Product quality issues find their way into rising costs at Tata Motors

Tata Motors Ltd’s shares fell 4% on Wednesday, reacting to foreign brokerage CLSA’s call to “sell” the stock as cost concerns continued in a weak demand environment. However, a spark of hope with news of improved Jaguar Land Rover (JLR) sales in some regions saw the stock recover slightly.

JLR, the British subsidiary that contributes 75% of the consolidated revenue, largely drives sentiment for the stock. CLSA’s recent report said that warranty expenses and provisions ratio were at a nine-year high in FY19.

Consolidated warranty expenses, which are mainly reflective of JLR’s costs, rose significantly in FY19. They stood at 3.9% as a percentage of consolidated revenue, higher than earlier years. This has raised concerns over and above the existing problems of high fixed assets vis-à-vis sales, negative free cash flows and high automotive debt.

Rising warranty expenses have also raised questions about product quality. “In addition to industry issues of lower growth and higher incentives, there are company specific issues such as dealer training and profitability, as well as perceptions around quality,” said a Deutsche Bank research report dated 7 June.

News reports had earlier said JLR had several product recalls in China because of product defects in 2017, leading to major concerns about product quality. “Management acknowledged that since JLR is a relatively young brand in China, a lot of structural issues were ignored when the market was booming between 2011 and 2015,” said the Deutsche Bank report. Meanwhile, rising inventory in the stand-alone entity because of plummeting commercial vehicle sales has fuelled Tata Motors’ problems.

That said, JLR’s June quarter sales has brought a flicker of hope for investors. June quarter sales were 11.6% lower than the year-ago period, but the media release on Wednesday highlighted that while China sales fell year-on-year in June, they were up 23.1% compared to May. In the UK, sales set a new record for June despite industry sales being down 4.9%.

A report by Maybank Kim Eng Securities India Pvt. Ltd, conceded that the firm is facing multiple headwinds but is optimistic about the road ahead. “At JLR, the weakness in China is abating and we expect volume expansion to be supported by the success of the new Evoque, Range Rover/Sport, Discovery and Defender models now also available as plug-in hybrids.”

For FY20, Tata Motors has guided to an Ebit margin of 1-3% led by significant cost savings at JLR, a turnaround in its China business and continued profitable growth in India. Ebit stands for earnings before interest and tax.

Both the company and the stock have been battered by these strong headwinds. While the Nifty index gained 5.04% in a year, Tata Motors’ shares have plunged 44.9%. It remains to be seen if the recent recovery in sales is a blip or whether it will be sustainable.