Jaguar Land Rover (JLR) reported a 13.4% year-on-year growth in Ebitda (earnings before interest, taxes, depreciation, and amortisation) despite a modest 4% y-o-y growth in revenues. JLR Ebitda margin improved by 160 basis points y-o-y led by richer product mix and favourable currency. Standalone continued to make losses led by high capital costs and losses in the passenger car business.
We maintain our Buy rating on the stock as we believe JLR product momentum is likely to remain robust over the next two years and Ebitda margin will remain resilient in 18-19% range led by favourable currency and mix. We have raised our target price to R680 (from R570 earlier) led by an increase in earnings estimates for JLR due to higher Ebitda margin assumptions.
JLR volume momentum to accelerate: JLR reported a net profit of £450m (-11% y-o-y), which was 13% below estimates driven by forex loss on unrealised hedge book of £85m and higher-than-estimated depreciation expenses. Net revenues of £4.8 bn (+4% y-o-y) were in line with estimates. Volumes grew by 2% y-o-y due to production constraints as the company prepares to start production of Discovery Sport and Jaguar XE in early CY2015. Average selling price increased by 2.3% y-o-y reflecting positive product and market mix. JLR Ebitda improved by 13.4% y-o-y led by 160 bps y-o-y expansion in Ebitda margin. Other expenses declined by 11% y-o-y, which was driven by (i) £80m gains on the forex hedges, (ii) £34m gain on revaluation of asset and liabilities and (iii) lower publicity expenses. The company had also reported £79m annual incentives, which they received from the UK government in Q2FY14, which has not come in H1FY15 and will likely come in H2FY15.
Standalone losses were lower: Standalone business reported a PBT loss of R11.1 bn in Q2FY15, which was 8% lower than our estimate of a profit before tax loss of R12 bn. Net sales of R87.5 bn (-1.3% y-o-y) was 6% ahead of our estimate led by better ASPs (average selling price). Standalone Ebitda loss of R2.6 bn was lower than our estimate of R3.5 bn due to better-than-estimated revenues. The company reported a tax expense of R7.4 bn despite a PBT loss, leading higher-than-estimated net loss.
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Raise JLR earnings estimates: We have increased our earnings estimates for JLR by 17-18% over FY15/16e driven by 240-270 bps increase in Ebitda margin assumptions. The key reason for this increase is change in GBP-USD rate from 1.66 earlier to 1.60 as GBP has depreciated versus USD. Our target price has increased to R680 (from R570 earlier) based on SOTP (sum of the parts) valuation.
Key highlights of JLR performance
* JLR wholesale volumes grew by 2% y-o-y while retail volumes grew by 8% y-o-y in Q2FY15.
Retail and wholesale volumes grew by 14.6% and 13.8% y-o-y in H1FY15. Key driver of volumes were Range Rover and Range Rover Sport. Volumes of these models were up 38% y-o-y and 30% y-o-y in Q2FY15, which led to y-o-y improvement in product mix. Jaguar volumes declined by 5.6% y-o-y in Q2FY15, which was a key drag on the performance.
* China volumes grew by 6% y-o-y in Q2FY15 and 36% y-o-y in H1FY15 while UK volumes grew by 14% y-o-y in Q2FY15. North America and European markets declined this quarter. Production volumes are also low in Q2FY15 due to month-long vacation in August at UK plants because of which employee strength was reduced.
* We expect Range Rover and Range Rover Sport volumes to grow at a strong pace in H2FY15, also capacity of these models will be increased by 50,000 units on an annual basis in the Solihull plant.
n The company expects to increase UK capacity from 450,000 units currently to 550,000 units by end of March 2015. It is looking at an initially capacity of 50,000 units for Jaguar XE by March 2015, which will be subsequently increased to 100,000 units.
* China plant is likely to begin production by end of CY14 with an installed capacity of 130,000 units. The company will produce Range Rover Evoque in Q4FY15 from the China JV. Discovery Sport and Jaguar XF will be produced later from the JV.
* Discovery Sport has started production and will be available at retail outlets from early CY2015. Jaguar XE will begin production in Q4FY15 and will be available in retail outlets in Q1FY16. Company will launch all-wheel drive Jaguar XE in US market and is likely to launch the vehicle in Q4FY16 in US market.
* Gross margin improved by 90 bps y-o-y and 120 bps q-o-q led by better product mix. Staff cost was higher than our estimates due to addition of new employees in Halewood plant for Discovery Sport.
* Other expenses declined by 11% y-o-y, which was driven by (i) £80m gains on the forex hedges, (ii) £34m gain on revaluation of asset and liabilities and (iii) lower publicity expenses. The company had also reported £79m annual incentives that they received from the UK government in Q2FY14, which has not come in H1FY15 and will likely come in H2FY15.
* The company has an outstanding hedge book of £18 bn and expects currency to have a positive impact in the coming quarters due to recent depreciation of GBP versus USD.
* The company has a policy of booking three-year forward revenues. It books 65-85% of first-year exposure, 45-65% of second-year exposure and 25-45% of third-year exposure on an ongoing basis.
* The company has plans to increase dealers in China to 250 in next 18 months from 161 currently.
* Total R&D spend was £336m and capex spend was £427m in Q2FY15. Total spend on capex and R&D in H1FY15 was £1.45 bn and company expects to spend £2.1 bn in H2FY15.
* JLR posted a free cash flow of £497m in Q2FY15 due to working capital savings of £348m. Free cash flow in H1FY15 was £502m.We expect JLR to be free cash positive in FY15.
—Kotak Institutional Equities