JLR seeks funding after huge losses

Tata Motors-owned UK-based company, Jaguar Land Rover (JLR) is striving to raise investments worth US$ 1 billion, mere days after reporting astounding losses. It aspires to procure the same within 14 months.

JLR suffered a tremendous blow to the tune of US$ 4 billion this month. This happened after its sales tumbled 35 per cent in China. In the last business quarter of 2018, the company incurred total losses of US$ 354 million. As a result, it had to cancel the production of Range Rover SV Coupe and Land Rover Discovery SVX. Moreover, nearly 10 per cent of its workforce (4,500 jobs) is being cut as JLR is formulating a turnaround plan.

The losses were driven by an impairment charge of US$ 3.9 billion. Although non-cash in nature, it spiked the already-elevated yields in some of UK’s unit bonds. Nearly half the value of the write-down is generated from tangible assets. These are failing to generate adequate value due to weak market conditions in China, technology disruptions and rising debt costs. The rest is on intangibles, a major chunk of which was spent on technology and intellectual property.

Initially, JLR attributed the losses to the challenging market environment in China including declining sales and China’s trade dispute with the US. It also portrayed some of the blame on the eventuality of Brexit. As a result, Royal London Asset Management has already cut back its exposure to the company citing Brexit-specific risks and the company's ability to maintain access to the financial markets.

However, Automotive News Europe revealed the real issue, i.e. quality control. In 2014, JLR began production at a JV with China’s Chery Automotive. Local production at a facility in eastern China proved very beneficial on the surface. It allowed JLR to make the necessary vehicle modifications as required by the Chinese market. It was also able to dodge a 25 per cent tariff. But things started to spiral downward when customers began reporting a number of defects relating to the engine, instrument panel, airbags and the battery. Concerns pertaining to product quality began to surface.

In 2017, JLR issued 13 recalls for China alone. In all, JLR had to recall around 1,06,000 vehicles, equivalent to 70 per cent of its 2017 sales. Since the vehicles were produced in China, JLR’s argument blaming the US-China trade tensions was not compelling. Moreover, its peers like Audi, BMW, Mercedes-Benz, Volvo, Lexus and Cadillac posted robust sales growth in China during the same period.

The cash injection of US$ 4 billion will facilitate the replacement of maturing bonds and aid investments in JLR’s new range of electric cars, the development of which is proving to be expensive. The company may also consider availing other bank financing or lease assets, according to Automotive News Europe. Presently, owing to challenging market conditions, JLR’s bonds are trading below par.

JLR’s 4.5 per cent bonds which mature in January 2026 have fallen to a low of 77 cents on the Euro, which is comparable to a yield of nearly 8.9 per cent, said news reports. JLR still possesses US$ 2.45 billion undrawn credit facility and US$ 3.2 billion in cash.

In order to achieve a successful turnaround, JLR will have to recover from its struggles in China. There is uncertainty as to when the sales in China will pick up again. JLR’s dealer network in China is quite ineffective, with only 18 per cent of its showrooms located in 'tier-one' cities like Beijing and Shanghai.

To resolve these issues, JLR will scale back deliveries to prevent dealerships from having surplus stock. Furthermore, it will focus on improving branding and marketing.

Although its obstinately negative free cash flows have improved, S&P Global Ratings guesses that its measure of free operating cash will continue to be significantly in the red for two years. If the cash burn matches the average 670 million pounds a quarter observed since March 2017, JLR may struggle to survive another year.

JLR’s Debt to EBITDA ratio is rising and implied equity value, based on a sum-of-the-parts analysis of Tata Motors, is shrinking. Despite major operational afflictions, the company continues to spend billions on investment and hundreds in dividends to its parent. Disturbingly, its operating cash flow is falling relative to capital expenditure, making it harder to pay for investments without resorting to raising debt.

JLR’s free cash flow remains in the red, at a negative 361 million pounds in the December quarter. Although, the management has attributed that to the pace of its technology investments; investors are privy to ask whether future spending could yield positive results given the weak return on previous expenditures. The company could seek financial aid from Tata Motors; however, the present business environment in India is not conducive to this possibility. The improvement in its commercial vehicle unit is already decelerating. A bailout of such massive proportions would jeopardize Tata Motors when it has just rescued itself from JLR’s shadow.

If the cash-starved JLR approaches the market for more cash, it would have trouble selling paper for less than 8 per cent, which is the current yield on the 2026 notes.

On Monday, Tata Motors opened at Rs. 162.30 per share and hit a high and low of Rs. 163.45 and Rs. 159.20, respectively. At 11:10 am, the stock was trading at Rs. 160.45, down 0.40 per cent.