Tata Motors & Jaguar Land Rover: China Drag Diminished?

Citi upgraded its bond call on the Jaguar Land Rover unit of Tata Motors  after Tata reported earnings last week.

Tata stock, down 25% so far this year, is off by 54% over 12 months, prompting Goldman Sachs to close its sell rating on Tata Motors equity Monday. Citi Analysts Manish A. Somaiya and Esha Ranganath note that for the Jaguar Land Rover unit, while China revenue accounted for a third of fiscal 2015 earnings, China is only about 19% of fiscal year to-date retail volume compared to 27% in the prior year. They write:

“Management cited the 10% year-over year decrease in China retail volumes for the fiscal third quarter (including joint ventures vs. -32% in the fiscal second quarter and -33% in the fiscal first quarter) as an indication that declines in the region have stabilized while still citing the region as a main factor in lower year-over-year earnings before interest, taxes, depreciation and amortization (EBITDA) (we assume this is a function of JV transition and higher China margins) …”

The Citi analysts raised their issuer weighting on Jaguar Land Rover (TTMTIN) to Marketweight from Underweight, and raised their senior notes ratings to Neutral from Sell. With their sell rating last fall, they cited weak China revenue. The fresh decision reflects the following:

1. “Management actions including capex reduction bolstering liquidity,
2. Volume growth in other regions offsetting a softer China and,
3. Possible stabilization of decline in China.

While we still anticipate a negative free cash flow year and slightly higher gross leverage of 0.9x at fiscal 2016 year-end (vs. 0.8x currently), we like the company’s strong balance sheet and could see investor focus on higher quality defensive names providing a positive technical. Additionally, we continue to monitor potential execution risk from focus on multiple product launches …

Guidance included FY2016 capex reduction to £3.3 billion ($4.7 billion) from £3.5 billion previously and indications of negative free cash flow (FCF) in the near to medium term (albeit offset by a strong balance sheet and cash balance). On the call, management reaffirmed EBITDA margins at the lower end of 14-16% range as a result of model mix, launch costs, and mixed economic conditions incl. China. At the same time, management aims to fund capex from operating cash flows as evidenced this quarter and anticipates continued working capital benefit during fiscal fourth quarter given seasonal benefits during the second half of the fiscal year. At a high level, we estimate FY2016 EBITDA of £2.9 billion, implying a 14% margin in-line with low end of guidance. Our FCF use estimate of ~£1.0 billion for the year results in gross leverage increasing slightly to 0.9x at year end.”