Tata Engines (NYSE: TTM), a major India-based automaker with a leading presence in commercial vehicles, as well as utility vehicles, trucks, buses and defense vehicles, recently reported a below-average quarter on the decline significant impact on Jaguar’s profitability Land Rover Operations (JLR). It should be noted that a weaker product mix and the inability to pass on headwinds to input costs without experiencing a corresponding drop in volumes were the main areas of concern, although there is light on the end of the tunnel given JLR’s growing order book. Additionally, Tata remains on track for a cyclical rebound amid a pickup in semiconductor supply – just in time to respond to buoyant volume prospects following the launch of the new Range Rover.
As large OEMs such as Tata Motors tend to benefit from operating leverage, any improvement in volumes should have a disproportionately positive impact on cash flow and, by extension, accelerate deleveraging over the coming quarters. At ~5x EV/EBITDA, the stock is also cheap, leaving ample room for upside as the domestic and JLR business recovery takes shape.
Jaguar Land Rover was the weak spot, but don’t discount them just yet
The biggest disappointment in Tata’s Q1 2023 results was JLR’s EBITDA figures at ~£279m (-38% yoy), due to lower volume following the latest series of price increases, a negative shift in product mix (i.e. lower volume contribution from Range Rover and Range Rover Sport) and headwinds from China (decreasing volumes from 50% vs. prior year), on the other hand, higher inflation-related contribution costs (negative impact of around 350 bps) were the main headwind, highlighting the lack of power of JLR’s pricing in the current environment. It’s worth noting that even with higher list prices, realized selling prices were actually down about 2% QoQ. Compared to European competitors such as BMW/Audi/Mercedes, JLR volumes also underperformed due to an outsized impact from semiconductor constraints.
While management sticks to its strategy of raising prices further and implementing cost-cutting measures to recoup cost inflation, a recovery in volumes and an easing chip shortage will likely the key to a P&L rebound from here. So far, signs of recovery have been positive – JLR’s order book now stands at around 200,000 orders amid positive customer bookings for the new Range Rover, Range Rover Sport and Defender models. Assuming that new models intensify over the next few quarters alongside production, the overall product mix is also expected to improve, presenting JLR’s EBIT margin of around 5% on the upside and forecasted available cash of approximately GBP 1 billion for 2023.
Transitional pressure on passenger car margins, but outlook remains as strong as ever
Tata’s domestic passenger vehicle business may have seen lower EBITDA QoQ margin on higher promotional spend this quarter, but revenue growth of around 10% QoQ due to higher volumes and prices high has been extremely positive. The company also saw record wholesale and production numbers in the quarter at more than 130,000, with robust booking pipelines and low channel inventory. More broadly, the company appears to be one of the main beneficiaries of a strong product cycle (including its new rickshaw variants) – a tailwind for its market share over the coming quarters.
The current backlog already has a backlog of up to three months and, despite waiting periods ranging from four weeks to three months, has seen relatively few cancellations. Assuming chip supply improves further from Q2 (in line with management expectations), the company should be well positioned to meet demand via a 10-15% capacity debottleneck. Beyond the immediate future, the refresh cycle is also expected to begin next year and increase volumes, while management’s commitment to also launch new products based on product gaps bodes well for medium and long term prospects.
Continued recovery in demand supports outlook for domestic commercial vehicles
The outlook for Tata’s commercial vehicles remains as strong as ever amid strong freight demand and truck fleet utilization. While most of the post-COVID rebound had been focused on large fleets, management is also starting to see a recovery in demand from smaller fleet operators. It should be noted that Tata’s Trucker Sentiment Index is now at a two-year high for the medium and heavy commercial vehicles and the medium and light commercial vehicle categories. I would also like to point out that the bullish reading comes despite demand from smaller fleet operators restrained by tighter funding standards (85-90% LTV vs. 95-100% in the last cycle) as well as an uncertain operating environment.
That said, with commodity prices also starting to decline and ongoing geopolitical tensions leading to higher freight rates, any headwinds in funding should be more than considered, even for smaller fleet operators. Thus, Tata should see a domestic cyclical recovery in segmental EBITDA margins from here, with the next catalyst likely being the next steel contract price revision (likely to lower rates).
Booming EV business presents long-term options
EV volumes remain a small portion of passenger vehicle volumes at ~7% this quarter – in comparison, the contribution from internal combustion engines was 64% and 18% for gasoline and diesel, respectively . Nonetheless, Tata Motors’ continued leadership in the electric vehicle market is commendable, especially given the tight supply backdrop. According to management, the appetite for electric vehicles is positive – many of its models currently have a waiting period of seven months and more (well above its ICE models). Additionally, the company has a strong EV pipeline, having recently launched a longer-range version of the Nexon EV and maintaining plans to launch more models in the coming years.
In India, however, EV penetration is likely to remain in the low to mid-single digit % range unless EV costs become more competitive. Admittedly, this is a tough question in the short term, with battery material costs rising amid ongoing supply disruptions, but in the long term Tata’s EV business presents an important option. In particular, the company’s lead has allowed it to collect crucial customer and powertrain data, enabling it to access capital across cycles – the recent investment of approximately $1 billion from TPG, for example, pegs the EV segment at a whopping ~$9.1 billion after-money valuation.
Weak quarter but on track for a rebound
Tata Motors may have disappointed this time around, but the outlook is far from bleak – the semiconductor supply should improve from here, and with the new Range Rover already receiving a positive response , the volume outlook after the second quarter could surprise on the upside. Operating leverage from improved volumes could have a disproportionately positive impact on earnings and cash flow, helping to accelerate debt reduction. Expectations are also low with the share price at the current multiple of around 5x EBITDA going forward, so any positive signs of a recovery in domestic business as well as for JLR could catalyze a re-rating.