BackFocus shifts to Tata’s acquisition strategy as JLR loses its pace
The payout for JLR was comparatively smaller, even though analysts had concerns about its large lossesWhile China’s luxury car market has been slowing down, JLR’s Dec quarter shows a 46% year on year sales drop
PremiumCHENNAI : In buying Jaguar Land Rover (JLR), did Tata Motors Ltd bite off more than it could chew? That may seem like an unfair question, at first, especially given that the acquisition was seen as a success for the better part of the past 10 years.
Indeed, Tata Motors shares were flying high not too long ago and had beaten benchmark market indices hands down.
But things have changed drastically in the past year. In early 2018, annualized returns of Tata Motors shares stood at a respectable 20% since the time of announcement of the JLR acquisition in March 2008. Annual returns have dwindled to a mere 4% currently, about the same as what banks offer customers for savings banks accounts. The benchmark Nifty 500 index has risen at an annual rate of 12% during this period.
Also, this puts Tata Motors at only a slightly better position than Tata Steel Ltd, since the time it made the disastrous decision to acquire Corus Plc in October 2006. Tata Steel shares have risen at an annual rate of 1.3% since then, far lower than bank deposit rates, leave alone the 13.6% return of the Nifty 500.
Analysts and experts are loath to talk of the Corus and JLR acquisitions in the same breath. The UK-based steel company seemed like trouble from the word go, acquired as it was at an exorbitant valuation after an intense bidding war with Brazil’s Companhia Siderúrgica Nacional. Tata Steel had ended up paying 33% more than what it had originally planned for Corus, which unsurprisingly led to large write-offs eventually.
The payout for JLR was comparatively smaller, even though analysts had concerns about its large losses. But Tata Motors surprised one and all with a turnaround. Indeed, for several quarters until FY18, JLR’s net profits were more than 100% of Tata Motors’ consolidated profit, offsetting the losses recorded by its domestic operations.
“Jaguar Land Rover saw a dramatic revival in its fortunes, with one launch after the next, from the Evoque to the F-Pace, being received with great enthusiasm in its home market of the UK, and more importantly, in the Chinese market, which soon displaced the US as JLR’s biggest overseas market," Mukund Rajan, former chief ethics officer of Tata Sons Ltd, writes in his recent book on the group.
But the nosedive in Tata Motors shares now suggests that a little over 10 years since JLR was acquired, the Tata group’s second major global acquisition is also stuttering.
While it has been clear that JLR has been struggling on account of Brexit and some other reasons, the staggering £3.1 billion write-down of capital in the December quarter came as a rude shock for investors. Suddenly, things seem far worse than they had earlier imagined.
The luxury carmaker is facing tumbling sales, rising inventory, more write-downs and weak cash flows at a time when financially better-placed competitors are gearing up for a transition to new technologies. “A big worry is that JLR does not have the capital necessary for future growth, especially with the shift away from traditional diesel vehicles," the head of research at an institutional brokerage said on condition of anonymity.
The sudden U-turn in JLR’s fortunes raises these disturbing questions: Is the Tata group’s strategy to become a global auto giant backfiring? After labouring hard to get into the big league with manufacturers such as BMW, Mercedes-Benz, Audi and Cadillac, is JLR’s management failing to cope with the pace of change in technology and the industry in general? Was the group ill-equipped to foresee macroeconomic and technological challenges and move deftly to address them?
As an industry expert says, “Leadership is about putting capital, technology and people at the right place and right time." A case in point is JLR’s miserable show in China (see chart).
Soon after JLR’s launch in China, sales had galloped. But the Chinese joint venture (JV) with local auto firm Chery Automobile Co. Ltd is now a millstone around its neck. The region, which at one time accounted for about a fourth of total sales and fuelled JLR’s Ebitda margin to highs of 15-17%, is now in the red. Ebitda stands for earnings before interest, taxes, depreciation and amortization.
Worse still, the problem is not just to do with the slowdown in China’s auto sales. While growth in China’s luxury car market is slowing down, JLR’s December quarter shows a 46% year-on-year sales drop.
A report in Automotive News Europe says JLR had several recalls in China due to product defects in 2017, leading to major concerns about product quality. The report adds that dealers have been saddled with inventory, forcing them to sell inventory at discounts. “Jaguar at 70% price" has reportedly caught on as a catchphrase in China. The company admitted in its December analysts’ call that its discounts were higher than those offered by its competition to trim rising inventory. All of this has dented JLR’s brand image and raises questions about how long it may take for a recovery.
Indeed, the closely watched annual study of new car quality by marketing information services firm J.D. Power involving 31 brands in 2018 showed that Land Rover and Jaguar ranked last. Land Rover owners reported 160 problems for every 100 vehicles in the first 90 days of ownership, far higher than the industry average of 93 problems.
In response to a question from Mint, a JLR spokesperson said: “We are dedicated to delivering the finest quality vehicles to our customers and improving this is a continuous commitment throughout the design, engineering and manufacture of our cars. We have the processes and people in place to ensure we will do so. Product quality is a key part of our ‘Accelerate’ transformation programme. JLR initiated Project Charge and Accelerate to cut costs and improve cash flows by a total £2.5 billion over 18 months." That looks to be an uphill climb, at least in the near term.
A Nomura Research report says the shift towards electric vehicles and hybrids will need higher investments, thereby affecting free cash flow (FCF) generation significantly for relatively small firms such as JLR. Note that the firm has forecast negative cash flow in FY19 and FY20, with a return to positive cash flow thereafter. “We now don’t expect JLR to generate positive FCF even in FY21F unless there is a sharp improvement in volumes. We also don’t expect the China JV to turn profitable over FY20/21F given much tougher conditions," says the report.
Besides, JLR’s problems don’t lie only in China. Macro challenges such as Brexit, US-China trade tensions and de-dieselization are also affecting performance. Even as JLR sales contracted 4.6% in 2018, BMW’s worldwide sales grew 1.8% during that period, while Mercedes-Benz sales expanded nearly 1%, making it the eight consecutive year of growth for the luxury car company.
Brexit, in fact, warrants a fresh look at the entire production and sales strategy. And the consumer and regulatory shift away from diesel vehicles puts JLR on a weak footing, given that its portfolio is diesel-heavy.
While it highlighted the success of its recent hybrid/electric vehicle I-Pace in the December quarter analysts’ call, the worry about the lack of financial muscle at a time of industry transition is a worry, as the head of research said earlier.
Long-standing luxury brands with deep pockets such as BMW, Cadillac, Daimler and Audi look set to race ahead in the period of transition; JLR, with talks of trimming and cost-cutting, looks ill-equipped to keep pace.
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