Tata Motors rating – Buy: Chip shortage, input prices cast shadow

The company has an order book of c128K units and channel inventory of less than 50K units (compared to an optimal stock of c80-90K units).

TTMT reported a loss of `44 bn in Q2FY22, coming off a similar loss in Q1FY22. However, on a sequential basis, JLR volumes were 24% lower, impacted significantly by the semiconductor shortage. In addition, the margins in the domestic CV business were impacted due to high commodity costs, a weak product mix and high incentives on account of competitive intensity. These trends were however expected and not a negative surprise. Positively, profitability of the domestic PV business saw a decent uptick and was better than the CV business in H1FY22 for the first time in many years.

Even the Ebit margin performance (-4.7%) in the JLR business was decent considering the volume loss (c50%). Management alluded to strong cost-reduction initiatives yielding a breakeven volume of 350K units per annum for JLR, from c400K at the end of FY21.

Supply normalisation key as order book remains strong: While the semiconductor shortage remains dynamic, JLR expects a gradual recovery in supply from Q3FY22 onwards. Among various measures, long-term (18-24 months) planning/contracts with chip manufacturers should help improve supply visibility, in our view. The company has an order book of c128K units and channel inventory of less than 50K units (compared to an optimal stock of c80-90K units).

Therefore, factoring in the order book and inventory restocking, JLR will need c160K wholesale dispatches to normalise supply vs demand. In a scenario where these dispatches are unwound over the next eight quarters, it implies an average incremental dispatch of c20K per quarter and a margin tailwind of c450-500bp (we estimate every increase of 1K units per month would be a tailwind of c70bp on the current breakeven volumes). Also, working capital unwind could help to generate strong FCF and consequently reduce debt.

Domestic outlook is strong: We have been positive on the domestic PV business. TTMT has seen a strong response to its recent launch Punch, driving a 50% m-o-m increase in overall bookings in October. The firm’s strong focus and leadership on EVs should further enhance investor sentiment, in our view. The outlook for the domestic CV business is improving as well with a sequential ramp-up in sales and improved offtake for MHCVs.

Retain Buy and TP of Rs 550: We have not made significant changes to our FY23 and FY24 estimates. We marginally increase our FY22e revenues and margins to factor in better-than-expected realisations and profitability in the JLR business in Q2FY22. Our FY22e earnings estimate is impacted by higher interest expense and exceptional charges. Supply normalisation remains a key catalyst, in our view. The semiconductor shortage delays the net debt reduction journey, but in our view does not impact the long-term business transformation story.