JLR says Tata to profits, yet again

From time to time, it makes sense to remember the story of the 2008 Global Financial Crisis. While the current pandemic-led crisis is nothing like the 2008 one, effects of the latter keep popping up in “daily business” from time to time.

The story approximately went like this - interest rates were low. Rising levels of securitisation meant bankers who “originated” loans didn’t care all that much about the ability of the borrowers to repay. Securitisation also meant that bankers and other financial industry people could make “side bets” on the loans. Financial innovation in this period resulted in the proverbial “alphabet soup” - CDO, CLO, MBS, ABS, and so on and so forth.

A combination of financial engineering and low interest rates allowed people to borrow more than they normally would. Then the federal reserve started raising rates. Some loans went underwater. Side bets meant that banks and financial institutions started getting into trouble. Interest rates rose further. More loans went underwater. More people and companies got into trouble. And so on and so forth.

The above story is obviously an oversimplification, and it ought to be since the Global Financial Crisis was so complex. The most common stories of the crisis are told through the American mortgage industry, and investment banks, but the crisis did leave considerable debris elsewhere as well.

For example, cheap rates meant a massive increase in leveraged buy out (LBO) activity in the years preceding the crisis. A LBO is a transaction where company A buys company B, and finances the deal largely by pledging company B’s assets. It’s like I borrow money in your name so that I can buy you. Go figure.

This is not a great figure, and it is outdated, but it serves our purpose - look at the total volume of LBOs by year in this graph. Look at 2006 and 2007 towering over the rest.

private equity backed LBO volume_chart

Normally LBOs are associated with Private Equity companies. In fact, LBOs are a rather common method for them to acquire companies (for the purposes of turning them around and selling them on). However, the boom in 2006 and 2007 was so massive that even otherwise conservative corporates entered the market.

The Tata Group, India’s much-storied and highly-respected conglomerate, was one of these “otherwise conservative corporates” who used the credit boom to do not one, but two massive LBOs.

First, Tata Steel bought out the Anglo-Dutch steelmaker Corus in 2007. Then, in 2008, weeks before Bear Stearns got sold at a throwaway price to JP Morgan, Tata Motors, the group’s automobile division that historically made trucks and budget cars, bought out luxury car maker Jaguar LandRover (JLR) from Ford. Neither acquisition has worked well, though the JLR acquisition has worked out marginally better.

Unlike Corus, which has largely been in the news for the wrong reasons (mostly shutting down plants and sacking workers), JLR at least occasionally makes profits, like it did in the second half of 2019 (Indian companies mostly use an April to March accounting cycle, so the second half of 2019 is termed as Q2 and Q3 of FY2019-20). And now thanks to the pandemic hitting, and originating in China (which is JLR’s largest market), JLR is back to making losses.

Hit by pandemic, company’s flagship subsidiary, Jaguar Land Rover (JLR) suffered a loss of £501 million in the March quarter and £422 million for the full year on revenues of £5.4 billion and £23 billion, respectively. 

So what is Tata Motors doing about it? For starters, it is sacking 1000 workers.

"Against the backdrop of the COVID-19 pandemic, the company has taken the difficult decision to reduce the number of contract-agency employees in its manufacturing plants over the coming months," it added.

The jobs are expected to be cut from across the business' UK manufacturing sites, a process that will begin at the end of July and last through the year.

And it is not just JLR that has been losing money. The parent company Tata Motors has been losing money as well, losing ₹52 billion (~$700 million) in the Jan-March quarter.

Nevertheless, the company expects to end FY21 (April 2020 - March 2021) with “positive free cash flow”, according to the company’s statement that accompanied its quarterly results. How is it going to achieve this positive free cash flow, apart from sacking 1000 JLR workers?

For one, it is going after “special projects”, as part of a mission to cut costs by ₹60 billion. How will this money be saved?

"Regulatory compliant gets priority. Whichever vehicles or platform that are in advanced stages of landing will get priority and clearly some of the low yielding projects as well as some of the projects that we believe have to be pushed out given the current demand scenario and therefore there may not be customer demand for it those are being pushed out. We are not hesitating in taking those calls because the demand environment is fundamentally altered," said PB Balaji, CFO, Tata Motors.

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As a result, Tata Motors is dropping capital expenditure (capex) spends by almost 56 percent to Rs 1,500 crore for the current year.

"We have also planned for an aggressive cost reduction involving an additional capex and working capital saving of about Rs 4,500 crore. Thereby cumulatively about Rs 6000 crore of cash reduction plan is being planned," added Balaji.

Last year, Tata Motors made investments to the tune of Rs 5,344 crore in products and technologies and finished the year with negative free cash flows of Rs 6,000 crore.

Also on the table is a proposal to split the passenger car division from the truck division.

The company is in the midst of hiving off the passenger vehicle business along with the electric vehicle business and place it as a subsidiary. The idea behind this is to bring in a strategic partner for which Tata Motors is talking to 'several OEMs', said Balaji. Presently, the car and truck business are part of the same entity which prevents Tata Motors from unlock value only in a specific division. This process is expected to be complete before the end of FY21.

Not all news is bad, though. China, where the virus originated, and which locked down approximately a quarter before the rest of the world, has already shown revival in demand. JLR’s sales in May went up by 5% on a year-on-year basis. Along with offering hope to JLR, it also offers hope to the rest of the world - that once the virus subsides and the lockdowns are lifted, demand is likely to return.