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JLR: Semiconductor shortages still the biggest challenge

Maintains FY23 EBIT and FCF guidance, and near zero net debt by FY24

We meet the management of TTMT to get an update on the business, especially for JLR, considering the changing operating environment. Semiconductorshortages still remain the key bottleneck for JLR, which is in turn impacting profitability and cash flows. The management maintained its FY23 EBIT margin/FCF guidance of 5%/GBP1b for JLR. It expects to be near zero net debt levels for the consolidated Automotive debt by FY24. The key takeaways from our meetings are:

* Demand is not a concern in the Premium segment. Macro headwinds are yet to impact demand. The order book is still growing and cancellation rates are still very low. Its order book is now equal to three quarters of production, and hence any demand impact will reflect only after four quarters.

* For JLR, the biggest issue remains semiconductor supplies. JLR is the most impacted player given the higher usage of semiconductorsin its products, smaller scale, and product launches starting with the Defender. The Defender, RR, and RR Sport comprise 60% of its order book and is growing. JLR's focus is on prioritizing available semiconductorsfor high margin products. Visibility for its entire chain is currently at two-to-three weeks, but needs to go rise to twoto-three months.

* JLR aims to boost production to 110-115k units per quarter (v/s its wholesale guidance of 90k units for 2QFY23).

* Jaguar aims to reinvent itself as a niche brand rather than focusing on the mainstream Premium Car segment. This will result in the first new Jaguar EV on a dedicated architecture by CY25, and eventually becoming a completely electric brand.

* JLR’s capex investment is comparable with that of its peers, at 8-10% of sales (at GBP2.5-3b). Its peers are also investing in batteries, whereas JLR is relying on its partners for batteries. Capex of GBP2.5-3b is lower than its past peaks as the latter included: a) capacity expansion in Slovakia, b) an R&D center, and c) multiple platforms under development, including that for Jaguar.

* Its near zero net debt target for JLR by FY24 will be driven by an improvement in supplies, leading to a reversal in working capital, which can release GBP1.2- 1.5b. We expect an FCF after interest expense of GBP1b in FY23. Net debt stood at GBP3.2b at the end of Mar’22.

* An EBIT margin of 10% for JLR by FY26 (v/s its 5% guidance for FY23) will be driven by a mix and operating leverage.

* India PV will see a launch of coupe Curve based on Gen2 architecture in CY24, which will compete in the Creta segment. The EV variant will be rolled out first, followed by ICE.

* India PV capacity stood at 550k units, excluding Ford (fully utilized). Ford will add 300k units (scalable to 400k units). This should be sufficient for the next two years.

* Consolidated near zero net debt will be driven by: a) INR75b from TPG, b) release of working capital from JLR and an improvement in operating profit, c) India business FCF, and d) asset monetization. Net Auto debt was INR420b as of Mar’22, excluding lease liabilities of INR67b. It doesn't include any equity issue or monetization of JLR.

Valuation and view:

TTMT should witness a gradual recovery as supply-side issues ease (for JLR) and commodity headwinds stabilize (for the India business). It will benefit from: a) a macro recovery, b) company-specific volume and margin drivers, and c) a sharp improvement in FCF and leverage in both JLR as well as the India business. The stock trades at 16.8x FY24E consolidate P/E and 4.2x EV/EBITDA. We maintain our Buy rating, with a TP of ~INR520/share (Jun’24E based SoTP).

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