Short-term woes for Tata Motors

With consolidated margins likely to remain under pressure and capacity constraints at JLR, gains for the stock are capped

Tata Motors has surprised negatively by posting a sharp drop in profits despite meeting sales expectations, due to high cost pressure in India operations and JLR seeing higher sales of low-margin products as well as cost increases. Going ahead, the prospects of India business are unlikely to improve soon, while for JLR, the demand for its products remains healthy and will be a function of new launches where there are a few in the offing. However, margins for JLR may not improve soon as sales proportion of low-margin products is likely to remain at elevated levels. Overall, JLR’s performance will continue to drive the stock, which could remain range-bound given that the company has limited capacity to push sales significantly higher. Once the China facility goes on stream by end-2013 or if the company could de-bottleneck existing capacity, there is limited room to cater to underlying demand. Post results (which came after market hours in India) though, its ADR is up about two per cent intra-day.

Against expected net profit of Rs 2,770 crore for December 2012, it posted Rs 1,627.50 crore, a year-on-year (y-o-y) drop of 52 per cent, and the lowest in three years. At the consolidated level, too, income from operations at Rs 46,089 crore in December, reflects a mere y-o-y growth of 1.8 per cent.

Main reason for the drop in profit was a sharp reduction in operating profit margin, both in the domestic and JLR businesses. As a result, consolidated operating profit margin fell from 16 per cent to 13.3 per cent y-o-y. Domestic business witnessed a reduction in margin from 6.7 per cent in December 2011 to 2.2 per cent in the recently concluded quarter, while JLR margin fell from 17 per cent to 14 per cent.

Margins of JLR slipped on account of higher sales of lower-realisation models and variants of Evoque and Freelander. Domestic margins fell on account of rising costs, higher discounts and poor performance from the medium and heavy commercial vehicle (M&HCV) segment – the company’s main stay in India. The saving grace in the domestic market was a strong performance from the light commercial vehicle division, mainly on account of its model ‘ACE’. Its passenger vehicle (PV) sales slumped by 36 per cent while exports dipped by 18 per cent y-o-y. So, on standalone basis, Tata Motors has posted a loss of Rs 458 crore, for the first time since December 2008.

In the domestic market, high competition is likely to continue, with pressure being felt at the M&HCV segment. Higher operating cost and low freight availability on account of weak economic outlook are expected to put pressure on domestic sales. Tata Motors’ management have confessed that marketing cost is likely to go up in coming months. Thus, going forward little can be expected from the domestic business.

As for JLR, the company still relies a lot on its China operations for growth. In December 2012, the share of China’s contribution increased to 21 per cent from 17 per cent on account of rapid rise in dealer network and touch point, resulting in a 54 per cent growth in sales. UK posted a growth of 11 per cent, Europe seven per cent while America recorded a six per cent drop.

However, net profit from JLR came down from £393 million to £296 million, a drop of 25 per cent y-o-y. This drop is on account of product and variant mix, higher marketing costs and negative currency movement. Margins are unlikely to improve at least in the current quarter given these headwinds will continue to persist. However, a fact that can impact analysts view on the company is that for the next fiscal, the company is expected to post a negative free cash flow. This, the company’s management says, is on account of a revised capex of £2.75 billion as against £2 billion earlier.

In the short run, however, no good news is expected to come out of the company.