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JLR’s volume growth turns positive in June, but overhangs remain

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ET Intelligence Group: Jaguar Land Rover (JLR), the driving force at Tata Motors, logged 15 per cent unit sales growth in June but that hasn’t cleared the fog on the windshield. In a sluggish global economy, autos aren’t firing on all cylinders, and JLR’s high proportion of capitalisation of the R-D spend, and shifting consumer preference continue to weigh on the maker of Discovery. JLR contributes about three-fourths to total revenue of Tata Motors, and half of its fair value based on the sum of the parts valuation.

The stock of Tata Motors fell 10 per cent since the beginning of the year, and current underperformance is unlikely to reverse in the near term. JLR’s sales climbed for the first time in almost a year, thanks to incremental volume growth from Defender and recovery in China, where the company benefited from a low base. The Street has already priced in wholesale volume growth of 2-3 per cent in FY20.

Thus, higher growth in June alone may not move the needle on volume growth consensus. To be sure, in the first three months of the current fiscal year, JLR’s wholesale volume dropped 11 per cent to 118,550 units. But the balance sheet also requires a bit of scrutiny.

JLR’s earnings took a beating of around £3.1 billion in FY19 due to impairment of assets.

The current environment and consumer preference have meant that several of its R-D projects were not yielding desired returns.

JLR capitalises nearly 80 per cent of its R-D spend.

It means the amount invested in R-D adds to gross assets of the company rather than flowing through profit and loss account as expenses. This strategy works perfectly if the asset created has no obsolescence risk.

However, when the company finds that R-D assets created may not be commercially viable, it needs to be written off. The FY19 annual report shows that JLR continues to capitalise about 80 per cent of R-D expenditure, while BMW and Daimler follow the policy of capitalising in the range of 30-40 per cent.

Consequently, the net fixed assets to the percentage of sales have been consistently rising. According to CLSA, JLR’s net fixed asset to sales ratio stood at 50 per cent in FY19 against 32-35 per cent of its peers.

Higher proportion of capitalisation despite huge write-offs in the last fiscal has elevated the risk perception or probability of further write-offs. Besides, the warranty and provision ratio of JLR rose to a nine-year high, while this ratio has been relatively unchanged for its German peers.

This further weighs on financial performance and brand perception. The Tata Motors stock is trading at a 34 per cent premium to its German peers BMW and Daimler based on one-year forward projected earnings, compared with five-year average of 16 per cent.




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