Troubled Jaguar Land Rover hit by rating downgrade

Jaguar Land Rover’s (JLR) elevated leverage level has prompted Moody’s to downgrade the troubled automaker, and issue a ‘negative’ outlook on the company.

The UK manufacturer of premium passenger cars and all-terrain vehicles currently operates six sites in the UK, one in Slovakia and has a joint venture in China. The company, owned by India’s Tata Motors, generated 42% of fiscal 2019 unit (retail) sales in Europe (of which 20% in the UK), 24% in North America, 17% in China (including JV) and 16% in other overseas markets, resulting in total revenue of £24.2b for fiscal 2019.

In its comments on the company, Moody’s said the rating agency’s expectation is that leverage will remain elevated and free cash flow negative for fiscal years 2020 and 2021 as JLR seeks to turn around performance in China, executes its restructuring program and continues to invest in its future model line-up including electrification. 

As a consequence, Moody’s has downgraded the corporate family rating (CFR) of JLR to B1 from Ba3 and the probability of default rating (PDR) to B1-PD from Ba3-PD. Concurrently, Moody's has also downgraded the instrument ratings on the bonds to B1 from Ba3. The outlook remains negative. 

Tobias Wagner, Vice-President and Senior Analyst at Moody's, said: "The negative outlook further reflects the challenge to turn around financial performance in a subdued market environment and as other manufacturers also prepare to launch electric vehicles. Risks regarding a potential "no-deal Brexit" or potential US tariffs also remain." 

Moody's-adjusted debt/EBITDA is likely to remain above 5.0x for fiscal 2020 and 2021 while free cash flow is likely to remain materially negative, the agency said. 

“Both factors are not commensurate with a Ba3 rating and reflect the need to continue to invest in the future model line-up including electrification, the ongoing volume decline in China and related efforts to strengthen the sales operations and network in the region, balanced by overall cost reduction efforts such as project Charge and Accelerate, the company's restructuring programs, that will gradually benefit profitability.”

While JLR's profitability, measured by Moody's-adjusted EBITA margin has declined over the last several years, notably also because the metric deducts research & development expenses that the company capitalises, overall performance in fiscal 2019 was particularly weak with a negative margin (-3.4%), Moody's leverage at 14.0x and a negative free cash flow of £1.4 billion.

The Chinese market remains a major challenge for JLR as retail sales continue to decline.

Moody's believes that China was a major profit contributor and hence the decline substantially contributed to the decline in profitability in the last quarters. “After years of good growth JLR's retail volume growth in China turned negative in May 2018 (year-on-year) and has remained at high double-digit negative rates since July 2018.”

This can be partly attributed to an overall weaker market in China, with the segments JLR focuses on such as certain premium SUV segments declining more than the overall market average. However, the impact on JLR was further amplified by sales organization and network issues in the region. “While May 2019 retail sales, year-on-year, demonstrated a reduced volume decline than in previous months, a sustained turnaround is so far not evident despite the company's ongoing active focus on the region.”

In addition, ongoing trends such as electrification and the need to invest in hybrid and full electric vehicle options alongside investments to support the overall model line-up require continued significant ongoing investments in the next years, resulting in continued pressure on profitability and free cash flow. 

The investments include the launch of the Defender in 2019, the investment in a flexible architecture to enable all models to be offered with hybrid or increasingly full battery electric powertrain options from 2020 but also investments into the core product range.

However, Moody's also expects the company's restructuring program, project Charge and Accelerate, to support profitability improvements in fiscal 2020 and beyond not the least from the significant and already executed headcount reduction. 

Project Charge has also already led to additional working capital inflows, combined with a seasonally positive working capital profile in January to March and ongoing inventory reductions in China.