China slowdown in 2015 and now US in 2016; shouldn’t be that bad this time round: US slowdown is key risk for JLR in the coming quarters. We believe investors are concerned that the impending US slowdown will lead to another downward spiral for JLR, similar to what was seen in 2015 led by China. We believe the probability of a slowdown in the US is highly likely for various factors discussed later in this note, but the impact on JLR may not be as severe as the downward spiral seen in China last year.
Firstly, why do we think a slowdown in the US is so certain? 2015 was the sixth year of strong auto industry growth in the US and is the longest up-cycle seen in the past 40 years (chart), thereby, we believe, questioning the sustainability of growth in 2016e/17e. US light vehicle annual sales were ~$17.5m in FY15, which is the same as the presubprime crisis level. Auto consumer credit is nearly at an all-time high (~$1trn) and capacity expansion plans are ambitious, in our view. At current expected growth rates, utilisation will fall by 500bps for the industry thus putting pressure on prices. Furthermore, in the past few months discounting has increased across some OEs and segments (although luxury has continued to be resilient). Clearly all indicators suggest the market is at a peak and we should be ready for moderation. The luxury market is no different with growth moderating and 300-400K capacity scheduled to be commissioned in 2016. Importantly, we assume the extent of deceleration will be controlled and do not expect a hard landing. Auto loans may be at an all-time high but delinquency rates are still much lower than during the pre-subprime crisis. Consumer confidence is holding up while the oil price continues to be weak and the employment rate is holding up as well.
How bad can it get for JLR: JLR US volumes rose 25% in 2015 and it is now ~20% of total volumes. Undoubtedly, the US has clouded the outlook for JLR; however, our conservative margin forecast of 14-15% in FY17/18 already factors in slightly lower prices—more than volumes, we expect the US slowdown will result in pricing moderation across the globe. Furthermore, the current valuation of 7.5x forward PE (price-to-earnings ratio) doesn’t provide any credit for the strong new product traction by JLR. JLR is due to launch a significant number of new models in the US – XE, Gasoline ingenium engine Evoque, Discovery Sport, F-PACE – in the next 3-6 months. Last but not the least, the market appears well braced for the potential fall in US growth rates, which wasn’t the case for China.
How bad can it get for JLR?
US volumes are up 25% for JLR in 2015 and it is now contributing 20% of volumes. Undoubtedly, the US has clouded the outlook for JLR, however, our conservative margin forecast of 14-15% in FY17e/18e already factors in slightly lower prices. More than volumes, we expect the US slowdown will result in pricing moderation across the globe. Furthermore, the current valuation of 7.5x forward PE doesn’t provide any credit for the strong new product traction by JLR. Last but not least, the market appears to be well braced for the potential fall in US growth rates.
Valuation and risks
We use SOTP (sum of the parts) methodology to value Tata Motors. Our FY17e/18e earnings are unchanged as lower revenues are offset by slightly higher margins (both led by currency movements). We continue to value JLR on 5x EV/Ebitda and the domestic business at 9x EV/Ebitda on 12-month forward operating earnings (December 2016 earnings). We retain a fair value based target price of R460. Our target price implies an upside of 36.5%; thus we maintain our Buy rating on the stock.