Although the JLR franchise is set to take the next leap in volumes and scale new heights as the new Jaguar XE comes in, we are moving to Equal-weight. We believe earnings will lag volumes, and given the valuations and the Street’s bullish view on the stock, the margin of safety is limited.
Earnings will lag volumes: The next stage of JLR’s 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 JLR’s 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 slow–and 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 BMW’s 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