January 24, 2013 5:49 pm

Jaguar takes shine off Tata Motors

The fancy valuation premium deserves to be dented

If you spent £4,500 on Tata Motors’ shares in the wake of the financial crisis you could be driving a souped-up metallic Range Rover Sport with TVs in the back seats and blacked out windows. That is if you sold your shares on Wednesday. You might have to ditch the fancy features if you sold them on Thursday, when Tata’s shares lost 6 per cent. Its Jaguar Land Rover unit warned that margins probably fell in its third quarter ending in December 2012.

The twelve-fold growth in Tata Motors’ share price over the past four years has set high expectations. And JLR contributes 60 per cent of Tata Motors’ revenues and over 85 per cent of its pre-tax profit. Granted, the UK group’s sales have been robust – up 30 per cent over the past year. But its 15 per cent margins on earnings before interest, tax, depreciation and amortisation are falling as it sells more of its lower margin fuel efficient models (Evoque) and phases out older ones.

But this could be more than a blip at the end of a product cycle. JLR says it will increase capital spend by almost two-fifths in its next financial year ending in April 2014 in order to boost production. The plan is to reach annual sales volumes of about 500,000 units – against 360,000 last year – helped by the launch of new models. This will still pale against BMW’s 1.5m annual sales, yet it will stretch Tata’s balance sheet. Free cash flow is expected to disappear next year. And the speedy ramp up in volumes could boost marketing costs, which may erode its 100 basis point lead in margins over BMW.

Tata’s shares now trade on 8 times forward earnings – a one-sixth discount to BMW because of Tata’s less conservative accounting of R&D expenses. It also now trades a 10th lower than recent highs. Without more clarity on the impact on margins from JLR’s production increase, Tata’s fancy valuation premium deserves to be dented.

Email the Lex team in confidence at lex@ft.com

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