it out of the woods. The over dependence on diesel JLRs is down and the company is fine tuning electric and its I-Pace has got a very good response given its high level of efficiency (260-290 miles driving with one charge).

Reduction in developmental costs, increase production in low-cost Slovakia and increased localization in India, China and Hungary, plans to increase its dealer network by 15% to 1,800 by the year 2023 and once again, China is expected to emerge as the largest market for JLRs by 2021 – these are a few of the writings on the wall.

Well, the stock will be hammered down tomorrow morning and hitting a new low seems highly likely. So what will you do? One does not know its bottom as of now so be cautious while catching this fallign knife.

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