Tata Motors Ltd shares fell 6% on Thursday on BSE, echoing a steep drop in its American depository receipts. Investors were taken aback by negative announcements by its UK subsidiary Jaguar Land Rover Ltd (JLR) regarding lower profitability, increased capital expenditure and the consequent negative free cash flows. This will certainly take a toll on Tata Motors’ consolidated profit margins, given that JLR accounts for around 90% of net profit and 75% of net sales. But the key to the company’s valuation is: will the impact be long term?
JLR’s media release stated, “Ebitda (operating profit) is likely to be in the region of levels reported for the previous two quarters and Ebitda margin is likely to be slightly lower than in the previous two quarters.” With this, analysts’ forecasts that the increasing share of the new and highly successful Range Rover Evoque could lead to lower profitability have come true. Ebitda is earnings before interest, taxes, depreciation and amortization.
The management attributed lower margins to the change in product mix, higher incentives given in the global luxury car market and currency volatility despite higher sales volumes and revenue. But investors must note that going forward, increased sales of the new Range Rover, with the easing of production bottlenecks, should translate into better realization per vehicle. That could bring profit margins back on track over the next few quarters.
Of course, for the December quarter, the Street has cut estimates for JLR’s operating margin to 13-14%, lower than the September quarter margin of 14.8%. Given falling truck sales and the bleak near-term outlook for the stand-alone entity, the December quarter’s consolidated margin is likely to be 12-13%, down from analysts’ earlier forecast of 13.5%. Note that both these estimates show a drop from the 15.1% consolidated operating margin in the year-ago quarter.
The longer-term concern is about how JLR will manage the huge capital expenditure of £2.75 billion (around Rs.23,460 crore today) in fiscal 2014, after a £2 billion spend in the current fiscal year. The management view is that these investments are required for both research and development (R&D), and growth of product and market base. Analysts are concerned, however, that high capex along with rising working capital and strained profitability will translate into negative free cash flows in fiscal 2014. The company also announced a £400 million borrowing towards this end. According to Umesh Karne, analyst at Brics Securities Ltd, “JLR plans to launch 40 new models/variants in the next five years, which requires appropriate investments in both R&D and plant capacities.”
So far, JLR has steadily improved its performance, generating strong cash flows since it came into the Tata Motors stable in 2008. Consolidated operating margin for fiscal 2009 was a paltry 3.1% as sales were hit by the global economic crisis and debt was huge. Post-restructuring, the operating margin improved steadily till it scaled 14.3% in fiscal 2012.
A section of analysts is confident that operating margin and profit momentum will rebound as new products bring in bigger volumes by fiscal 2014. Of course, fiscal 2013 could see hiccups in consolidated margin and net profit mainly on account of the pressures experienced in the December quarter. “Our SOTP (sum-of-the-parts)-based target price is Rs.308/share (earlier Rs.335/share),” said Surjit Arora, analyst at Prabhudas Lilladher Pvt. Ltd, adding that at the current price of Rs.293.55 a share, negatives have been priced into the valuation.