Mumbai: The joint venture (JV) between Jaguar Land Rover (JLR) and China’s Chery Automobile Co. Ltd is likely to help JLR boost volumes in one of the world’s largest luxury car markets but margins could drop once the venture starts local production, analysts said.
This is because the money it saves by reducing imports may have to be passed on to buyers, affecting the price realization per unit, they said.
The duty on imported vehicles in China is around 25% and the quantum of benefit JLR gets will be governed by its local sourcing.
Encouraged by the response to its offerings from JLR and with the objective of furthering its presence in China, on 21 March, the firm entered into a 50:50 JV with Chery Automobile, committing $540 million. The foreign investment permitted in vehicle assembly in China is 50%, thereby mandating a JV.
“After the JV commences operations, we expect both realizations and margins in China to drop for JLR. While Ebitda margins (operating profit or earnings before interest, taxes, depreciation and amortization) may contract 300 basis points (bps), given that JLR’s share in the JV would be just 50%, its absolute Ebitda per vehicle is likely to decline 30%,” Mahantesh Sabarad, vice-president, equity, at domestic brokerage Fortune Equity, wrote in a note.
One basis point is one-hundredth of a percentage point.
Sabarad’s inference is based on the assumption that the imported content will comprise 30% of the locally manufactured vehicles; that the import duty in China will be 10%; that the local sourcing (of parts) will be 40% cheaper than that in the UK; that China’s conversion costs at 26% will be more competitive than UK’s 35%, and that the prices of the locally assembled models will be cheaper than imported models by around 6.5%.
Surjit Singh Arora, analyst at brokerage Prabhudas Lilladher Pvt. Ltd held a similar view. “With the average price per unit coming down, we expect the company’s margins to get moderated,” Arora said.
To make up for this loss, Sabarad said JLR will have to increase its volume by 44% and depend on royalties from the JV.
Since the acquisition of JLR by Tata Motors in 2008, sales in China have been expanding 52% a year. China is the company’s third largest market after the UK and the US.
According to a Fortune Equity Research report, while the UK is the least lucrative market in terms of margins at 10.9%, the margins in China at 22.6% are extremely high, notwithstanding the fact that profits earned in China are taxed, while those earned in the UK are not, owing to the deferred tax assets being carried forward.
Photo by Chris Ratcliffe/Bloomberg; graphics by Naveen Kumar Saini/Mint
JLR may not produce all the models locally, and may only choose to assemble high-volume but low-value models such as Freelander 2 in the country, said another analyst at a foreign brokerage. He declined to be identified.
The limited exposure to the JV will ensure that the firm continues to charge a premium, thus protecting margins and retaining the so-called elite perception buyers have of a UK-made brand. Hence, even as the volume gets a fillip, the company’s margins in China will start low and continue to be low, he added.
Another analyst from a domestic brokerage, who also requested anonymity, said as the pricing in China is based on where a particular model is produced, the average realization per unit will come down. According to him, with the Land Rover models not having a real competitor in China, there is ample scope for it to continue to expand at a brisk pace.
Experts also said that while the JV with a local partner will help JLR overcome regulatory hurdles, maintaining quality, brand image, and increasing competition in the luxury car market would be the challenges.
“Whenever a company switches from import to local production in a region, maintaining brand image and quality are two of the most critical challenges that it typically faces. This is even more crucial when it’s a luxury car company,” said Ashvin Chotai, a London-based independent auto analyst. He also said that besides operational issues, it would be important to see how the cultures of the two companies are integrated. Moreover, as the world’s second largest economy slows and China’s rich find an increasing abundance of vehicles to choose from, the discounts—which began late last year with entry-level models—are spreading to the priciest high-end sedans, Bloomberg reported on 20 March.
In an emailed response, Paul Chadderton, global PR director and corporate communications, JLR, said: “Demand for Jaguar Land Rover products in China is strong and sales volumes continue to grow. In the first two months of the calendar year, retails totalled almost 11,000 vehicles—a 95% increase over January and February in 2011. This follows a full year retail performance for JLR in 2011 of 42,000 vehicles—60% above 2010.”
JLR dealers in China have not reported any increase in inventory. He declined to comment on other aspects.
The Bloomberg report said the Credit Suisse Group AG projects average profit margins in China at the three high-end German carmakers—BMW, Mercedes Benz and Audi—to fall 4 percentage points by 2014 from the current 16-18%, closing in on global standards of around 10-12%. These three firms capture 70% of the luxury car market as others such as Toyota Motor Corp., General Motors Corp. and JLR are looking at stepping up their presence.
Brushing aside the concerns of slowing of luxury car sales in China, Shanghai-based Huaibin Lin, analyst at IHS Automotive, market research and sales forecast firm, said: “China’s luxury car market has been expanding at 36% per annum for the last 10 years, and it has a very good potential to grow even further,” said Lin, who expects the local factory to add at least 30,000 units in 2015—the first year of production—to JLR’s total sales in China.