Tata Motors Ltd’s shares fell sharply on Tuesday, making it the lowest closing in 15 months. The fall was triggered by news from its UK-subsidiary, Jaguar Land Rover Plc, of price cuts in its sports-utility vehicle (SUV) Evoque along with production adjustments to match falling retail sales in China.

The stock price reaction is unsurprising, given that China accounts for about one-fourth of JLR’s sales volumes. The moot question is: will the price cuts hurt margins? Some analysts say that higher localization, as production ramps up in the Chinese joint venture, will reduce costs. Besides, the impact of price cut (estimated to average 6%) on profitability would be offset by tax benefits that accrue on local production in China. This means that the price cut alone may not drag profit margins down.

A report by Edelweiss Securities on the company’s June quarter earnings indicates a drop of 270 basis points in JLR’s operating margin, given that the previous quarter’s margin of around 20% was at an all-time high. That suggests lower margins are already factored into the stock, which in the last one month has lost 8.7%, while the BSE Sensex and BSE auto index both gained ground. In fact, most brokerage firms concede that Tata Motors’ June quarter operating profit will be a tad lower or flat compared with a year ago.

It is the sales volume in China that are more important at this juncture. While JLR’s sales numbers for June would be out soon, monthly April and May data showed sales in the China region dip by about 27-30% year-on-year (y-o-y). All eyes are on the June quarter management commentary following the financial results, which is expected to throw light on the outlook for China.

Chirag Shah, associate director of Edelweiss Securities, who estimates that China’s contribution to JLR sales would be lower at about 21% for the current fiscal year, adds that a clearer picture would emerge in the forthcoming months as production in China from its joint venture ramps up.

For now, the company is adjusting supply to dealers to ease inventory pressure, after deliveries there fell by 23% this year through May. Dealer reports on auto sales are not so encouraging. They suggest that price cuts by both foreign and local brands in China have done little to spur demand. Sales of leading brands such as Audi and BMW are declining. A survey by MNI Indicators showed that the proportion of consumers who planned to buy a car shrank last month, while inventory levels indicated low market demand for the past nine consecutive months.

So far, China was the cash cow that built JLR’s coffers, given the slowdown in the developed markets. Moreover, with over 100% of the net profit accruing from JLR, Tata Motors’ stand-alone entity’s performance is less significant in its consolidated revenue and profit.

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