Earnings will lag volumes: The next stage of JLRs growth will be driven by Jaguar, which (i) has weaker profitability, and (ii) faces intense competition, so we expect earnings to lag bullish buy-side expectations.
China will be a challenge for new XE: China is JLRs most profitable market, but we believe that the new Jaguar XE will face tough competition in the market all peers are localised and thus have the ability to offer competitive pricing.
Indian business forms only 11% of Tata Motors' value: Here too, we expect volumes to recover but profitability to lag given the entry of new players and adverse business mix.
Lastly, Tata Motors is an OW (overweight) both on the buy side and the sell side, as Tata Motors transitions from a high-margin niche SUV player to an all-segment luxury player, earnings momentum will slowand this, in our view, will cap multiple re-rating. On our revised earnings forecasts, FY2016e P/E (price-to-earnings multiple) is 10x, in line with BMWs multiple, with 5% FY14-16e earnings CAGR (compound annual growth rate).
Too consensus for comfort
Tata Motors has emerged as the first truly global car company out of India and we believe the JLR franchise will continue to gain share across markets. However, we are turning neutral on the stock for these reasons.
OW on both sell side and buy side leaves limited room for negative surprises: While the last three years have been about slowdown in India, Tata Motors has performed well thanks to strong SUV growth in China and new model momentum. The stock has outperformed the Sensex by 61% over the last three years.
Valuations are not as attractive considering slowing earnings momentum: Tata Motors (adjusted for R&D capitalisation) is now trading at valuations similar to BMW and earnings growth is also moderating. As the next stage of growth will come from Jaguar, where competition is intense, we believe incremental re-rating in a slowing earnings growth environment is unlikely. Furthermore, compared to domestic autos, the stock is cheap in P/E terms but on PEG (PE to growth ratio)-- key ratio for an industry that is troughing and entering its next growth cycle-- relative to domestic autos, it is not attractive any more.
In Jaguar, margins are lower and competition is intense: With most of the SUV launches having already taken place, the next stage of JLRs growth will be driven by Sedan/Jaguar launches, for which competition is more intense and margins are lower. Thus, though we are positive on the success of Jaguar XE and CX17, we believe that Ebitda margins are unlikely to remain at the 18% level we saw in Q3FY14, and with rising depreciation charges (and higher capex), earnings will significantly lag volume growth.
Tough for Jaguar to crack China: We expect profitable growth in China will be tough to achieve since all competitors are localised, so Jaguar will find it tough to compete on pricing. Furthermore, Chinas luxury sedan market is seeing volume and pricing pressure, and both trends do not bode well for Jaguars success.
Earnings growth is slowing relative to our coverage: On our estimates, Tata Motorss earnings growth for FY14-16e will be a mere 2% vs. 23% CAGR for our coverage; slowing earnings will moderate stock performance. Overall, we raise our JLR earnings estimates by 32% for FY15 and 18% for F16 and this leads to the bulk of our consolidated earnings estimate upgrades. Although we are positive on Indias MHCV recovery, rising competitive intensity across segments leads us to cut our forecasts. Given the low base, the cut in earnings forecasts