Tata Motors stock's underperformance may continue till JLR sales improve

Though Tata Motors’ share price is already down 3-plus per cent over a year, multiple headwinds mean it is likely to continue lagging its peers and the benchmark Sensex. Consistent volume growth at its British-based arm, Jaguar Land Rover (JLR), is crucial for a re-rating.

Monday saw the stock reach a 26-month low. It has been the biggest underperformer among frontline automobile stocks over the past year, shedding 33 per cent of its value. In comparison, the broader markets and the peer index (excluding Tata Motors) are up 13-14 per cent. Lower volume growth at JLR, elevated levels of discounts and dealer incentives, environment regulations and the transition to electric vehicles (EVs) are some worries that led to the underperformance.

Its Indian operations did see volume revival in both the commercial vehicle (CV) and passenger vehicle (PV) segments. Even so, with 80 per cent of its revenue and all its profit coming from JLR, the performance of the Britain-based maker is crucial for the company and the stock. Analysts say the stock could continue to lag in the near term, until JLR's sales numbers improve.

The biggest worry has been the muted volumes in 2017-18 for the two marquee brands, Jaguar and Land Rover. JLR reported volume growth of only two per cent in FY18, despite several new launches and higher incentives, underlining the market's competitive intensity.

One of the challenges JLR faces is slowing volumes in Britain and the rest of the European Union (EU), 40 per cent of its sales. The sentiment on diesel vehicles is negative in these two markets, reflected in the 5-13 per cent fall in sales volume here during the past year. Earlier this month, the company indicated legislative uncertainty around diesel and the resulting lower demand in Britain and Europe continue to have a negative impact. After the ‘dieselgate’ scandal involving Volkswagen, European policy makers are contemplating tougher penalties for vehicle makers found supplying vehicles fitted with devices or systems aimed at cheating the air pollution rules.

The slowing growth in key markets, especially in the past two quarters, is offsetting that in China and other world markets. Growth in China is important — it is the largest (25 per cent of overall volume), fastest growing (20 per cent growth verses two per cent overall) and the most profitable market for JLR. Despite this fast growth, analysts say JLR’s performance in China has been in line with those of peers, while lagging that by Cadillac and Lexus. Cadillac overtook JLR as the fourth largest premium car brand in China by volume in 2017, according to UBS.

The volume pressure for JLR, especially in Europe, is expected to continue in the next six months to a year. Says Bharat Gianani of Sharekhan, “In Europe, there is a backlash on diesel which would continue to impact JLR, as the portfolio has predominantly diesel models. The UK (Britain) market outlook is also sluggish, as the economy is preparing itself for Brexit (that country’s departure from the EU) and would need to carry out trade negotiations with other countries and especially Europe.”

What is compounding matters for the company is increasing investment in less polluting vehicles and an impending switch to EVs. This could lead to more pressure on the stock. Analysts at UBS believe JLR faces multiple headwinds, with the sharp slowing in growth and business profitability, even as stricter emission targets and EV transition are on the horizon. The brokerage believes JLR’s value could de-rate further on a billion pounds of negative cash flow over the next three years.

Providing some support to the stock has been the strong showing in India. Overall volumes in the March quarter were up 35 per cent year-on-year, with strong gains for each of its segments. However, there are headwinds here as well. The easing of overloading restrictions in Rajasthan and Uttar Pradesh, for one. Chirag Jain and Indarpreet Singh of SBICAP Securities say the easing of these restrictions has already started impacting retail truck demand, product mix (demand-shift back towards lower tonnage ones) and discounts in the industry. This could lead to moderation in volume growth for Tata Motors, on profitability and impact the India valuation.

Says Gianani of Sharekhan, “The impact (moderating volume growth) of the standalone CV business on overall Tata Motors performance is important, as the standalone business as a whole would contribute about 35 per cent of overall valuations. The PV business is currently loss-making and, thus, the entire valuation of standalone is from the CV segment. So, the impact of CV is meaningful in overall valuation as well.”

Despite all these, the stock is trading at an attractive under-three times its FY20 ratio of enterprise value to operating profit. In comparison, Maruti Suzuki trades at a little over 14 times on the same metric. While the 75 per cent discount is large, till volumes at JLR improve on a consistent basis, analysts believe a re-rating story is unlikely to unfold at Tata Motors.

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