Fitch Ratings changes JLR’s outlook to ‘negative’ from ‘stable’

Fitch Ratings has revised Jaguar Land Rover Automotive plc’s outlook to ‘negative’ from ‘stable’, indicating a higher risk of a downgrade in its credit rating in the future.

The move comes in the wake of higher investments by the company into research and development and rising depreciation of past investments, resulting in more cash burn than expected, the ratings agency said.

Jaguar Land Rover is already in negative ‘free cash flow’, indicating that the company is sucking in cash instead of generating it as it invests for the future. Moreover, the rate of burn has increased.

“The Outlook change reflects Fitch’s projections of further negative free cash flow (FCF) in the next two years before gradually recovering to positive from end-financial year ending 31 March 2021 (FY21),” Fitch said.

“FCF (free cash flow) fell significantly in FY18 to negative 4.2% and we expect a further decrease to around negative 6% in FY19.

“Higher spending in 2019-2021 than in our previous assumptions will keep FCF in negative territory until at least 2020 in our projections.”

“The ratings may be downgraded if Fitch has reason over the next six to 12 months to believe that JLR’s FCF is not improving according to our projections,” it added.

While cash flow is being impacted by investments for the future, the company has also seen a decline in its profit (which are not dependent on investments in the future) despite posting revenue growth. This is due to high depreciation on past investments and rising production and labour costs.

As such, JLR’s adjusted profit margin, before tax and interest costs fell to 1.6% in the year ended March from 4.8% in the previous year. The number was 12.4% in FY15.

Fitch expects a turnaround soon.

“Depreciation will continue to weigh on profitability but we expect this to be partly offset in the medium term by improvements in productivity and savings in the manufacturing process. We project the EBIT margin to increase moderately to around 2% in FY19 and to recover gradually to 5%-7% through to FY22,” Fitch said.

“The profitability decline in FY17-FY18 is putting JLR at a disadvantage compared with its main peers as JLR is currently undergoing a period of challenges and significant expansion, both with respect to capacity and product range, resulting in negative FCF and lower margins than its through-the-cycle average,” it added.

Fitch pointed out that the company is making heavy investments into electrification, autonomous driving and shared mobility.

“The recently-launched I-Pace has gathered positive reviews and customer interest, but it is a drag on group profitability and cash generation,” said the ratings agency.

The rating agency has already baked in a revenue decline of around 5% in the current financial year due to deterioration in the company’s product mix, but expects revenue growth to hit mid- to high-single digits through to FY22.

Fitch also pointed out that a disorderly Brexit may significantly disrupt the group’s supply chain and ability to manufacture and then sell its vehicles.

It also noted that the company’s product portfolio is currently weighted towards larger, less fuel-efficient SUVs, with diesel models accounting for just less than 90% of JLR’s sales in Europe at a time when sales of diesel powertrain are falling in Europe.

“The group is increasing flexibility through its new modular platform and is broadening its product line to include more compact, fuel-efficient models but material uncertainty remains about the speed and extent of powertrain shift, notably in Europe,” it said.

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