Going by Tata Motors Ltd’s December quarter performance that missed profit estimates by a wide margin, the road ahead is likely to be a rough one. The main worry is due to the disappointing performance of its cash-cow Jaguar Land Rover Ltd (JLR) that has been churning out healthy profits for several years and which churned out 90% to 100% of the consolidated profits.

For the quarter, Tata Motors’ consolidated net profit of 1,212 crore missed Bloomberg’s 15-broker average estimate by a huge 48%. More importantly, its operating profit, although higher than the year-ago period, was also just three-fourths of what the Street had forecast. All this, in spite of a 16% jump in consolidated net revenue on the back of strong sales volumes, especially on the home ground.

What this clearly shows is that the costs during the quarter overtook realizations. The glaring miss is JLR’s operating margin of 10.9% against estimates of 11.5%. In fact, fiscal year 2018 has been a challenging one so far, with operating margins in the first and second quarters at 7.9% and 11.8%, respectively, coming lower than forecasts. While the management attributes the sales slowdown to the changeover of some Range Rover models and introduction of new ones, there are other concerns too.

Barring China, where sales grew by 14% year-on-year during the quarter, markets in the UK, Europe and North America have been challenging. The investor presentation clearly indicates that the changing trends towards fewer diesel vehicles in Europe and the UK and the trend towards electric vehicles in North America have led to a steep drop in sales in these regions (see chart). Even growth in China has simmered down compared to a few quarters ago.

Reiterating this, the management in the conference call said that the cost of responding to higher competition and product changes led to higher variable costs. Along with adverse currency movements, this weighed on profitability.

The worry is that the market product cycle uncertainty could see a trend reversal in JLR’s performance, at least in the near term. One can anticipate higher product development costs and depreciation costs with a strain on working capital too for some time ahead, signalling negative free cash flows.

Fortunately, the downturn in JLR was partially offset by a recovery in Tata Motors’ stand-alone business, as sales of domestic commercial vehicles shot through the roof (see chart) and passenger cars too recovered. Indeed, the company’s turnaround strategy was followed by a recovery in the domestic commercial vehicle market as a whole. Robust sales aided the transition from a loss in the year-ago period to a profit this quarter.

However, the stand-alone profit hardly matters except that it prevents a further drain on cash flows.

Without doubt, JLR’s poor performance will eclipse the uptrend in domestic business. This is already mirrored in Tata Motors’ stock price that has fallen 24% in a year, while shares of its competitor on the home turf—Ashok Leyland Ltd—have risen by 37%. Tata Motors’ shares have hugely underperformed even the benchmark indices in FY18 so far and are unlikely to see better days until JLR is on a firm footing once again.

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