Q3: When Jhunjhunwala grilled Tata Motors on its hedging policy

This was despite the fact the pound has depreciated in recent times, something that should be favourable for a company that has operations in the UK.

The losses arose because the company hedged a lot of its US dollar receivables’ positions before the British pound tanked in June last year after the Brexit vote. In a dramatic move, the sterling fell from 1.5 to the pound to about 1.2 levels.

On the conference call, Tata Motors told ace investor Rakesh Jhunjhunwala that it hedges 80 percent of one-year out payments, 60 percent to two years out, 45 percent to three years out and 25 percent to four years out.Jhunjhunwala has invested heavily in Tata Motors, confirming to a publication last year it was his largest portfolio pick. 

As per accounting rules, the impact of unrealized hedging profits or losses have to reflect on the income statement on a mark-to-market basis.

In other words, because Tata Motors has an aggressive hedging policy, the costs arising out of derivative positions that expire worthless (assuming the pound does not go back above the hedge level) will reflect as a loss on the income statement.

“One thing is very clear, because you have hedged beyond 1.25 (GBP-USD) you will always have a hedging loss [for the next few quarters],” Jhunjhunwala asked JLR CFO Ken Gregor, who replied in the affirmative.

Gregor also said on the conference call that very few positions are hedged since June 2016 as of now, but defended the company’s hedging policy saying such costs were mandatory to “protect” the business. “It is the nature of hedging”.

Tata Motors’ problems go beyond hedging. An unfavourable product-mix for JLR (people are starting to opt for cheaper Jaguars) and continuing losses in the India business mean some analysts are worried for the medium term prospects for the Tata Motors’ stock (CLSA downgraded the stock from a buy to a sell this morning).

“Hedging is not the main issue for the company,” Hitesh Goel of Kotak Securities told CNBC-TV18, pointing to the fact that it also means that it took in higher US dollar denominated revenues.

“So in the next quarter, if the pound continues to stay at around 1.2 levels, you will see higher absolute hedge loss. But you will also see higher net realisations,” he said.

Goel also said the company took a hit on margins in order to push JLR sales in the US.

He added that as the net hedging rate rolls over and the effect goes out over the course of next two years, and as new launches replace old models that are being phased out, both volume growth and margins should get better going forward.

Goel said that investors should use volatility in the stock to buy into it. “We have a 12-month price target of Rs 550.”