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  • Stock Recommendation | Tata Motors - BUY - Target price : 300

    Publish date: NOVEMBER 01, 2018

    JLR business facing headwinds.Tata Motors reported consolidated adjusted net loss of ₹3.3 bn in 2QFY19, which was led by loss in JLR business due to tough market conditions. Standalone business performance was also below par but demand for CVs in India remains strong. We believe management is on course to improve operating margins in both standalone and JLR businesses led by cost-reduction initiatives. We maintain BUY rating but cut our TP to ₹300 (from ₹425 earlier).

    JLR reported EBITDA of GBP511 mn (down 32% yoy) in 2QFY19, which was 7% below our estimate of GBP552 mn. Reported EBITDA margin was 9.1% in 2QFY19 (down 270 bps yoy) as compared to our estimate of 9.6%. Lower ASPs due to weaker product and geographic mix and higher other expenses led to miss in EBITDA margin. Realized hedge losses came in at GBP165 mn (down from GBP212 mn in 1QFY19) and were in line with our estimates. Gross margin improved by 130 bps qoq due to—(1) 110 bps owing to lower hedge losses on qoq basis, (2) reduction in variable marketing spend to 6.5% of sales in 2QFY19 from 8% of sales in 1QFY19 (note that there was one-off incentive of GBP99 mn or 1.9% of sales in China in 1QFY19), offset by (3) 170 bps decline in gross margin due to weaker mix. Other expenses were higher due to (1) GBP39 mn of one-off warranty provisioning and (2) GBP45 mn of start-up costs associated with the new Slovakia plant.
    The standalone business reported an EBITDA of ₹14 bn (KIE ₹19 bn) in 2QFY19, which was 26% below our expectations due to lower-than-expected gross margin and higher other expenses. In the conference call, the management highlighted that there were one-off costs of ₹1 bn above EBITDA but did not share complete details on the same. Adjusted net profit at ₹4.1 bn (KIE: ₹6.4 mn) was 36% below our estimates miss at EBITDA level. There were extraordinary losses below EBITDA of around ₹3.9 bn, which pertains to (1) ₹3 bn of forex losses and (2) ₹0.9 bn towards provision for impairment of CWIP and intangible assets on Thailand subsidiary.

    Management has cut its guidance on volume growth of JLR (now expects flat yoy growth) in FY2019 and expects breakeven at EBIT level in FY2019. However, the company maintained its 4-7% EBIT margin over FY2020-21E (KIE estimate: 2.7-4.1%). JLR management has initiated a GBP1 bn cost-reduction plan, which will be implemented over the next 18 months. JLR has also cut investment spending by GBP1 bn over FY2020 and FY2021 and expects to generate GBP500 mn through working capital reduction in JLR. In the standalone business, the company is confident of maintaining 4-6% EBIT margin guidance during this period. Maintain BUY with revised target price of ₹300 (from ₹425 earlier). Cut in target price is driven by 21-41% reduction in our consolidated earnings estimates largely due to significant cut in JLR earnings estimates.

    ▶ JLR reported EBITDA of GBP511 mn (down 32% yoy) in 2QFY19, which was 7% below our estimate of GBP552 mn. Reported EBITDA margin was 9.1% in 2QFY19 (down 270 bps yoy) as compared to our estimate of 9.6%. Lower ASPs due to weaker product and geographic mix and higher other expenses led to miss in EBITDA margin. Realized hedge losses came in at GBP165 mn (down from GBP212 mn in 1QFY19) and were in line with our estimates. Gross margin improved by 130 bps qoq due to—(1) 110 bps owing to lower hedge losses on qoq basis, (2) reduction in variable marketing spend to 6.5% of sales in 2QFY19 from 8% of sales in 1QFY19 (note that there was one-off incentive of GBP99 mn or 1.9% of sales in China in 1QFY19), offset by (3) 170 bps decline in gross margin due to a weaker mix. Other expenses were higher due to (1) GBP39 of one-off warranty provisioning and (2) GBP45 mn of start-up costs associated with the new Slovakia plant.
    ▶ Share of profits from JLR China JV declined significantly to GBP3 mn in 2QFY19 from GBP61 mn in 2QFY18 and GBP30 mn in 1QFY19. This was due to steep decline in China JV volumes, down 40% yoy and 43% qoq. China JV reported EBITDA margin was 15.5% in 2QFY19 versus 26.8% in 2QFY18. The company has launched Jaguar E-Pace in China JV, which should see improvement in volumes in 2HFY19. We expect EBITDA margin to remain around 19% in FY2019 (similar to 1HFY19 levels); the company might need to give some one-off cash incentives to compensate dealers for lower margin due to increase in discount levels.
    ▶ JLR’s overall wholesale volumes declined by 15% yoy to 130,652 units in 2QFY19; JLR UK P&L volumes declined by 10% yoy while China JV volumes declined by 40% yoy. In the UK P&L, Jaguar brand volumes grew by 5% led by the launch of E-Pace and I-Pace models while Land Rover volumes declined by 17% yoy due to demand pressures across markets. Volumes of all the existing models declined significantly on yoy basis except Range Rover and RR Sport models where volumes declines by 7-8% yoy.
    ▶ On the geographical front, China wholesale volumes (including China JV) declined by 39% yoy in 2QFY19 led by steep decline in both exports from UK and local China JV volumes. UK and Europe volumes declined by 8-12% yoy while exports to North America and rest of the world markets declined by 1% yoy in 2QFY19.
    ▶ Company’s first electric model I-Pace has been launched in UK and Europe markets and the model will be launched across other major markets in the next few months. This coupled with ramp-up of volumes of newly launched Jaguar E-Pace will drive improvement in volumes for the company in 2HFY19.
    ▶ Depreciation expenses were largely flat qoq in 2QFY19. Below the EBITDA line, company also reported a FX loss of GBP37 mn on unrealized hedges and debt. Realized hedge loss on the outstanding hedge book has reduced to GBP165 in 2QFY19 mn (GBP312 mn in 1QFY19) and current portion of hedge book was GBP397 mn in 2QFY19 (GBP562 mn in 1QFY19).
    ▶ The company started Slovakia plant last week and will shift Discovery production to Slovakia plant, which will free up capacity in UK plants. Slovakia plants’ cost of production will be GBP2,000 lower than UK plant as per the company. If company retains the benefit of lower cost of production in Slovakia plant, it could boost EBITDA margin of JLR by 40-50 bps in FY2020E.
    ▶ There was a negative FCF of GBP624 mn in 2QFY19 largely due to increase in working capital requirements (GBP112 mn) and investment spending of GBP996 mn. The company has reduced its annual capex guidance to GBP4 bn in FY2019E and FY2020E from GBP4.5 bn annually earlier. Additionally, the company has also taken initiatives to reduce costs and improve cashflows to the extent of GBP1.5 bn over the next 18 months, which will be led by (1) working capital savings of GBP0.5 bn in 2HFY19 and (2) cost-reduction targets of GBP1 bn over the next 18 months, which include efforts to lower RM cost per vehicle, lower fixed overheads, etc.

    Standalone business: Robust overall performance on yoy basis but profitability below our estimates
    ▶ Standalone business reported an EBITDA of ₹14 bn (KIE ₹19 bn) in 2QFY19, which was 26% below our expectations due to lower-than-expected gross margin and higher other expenses. In the conference call, the management highlighted that there was one-off costs of ₹1 bn above EBITDA but did not share complete details on the same. Further, there was a change in accounting policy (as per IND-AS 20) under which government grants are accounted in other non-operating income below EBITDA as compared to other operating income earlier. While we don’t have exact details on quantum of impact on EBITDA in 2QFY19 from the same but we note that the change in accounting policy led to restatement of EBITDA in 1QFY19 to the tune of ₹1.3 bn.
    ▶ Adjusted net profit at ₹4.1 bn (KIE: ₹6.4 mn) was 36% below our estimates miss at EBITDA level. There were extraordinary losses below EBITDA of around ₹3.9 bn, which pertains to (1) ₹3 bn of forex losses and (2) ₹0.9 bn towards provision for impairment of CWIP and intangible assets on Thailand subsidiary.
    ▶ Revenues increased by 29% yoy in 2QFY19 led by (1) 24% yoy improvement in volumes and (2) 3.6% yoy increase in ASPs driven by price increase taken during the year and improvement in product mix (higher MHCV volume mix). Volumes growth was driven by (1) 32%/25% yoy increase in MHCV/LCV volumes aided by industry growth on strong industry demand and market share gain and (2) launch of new Nexon utility vehicle.
    ▶ EBITDA margin came in at 7.9% in 1QFY19 (+200 bps yoy, flattish qoq), which was 240 bps below our estimates partly due to reasons highlighted above. Gross margin declined by 30 bps qoq (KIE: 90 bps qoq improvement) due to commodity cost pressures; on yoy basis, gross margin improved by 200 bps due to better mix and price increases. We note that employee cost increased by only 11% yoy leading to operating leverage benefits. However, other expenses increased by 38% yoy and led to 80 bps miss in EBITDA margin compared to our estimates.
    ▶ In terms of segments, EBITDA margin in the commercial vehicle business was 11.4% in 2QFY19 (down 150 bps yoy and 30 bps qoq) while EBIT margin was 8.7% in 2QFY19 (9.3% in 2QFY18). We note that the company achieved EBITDA breakeven in the passenger vehicle business due to improvement in volumes led by success of new models and company’s cost-reduction efforts. EBIT margin in passenger vehicle business was negative 8.7% in 2QFY19 as compared to negative EBIT margin of 25.6% in 2QFY18.
    ▶ The company spent ₹11.1 bn in 2QFY19 on R&D and capex, of this, ₹5 bn was spent on R&D (80% capitalized) while rest was on capex (largely investments ahead of BS-VI emission norms). FCF was positive at ₹7 bn. Net automotive debt for the consolidated entity was ₹410 bn as of September 2018, up from ₹330 bn in June 2018 due to negative FCF in JLR business.

    Consolidated EBITDA was 15% below our estimates
    The company reported consolidated EBITDA of ₹67.6 bn (down 24% yoy), which was 15% below our estimates due to weaker-than-expected performance of JLR and standalone business. Adjusted net loss in consolidated entity was ₹3.3 bn, which was driven by (1) miss at EBITDA level and (2) steep decline in profitability of the China JV due to lower volumes and higher incentives.


    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.


    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.


    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.


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