The scrip is at an all-time high, but going ahead, Jaguar Land Rover’s performance will hinge on demand from the US and China, favourable currency movements and depressed raw material prices

JLR was a show-stopper

Tata Motor's Q1 performance exceeded the Street's expectations by a wide margin thanks to a stellar performance from Jaguar Land Rover (JLR). Tata bought the British automotive company in 2008 for $2.3 billion in a deal that drew huge criticism at that time. JLR's successful turnaround could be the first step for the Tatas in proving critics wrong - the second, of course, will have to be lowering the massive consolidated debt quicker than expected.

JLR margins: 410 bps improvement

JLR's margins saw a huge 410 bps q-o-q improvement due to a mix of factors such as favourable currency movement, better product mix, and cost control. A weaker pound boosted the profitability of JLR's US exports. A weaker euro lowered costs. JLR also lowered its incentives (discounts) and exercised tighter cost control. Its EBITDA margins now stand at 15.5%. For margins to sustain in the coming quarter, the pound and the euro have to weaken and commodity prices will have to remain lower.

Tata Motors' standalone EBITDA margin was higher than expected due to higher 'other income' and lower amortisation of product development expenses. Ace Truck, Ace Magic and Winger continue to register strong sales. Indigo Manza had a successful launch.

Demand: Strong from US, China

Demand remains strong from China and North America (UK is still lagging). China made up for 11% of sales in Q1 (8% in FY10) while UK declined to 23% (28% in FY10). If demand remains so strong, incentives and discounts should remain low. JLR is launching the new LRX Land Rover and a smaller Jaguar - this should support volumes (next year). For competitors too, demand has been strong - Daimler and BMW recently raised guidance.

JLR inventory and realisations

JLR's inventory (both at the dealer and JLR end) are now down to a comfortable 77 days (102 days in Q1 FY10). It has sustained at current levels for three quarters now. Its realisations have been steadily climbing for a year now and were up 6% q-o-q - they have risen from £31,337 in Q1FY10 to £38,209 in Q1FY11.

Some supply constraints

Tata Motors indicated that with the current manpower, JLR is operating at close to full capacity. It is also encumbered by the supply of engines (from Ford). Hence, most models are on a waiting period of 2-3 months.

Cost-cutting

JLR sources nearly 20% of its components from low-cost centres like Eastern Europe which it plans to increase to 35% over the next few years. Warranty costs have been much higher for JLR at ~5%, versus ~2% for competitors. JLR says it will work on internal and vendor-related processes to minimise these costs. JLR plans to (eventually) shut down one out of its three operational plants and reduce the number of employees. For now, though, JLR has resumed hiring.

A quick look at some key numbers:

Consolidated:
Net sales: Rs270.56 billion (up 65% y-o-y, down 7% q-o-q)
EBITDA: Rs39.5 billion (up 563% y-o-y, up 17% q-o-q)
Net profit: Rs19.89 billion (down 10% q-o-q)

Standalone:
Net sales: Rs104.16 billion (up 63% y-o-y, down 15% q-o-q)
EBITDA: Rs11.75 billion (up 61% y-o-y, down 5% q-o-q)
Net profit: Rs4.4 billion (up 119% y-o-y, up 25% q-o-q)

Most brokerages tracking Tata Motors are completely blown away with JLR's performance and are predictably asserting that it will sustain. However, it faces three key challenges - US and China demand has to sustain at current pace but both economies are showing signs of strain, currency movements have to be favourable, and commodity prices have to be down.

For now, the dollar index is showing absolutely no signs of rising, so it may be difficult for even the last two conditions to come true. Tata Motors is at an all-time high today. Retail investors should exercise caution.  

 — Munira Dongre