International rating agency Moody’s Investors Service had a double whammy in store for Tata Motors Ltd. It has downgraded its ratings for both the parent company and its subsidiary Jaguar Land Rover Ltd (JLR). What’s more, this is the third downgrade for JLR and second for Tata Motors in less than a year.
Moody’s downgraded JLR’s corporate family rating from Ba3 to B1 and, that of the parent from Ba3 to Ba2. Indeed, the negative shift in the rating agency’s stance is not surprising, given that both JLR’s car sales in global markets and the stand-alone entity’s commercial vehicle sales are precariously poised. Indeed, as the chart alongside shows, Tata Motors’ equity shares had captured the decline in the company’s fortunes far earlier.
Note that JLR, which has been Tata Motors’ cash cow, is caught in a quagmire in China. The first downgrade from Moody’s in July 2018 was after sales in China suddenly hit the skids in June. This happened after many rounds of upgrades in earlier years.
Though the decline in China has now eased, the tide turned unfavourable in May, with sales declining in other markets such as the US, the UK and Europe.
As a result, the overall 13.5% year-on-year sales decline in May dampened investor sentiment, after a brief recovery that followed the better-than-expected March quarter results.
JLR’s downgrade reflects the rating agency’s expectation that debt/Ebitda or earnings before interest, tax, depreciation and amortization (Moody’s adjusted numbers) is likely to hold above five times for fiscal years 2020 and 2021, while free cash flow is likely to be materially negative. In addition, the need to invest in hybrid and electric vehicles would pile up pressure on profitability and cash flows. Besides, risks to sales growth would arise from a potential “no-deal Brexit" or from US tariffs.
Meanwhile, the downgrade of Tata Motors stems primarily from the floundering fortunes of JLR, which is its 100% subsidiary, accounting for most of its consolidated revenue, profit and debt.
“However, the last few months have seen India’s auto sector face challenges from slowing sales due to over-capacity, tightening liquidity and a shrinking dealer network," says Moody’s in the rating rationale.
The Street has already factored in these pain points. Brokerage firms have, over the last several months, steadily downgraded their FY20 and FY21 earnings forecasts, citing similar reasons.
A Nomura Research report dated 6 June says that high investments will keep free cash flows negative until FY21, even as JLR’s Ebit (earnings before interest and tax) margins will be 3-4% in the short term (FY20-FY21). Also, Tata Motors’ stand-alone business is seeing a downtrend in medium and heavy commercial vehicles.
As pointed out earlier, Moody’s downgrade only affirms these concerns.