JLR has endured a turbulent operating environment over the last two years, led by a troika of adverse macro, product mix (due to pipeline favouring Jaguar) and market mix (due to the underperformance in China led by product quality issues, high inventory, high discounts and low dealer profitability).
…but part of those challenges being addressed…: Some of the aforementioned challenges, particularly on product/market mix, are likely to ease based on product pipeline visibility and initiatives undertaken by JLR in China. JLR's product pipeline is dominated by LR (Land Rover), with four of the five new product launches over the next 2-3 years coming from the LR brand. LR's contribution is already improving since Q2FY20. In China, JLR has been focused on (i) reducing inventory (now at lowest levels since 2017), (ii) improving dealer profitability and (iii) brand-led pull strategy. JLR has been outperforming its peers in China since Jul'19.
…and firm focus on controlling cost/capex will lead to steady recovery: JLR's cost-cutting initiatives under 'Project Charge' have started reflecting in P&L, with £0.5 bn of the targeted £1 bn of cost savings achieved till Sep'19 and the balance £0.5 bn on track to be achieved in 2HFY20. On the investment side, it has cut capex and working capital by £1.7 bn (v/s target of £1.5 bn) till Sep'19.
India business-bottoming out but recovery to be gradual: Over the last 4-5 months, the CV business has aggressively cut systemic inventory by ~29k. Systemic inventory is now the lowest in the last six quarters and dealer inventory is at ~35 days. This sharp reduction in volumes/production resulted in high pressure on profitability. Despite stable gross margins in 1HFY20 (v/s FY19), Ebitda/Ebit margin shrank by 530bp/800bp y-o-y in 1HFY20 due to operating deleverage. We do believe that the worst of the CV cycle is behind (barring any disruption during BS6 transition), but a sustained recovery in volumes would be gradual.
Valuation and view: Over the last three years, JLR has suffered from an adverse product/market mix and higher capex, resulting in negative FCFF over FY18-20. JLR has been focused on cutting capex/cost, benefits of which have started to reflect now. Finally, the mix is normalising with a recovery in LR and China. On the other hand, India business appears to have bottomed out in Q2FY20, although a full-blown recovery may be a few quarters away. Hence, we had recently upgraded the stock to Buy as it offers a favourable risk-reward. Our target price stands at ~Rs 195.