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Morningstar | Tata Motors Reports Fiscal 2019 4Q Back in Black; Bumpy Road Ahead

Narrow-moat Tata Motors, which is India's largest commercial truck producer and owns the Jaguar and Land Rover, or JLR, luxury brands, reported fiscal fourth-quarter 2019 ended March 31 diluted earnings per ordinary share of INR 3.28, firmly back in the black versus the sell-side consensus estimate for a loss of INR 27.31 per share. JLR performance was still weak versus the year-ago period on dramatically lower China volume but showed significant improvement over the fiscal third quarter. Tata Motors Ltd. stand-alone, or TML, performance improved, partially offsetting weaker India commercial vehicle demand and higher commodity costs. Management maintained guidance that consolidated EBIT margin would remain in the low single digits through fiscal 2021, mid-single-digit percentages from fiscal 2022 to 2023, and long-term high-single-digit percentages. Despite the bumpy road ahead toward turnaround, India-traded shares rallied 8% on the solid fiscal year-end results.

However, we caution investors that we may lower our INR 580 fair value estimate by as much as 20% once we roll our model to the next fiscal year. Even though we do not anticipate changing our normalized sustainable midcycle assumptions, our outlook is based on the higher level of debt incurred while JLR burns cash during its restructuring. Increased debt is likely to result in a lower portion of our enterprise value going to equity as well as a higher discount rate as our systematic risk rating and credit risk ratings would be negatively affected by Tata's higher balance sheet leverage. We currently discount Tata group future cash flows using an 8.6% weighted average cost of capital. After rolling our model to the next fiscal year, our discount rate could be in the 9% range. If our fair value estimate were 20% lower, the shares of Tata Motors would still be 5-star-rated, trading at a 39% discount.

We think JLR margin degradation has troughed in fiscal 2019 but will persist through fiscal 2020. The group's Charge restructuring program initiated in fiscal 2019 has already delivered GBP 1.25 billion in lower capital spending, improved working capital, and cost savings, out of a GBP 2.5 billion target. As the company reaches Charge objectives in fiscal 2020, management will initiate the next phase, Accelerate. However, we forecast cash burn (cash flow from operations less capital expenditures and capitalized development) as JLR continues to experience plummeting Chinese light-vehicle demand and higher spending for powertrain electrification and autonomous technologies. Barring a no-deal, hard Brexit, JLR management said it expects fiscal 2020-21 EBIT margin of 3% to 4%, 4% to 6% EBIT margin for fiscal 2022-23, and long-term profitability of 7% to 9%.

Consolidated revenue for the fiscal fourth quarter declined 3.9% to INR 86,422 crores on an 8.2% decrease in global wholesale units, with TML volume dropping 8.2% and JLR down 8.0%. JLR revenue declined 5.1% partially offset by favorable currency translation to INR but in GBP, revenue declined 5.6%. TML commercial vehicle sales softened in the quarter on new axle load limits, higher fuel prices, and reduced credit availability. Even so, TML passenger vehicle unit volume decreased 1.2% during the fiscal fourth quarter. With a 6.1% increase in sales volume, TML sport utility vehicles only partially offset a 5.3% decline in passenger cars. Tighter credit availability and higher fuel prices may continue to crimp passenger vehicle sales.

Fiscal fourth-quarter 2019 consolidated EBIT margin before special items of 3.4% contracted 280 basis points versus last year, due mainly to JLR's margin contracting 240 basis points versus 5.4% margin reported a year ago. Even so, demand for light commercial trucks and sport utility vehicles in India resulted in enough favorable operating leverage for TML EBIT margin to expand by 60 basis points to 2.3% versus 1.7% in fiscal fourth-quarter 2018.