There was a knee-jerk reaction in the market today after Tata Motors said a chip shortage is going to hurt their margins in both the first and second quarters. How grave is this problem and did you foresee this coming in?
Everyone expected this shortage to get resolved by mid of Q2 or by the end of Q2. But now they are saying that the entire Q2 will have this issue and they will report a negative EBIT margin in Q2 as well. They had already highlighted in their conference call that Q1 would be a loss because of the supply issue.
This is a negative development. FY22 earnings would be cut sizably because of this and that is why the stock reaction. But this is a short-term issue and not a structural one. It is purely about the shortage of some components and nothing to do with the quality of the JLR product. It is an industry-wide phenomena and not very specific to the company. Some people are facing more problems, some are less. So any major price correction is definitely a very good opportunity to have such a great company.
After this commentary, are you going to rework your price target?
We follow a two-year target price and so we looked at FY23 and FY24. The issues should get resolved before the end of FY22. The company has a strong order book. If the issue gets stretched to Q2-end or maybe to Q3, its spillover positive impact will happen in FY23. So some volumes from FY22 would get shifted to FY23. FY22 earnings will see downward revision by the Street, including us, but FY23 earnings may get slightly upward revision because of this. So the price target should not change much.
Do you think that the redeeming factor would be the company’s plans to prioritise production of higher margin vehicles? They are also seeing a substantial improvement in the operating cash flows in the second half of the financial year as the chip supplies improve.
It is a key positive point. One should consider it as a new experiment. It is probably for the first time that the company will focus on high margin products. They have limited resources to produce a limited number of vehicles. So they will completely ignore loss-making products or very low margin products. It is very much possible that the fall in margin and profitability may not be as high as the decline in volumes.