Brexit, US tariffs, investments in future technologies, excess capacity and high cost structure are taking their toll on JLR.
There is a saying among market veterans that Tata group firms are sound companies to lend to, but not to buy shares in. After Friday’s 20 percent drop in Tata Motor shares, said market veterans must be smiling smugly. The stock was battered by as much as 22.4 percent in early trade before recovering a bit. Analysts are falling over themselves to downgrade the stock or cut target prices after its record loss in the December quarter. There can be no two views that medium term prospects for Tata Motors are as bleak as a picnic in the Gobi desert.
The firm is facing a perfect storm. Chinese sales have fallen off the cliff, its bet on diesel has gone wrong, it has to accelerate investments to get its product and technology mix right, all this while keeping costs from spiralling. Rating agency warnings and unhappy bond holders means that debt costs are rising; the yield on Jaguar’s 4.5 percent bond maturing in 2027 is close to 9 percent.
Tata Motors hopes that taking an impairment of 3.1 billion pounds at JLR in the December quarter will help cut costs. It will save 300 million pounds in amortisation and depreciation costs. But that may not be enough. The company itself has indicated that free cash flow will be negative for at least five quarters. That’s not surprising given its 12 billion pound capex programme over three years. JLR won’t do much to improve cashflows. Indeed, its management has cut its EBIT margin guidance to 3-6 percent from fiscal years 2020-2022 compared to 4-7 percent earlier.
A big part of the disappointment is owing to the slowdown in China. In the December quarter, retail sales fell 47 percent in China. In January 2019, they declined almost 40 percent. To be fair to JLR and Tata Motors, the China market has been tough. Auto sales fell for the first time in two decades in 2018. So, JLR has not been alone. Apple Inc said earlier this month that it would miss its sales target for the December quarter by at least $5 billion. According to the Nikkei Asian Review, nine-month net profits for Japanese companies with heavy exposure to China fell 8 percent year-on-year compared to a 2.9 percent drop for all Japanese listed firms.
A second factor of course is that globally most automakers are having a tough time. There is a technological disruption in the industry – electric vehicles, hybrid vehicles, self-driving cars etc – that is prompting huge investments and reduced profit forecasts.
Having said that, JLR’s problems are bigger. Some, like for example, Brexit, where a bad deal for Britain leaving Europe could cause a billion-pound dent in JLR’s profit statement, or US President Trump’s constant tariff threats, are fait accompli. Others are of JLR’s own making. That includes its excess capacity and even its China strategy of pushing sales at high discounts, or the diesel bet in Europe.
The excess capacity and aggressive investments in future technologies has led to an unsustainable cost structure. The Project Charge programme to reduce 2.5 billion pounds in costs is just the first step. But a big question remains as to how much returns will its investments bring? Remember, the 3.1-billion pound writedown also included research and development investments. The immediate focus of the management should be on how to up the ante in China, the world’s largest market. The current turnaround action plan of cutting dealer stock and inventory, and giving additional support to dealers doesn’t inspire much confidence.