Tata Motors’ 50% Drop In Profits In Q1 Is Not All Bad News

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Tata Motors‘ (NYSE:TTM) British marquee brand Jaguar Land Rover is the most important division for the company, forming just under 90% of the company’s valuation as per our estimate. JLR has had a solid year so far in 2016, selling a record-breaking 336,052 vehicles between January and July, up 23% year-over-year. However, despite strong revenue growth of 9% year-over-year in Q1 fiscal 2017 (April-June 2016), the consolidated profit after tax fell 38% year-over-year in the quarter. This was primarily due to unfavorable foreign exchange. Let’s look at how this happened.

Tata Motors had a solid Q1 with strong volume increases at both JLR and the standalone business, where commercial and passenger vehicle sales grew 8% year-over-year. However, the group’s consolidated profit after tax more than halved in the quarter, primarily due to unfavorable currency translations. Most of the foreign exchange impact on Tata Motors’ Q1 was at JLR. The foreign exchange impact at the division stood at £207 million, including revaluation of £84 million that mainly consisted of euro payables, resulting from the depreciation of the pound sterling after the June 23 U.K. vote to exit the European Union, and negative £123 million in the hedges realized in the quarter. In fact, excluding the £84 million, the EBITDA margin for JLR rose more than 150 basis points for Q1.

However, despite the loss in profits in Q1, things might be looking up for JLR and Tata Motors. The pound has depreciated 12% against the U.S. dollar and 11% against the euro since the June vote. As the company has hedged currency risks, it could realize losses for some time, however, a weaker pound is expected to benefit JLR over a longer period of time. More than 80% of the vehicles produced in the U.K. are sold abroad. In fact, 60% of the revenue is either linked to the U.S. dollar or it depends on it, and 20-25% of the revenue is in euros. The depreciating pound should boost JLR’s top line.

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The other advantage could be that JLR’s competition, especially the German trio of BMW, Mercedes-Benz, and Audi could become more expensive in the U.K., as a result of higher model prices in order to mitigate their foreign exchange losses.

On the other hand, possible tariff barriers depending on the trade agreements, could impact JLR’s Europe sales. Exports from the U.K. to Europe form roughly 24% of JLR’s total and could become subject to tariffs, raising model prices. The brand sources about 40-50% of its components from the European Union itself. The impact of the possible component import duties could be somewhat subdued due to the large number of JLR exports. This is as JLR could afford to lower model prices in Europe due to the appreciating euro against the pound. The extra cost of import duties could be added to the lowered model prices, to mitigate the impact of tariffs.

So the overall impact of the depreciating pound on JLR could be positive in the long term. However, there will always be the worry of slowing customer demand within the U.K., JLR’s single largest market. The U.K. represented 21% of Jaguar Land Rover’s net vehicle sales in the first half of the year. JLR, headquartered in the UK itself, has 25,000 of its 26,000-plus employees working there. Growing uncertainty after the U.K. voted to exit the European Union could weigh on the consumer and business confidence and negatively impact vehicle sales going forward.

Although JLR’s profits were hit in Q1, the solid sales growth and positive long-term impact of the depreciating pound reflect how the company could be headed for stronger results in the coming quarters. Jaguar has been the primary growth driver for JLR, with retail sales rising 69% year-over-year for the brand through July. Demand for the compact vehicles Jaguar XE and F-Pace has taken off, and these two newly launched models formed almost 70% of the retail sales for Jaguar last month. On the back of growth for its compact vehicles, as well as for Land Rover models such as the Discovery Sport, JLR could keep growing at a fast pace.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Tata Motors

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