Tata Motors, which scaled its 25-month low on Friday, has been the biggest underperformer among frontline auto stocks over the past year, shedding 31 per cent of its value. By comparison, the broader markets and peer index (excluding Tata Motors) is up 13-14 per cent. Lower volume growth at Jaguar Land Rover (JLR), an elevated level of discounts/dealer incentives, environment regulations and the transition to electric vehicles are some of the worries that have led to the underperformance. While its Indian operations have seen a revival in volumes, both in the commercial vehicle (CV) and passenger car segments, given that 80 per cent of its revenues and all its profits come from JLR, the performance of the British car maker is crucial for Tata Motors and the stock. If analysts are to be believed, the stock could continue to underperform in the near term, until JLR's sales numbers improve.
Many issues for JLR
The biggest worry has been the muted volumes for the two marquee brands of Jaguar and Land Rover in FY18. JLR reported volume growth of just two per cent in FY18, despite several new launches and higher incentives underlining the competitive intensity in the market. One of the challenges JLR is facing is a slowdown in UK and EU volumes. These markets account for 40 per cent of its sales.
The sentiment towards diesel vehicles is negative in these two markets, and that is reflected in the 5-13 per cent fall in sales volume in FY18. The company earlier this month indicated that the legislative uncertainty around diesel and the resulting lower demand in the UK and Europe continue to have a negative impact. After the ‘dieselgate’ scandal involving Volkswagon, the UK and EU are contemplating tougher penalties for car makers found supplying vehicles fitted with devices or systems aimed at cheating air pollution rules.
The slowing growth, especially in the past two quarters in key markets, is offsetting growth in China and other world markets. Growth in China is key since it is the largest (25 per cent of overall volumes), the fastest-growing (20 per cent growth versus overall two per cent), and the most profitable market for JLR. Despite a fast growth rate, analysts say that JLR's performance in China has been in line with those of peers, but it has underperformed Cadillac and Lexus. Cadillac overtook JLR as the fourth-largest premium car brand in China by volume in CY17, according to UBS.
The volume pressure for JLR, especially in the UK and EU, given the diesel headwinds, is expected to continue in the next six months to a year. Bharat Gianani of Sharekhan says: “In Europe, there is a backlash on diesel, which would continue to impact JLR as the portfolio has predominantly diesel models. The UK market outlook is also sluggish as the economy is preparing itself for Brexit and would need to carry out trade negotiations with other countries, especially in Europe.”
What is compounding the matters for the company is an increase in investments in less polluting vehicles and an impending electric vehicle switchover. These could lead to further pressure on the stock. Analysts at UBS believe that JLR faces multiple headwinds with a sharp slowdown in growth and business profitability, even as the emission target and electric vehicle transition are on the horizon. The brokerage believes that JLR’s value could de-rate further on 1 billion pounds of negative free cash flow over the next three years.
Some help from India
What is providing some support to the stock, however, has been the strong showing in the India business. Overall volumes in the March quarter were up 35 per cent year-on-year, with strong gains for each of its segments. However, there are headwinds here as well. The easing of overloading restrictions in key states of Rajasthan and Uttar Pradesh are expected to play the spoilsport.
Chirag Jain and Indarpreet Singh of SBICAP Securities say that the easing of restrictions has already started impacting retail truck demand, product mix (demand-shift back towards lower tonnage trucks) and discounts in the industry. This could lead to a moderation in volume growth and profitability for Tata Motors, and impact its India valuations. Gianani of Sharekhan says, “The impact (moderating volume growth) of standalone CV business on the overall Tata Motors performance is important as standalone business as a whole would contribute about 35 per cent of overall valuations of Tata Motors. PV business is currently making losses and, thus, the entire valuation of standalone is from CV segment, so the impact of CV is meaningful in overall valuation as well.”
Though there are multiple headwinds, the stock is trading at an attractive FY20 enterprise value to operating profit of under 3 times. By way of comparison, Maruti Suzuki trades at over 14 times its FY20 estimates on the same metric. While the over 75 per cent discount is large, till volumes at JLR improve on a consistent basis, analysts believe that a rerating story is unlikely to unfold at Tata Motors.