Operating leverage is a double-edged sword, and Tata Motors Ltd illustrates this well. Factors that had dampened sales of its UK-based luxury car subsidiary, Jaguar Land Rover Automotive Plc (JLR), in the September quarter (Q2FY25) have now been resolved, setting the stage for a sales recovery in the second half of the fiscal year. This anticipated rebound in operating leverage may explain why Tata Motors' shares showed resilience on Monday despite a weak Q2 earnings report.
JLR’s wholesale volumes declined by 9,500 units year-on-year to 87,300 vehicles in Q2. This drop stemmed from disruptions such as severe flooding affecting a key high-grade aluminium supplier and an unforeseen event of temporary hold on 6,029 vehicles for quality control checks. JLR’s impact on Tata Motors is substantial, given its sizable 80% contribution to consolidated profit in FY24 Ebit.
Against this backdrop, Tata Motors’ consolidated performance was expected to show strain, yet the results were still disappointing. Consolidated Ebitda (earnings before interest, tax, depreciation, and amortization) declined 15% year-on-year to ₹11,671 crore in Q2.
JLR's Ebit margin dropped by 220 basis points (bps) to 5.1%, falling sharply below most analysts' expectations due to the underestimated impact of negative operating leverage. Tata Motors’ presentation indicates that the lower volumes alone reduced the Ebit margin by 214 bps, though the company managed to offset some of the higher variable marketing costs through savings in variable and other expenses.
But is JLR’s Q2 margin drop a worry? Not really. Despite the poor show last quarter, the management has maintained the full-year FY25 guidance for JLR at revenue of £30 billion and Ebit margin at 8.5% or more. To meet this revenue target assuming Q2FY25 price realizations, JLR needs to achieve 3.6% year-on-year growth in wholesale volume during H2FY25. As mentioned earlier, the temporary hit on sales seen in Q2 is expected to reverse going ahead, which can ease the pressure to achieve the full-year target to some extent. Further, new product launches should also aid in boosting sales volume.
Management's commentary suggests that pricing pressures are unlikely to intensify. However, to meet the full-year Ebit margin guidance, JLR would need to achieve a 9.7% margin in H2FY25—a challenging target. Yet, if depreciation and amortization costs decline alongside an improvement in Ebitda, this goal remains within reach.
The company expects JLR’s Ebit margin at 10% for FY26, the management said in the earnings call. It added that the company has had to make higher investments to keep the ICE (internal combustion engines) portfolio going than what was envisaged earlier. Hence, they have reduced free cash flow guidance from £1.8 billion to £1.3 billion for FY25.
Meanwhile, Tata Motors’ domestic commercial vehicle (CV) business showed almost 20% year-on-year drop in sales volume to 86,000 units, but revenue fell at a slower rate of 14% as price hikes helped. Ebit margin slipped a marginally 10 bps year-to-year to 7.8% as commodity price deflation cushioned margin.
Since the announcement of Q1 results on 1 August, the Tata Motors stock has declined by approximately 30%, as concerns over weak global demand weigh on JLR’s prospects. Additionally, demand for domestic commercial vehicles and passenger vehicles (PV) is moderating. As a result, the stock’s valuation has dropped to an EV/Ebitda multiple of 6x and a price-to-earnings multiple of 12x for FY26, based on Bloomberg consensus estimates. For the stock's performance to improve, a stronger rebound in volume growth will be essential.
