Brexit, high capex to keep Tata Motors under pressure; stock falls

Topics Brexit

The share price of Tata Motors has slipped about 12 per cent over the past fortnight on various worries - impact of Britian's leaving the European Union ('Brexit'), high scale of investment over the next couple of years and muted volumes at it UK subsidiary, Jaguar Land Rover (JLR).

The immediate trigger was Brexit, scheduled for the coming March. Global investment banker Goldman Sachs thinks this could affect JLR on both demand front and sourcing costs. Of the company’s eight global plants, three are in Britain and at nearly half a million units, these account for more than half the overall annual capacity. What would escalate this is any raise in tariffs, given the current American government stand on imposing about 20 per cent customs duty on vehicles made in Europe; JLR has no manufacturing base in the US.

Another uncertainty is volume growth. Analysts at Citi Research say the company is more realistic now, with internal volume growth pegged at five to seven per cent annually as compared to 10-12 per cent earlier. This is due to various factors. Consumer sentiment has turned negative on the back of the Volkswagen diesel emission scam. Given the potential for more and stiffer regulations, the fact that around 85 per cent of cars vehicles sold in Europe for JLR are diesel-powered makes it tough for the company. The share has come down from about 90 per cent a year before but it is still a diesel-heavy portfolio. Some of the volume headwinds also reflects in the June numbers of JLR, with year-on-year growth only 0.9 per cent. Europe saw a four per cent fall; UK growth was flattish.

The other issue, a negative from the Street’s perspective, is the high level of investments. JLR will be investing £4.5 billion each year through to 2021. Of this total capital expenditure (capex) plan for about £13 billion, a little more than half will be on new products. A fifth will be on electrification and related matters; the rest will be on capacity. So, FY19 and FY20 could see the company report negative cash flow.

In the near term, the company is preparing itself in line with changing customer need. In addition to cleaner internal combustion engines (ICE), hybrids and electric vehicles, the focus will also be on infotainment, connectivity and autonomous driving. From the current 12 models, the company will take the new model tally to 16, including the Defender and the company’s first fully electric vehicle, I-Pace, to be launched shortly. Its modular and longitudinal architecture will allow it to launch hybrid, ICE and electric variants of any model from the same platform.

Analysts at Deutsche Bank see two catalysts for the stock. They believe if the I-Pace can get orders of 25-30,000 units annually, it could change the stock's value perception and reduce worry over diesel. The other trigger is improvement in margin performance on the back of cost cuts and a better mix; China has cut its import duty. Operating leverage and lower costs should help JLR achieve a margin gain of 280 basis points. The company has a near-term target of four to seven per cent for earnings margin before interest and taxes (Ebit) and a longer term one of seven to nine per cent. The Ebit margin for FY18 was 3.2 per cent.

The other positive for the company is the strong India performance. Both commercial and passenger vehicles saw robust volume growth. While the India turnaround bodes well, the Street will continue to look for improvement in JLR, since a majority of revenue and almost all its profit comes from the British subsidiary. However, for the latter, with the Brexit concerns and the time it will take for product rollout and higher capex, the next few quarters will be challenging.

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