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Standard & Poor’s: U.K. -Based Automaker Jaguar Land Rover Automotive Outlook Revised To Positive; ‘BB’ Ratings Affirmed

U.K.-based automaker Jaguar Land Rover Automotive PLC (JLR) continues to generate strong operating cash flow, and we expect adjusted debt to remain fairly limited despite rising capital expenditures and our forecast of negative free operating cash flow. We see at least a one-in-three possibility that JLR’s leverage metrics will remain strong over the next two … Continued

  • U.K.-based automaker Jaguar Land Rover Automotive PLC (JLR) continues to generate strong operating cash flow, and we expect adjusted debt to remain fairly limited despite rising capital expenditures and our forecast of negative free operating cash flow.
  • We see at least a one-in-three possibility that JLR’s leverage metrics will remain strong over the next two years.
  • We are therefore revising the outlook on JLR to positive from stable. We are affirming the long-term rating on the company at ‘BB’. The stand-alone credit profile on JLR is unchanged at ‘bb+’.
  • The positive outlook reflects our view that we could raise the rating on JLR within the next year if we expect JLR’s financial metrics to remain
  • sufficiently strong to support a higher rating on JLR’s parent company Tata Motors.

Standard & Poor’s Ratings Services today revised its outlook on U.K.-based auto manufacturer Jaguar Land Rover Automotive PLC (JLR) to positive from stable. At the same time, we affirmed our ‘BB’ long-term corporate credit rating on JLR.

We also affirmed our ‘BB’ issue ratings on the senior unsecured notes issued by the company. The recovery rating remains ‘3’, indicating our expectation of meaningful (50%-70%) recovery in the event of a payment default.

The outlook revision on JLR follows that on its parent company Tata Motors Ltd. (see “Tata Motors Outlook Revised To Positive On Likelihood Of Stronger Performance Of JLR; ‘BB’ Rating Affirmed,” published today on RatingsDirect), and reflects our view that JLR will continue to generate strong operating cash flows over fiscal years 2015 and 2016 (year-end March 31). We see at least a one-in-three chance that despite significant capital expenditures (capex) and
potentially negative free operating cash flows (FOCF), JLR’s leverage metrics will remain sufficiently strong to support a higher rating on Tata Motors during the next 12 months.

Our base-case scenario takes a cautious view of JLR’s future volume growth in fiscal years 2015 and 2016, which will include new products for both the Jaguar sports saloon and sports car brand, and the Land Rover premium/luxury sports utility vehicle brand. We estimate generally stable reported EBITDA margins in the 16%-17% range over the same period.

Importantly, JLR is continuing to increase capex to fund new products, improve and develop existing assets, and to a lesser extent spend on capacity additions outside the U.K. For fiscal 2015, we forecast capex of £3.5 billion-£3.7 billion, with continued heavy spending in fiscal 2016. We therefore see a risk that operating cash flow may not be sufficient to fully meet expected capex, and thereby factor in negative FOCF during the next two years, causing JLR’s adjusted debt (negligible as of March 31, 2014) to rise commensurately. We forecast JLR will continue to pay only limited annual dividends to Tata Motors, consistent with the £150 million paid in respect of financial 2014, enabling JLR to largely retain its cash flows for funding capex.

We recognize that the additional debt would weaken adjusted credit metrics, but we expect JLR to maintain credit metrics which are strong for the ratings, with adjusted debt to EBITDA of no more than 1.0x by fiscal 2016, and funds
from operations (FFO) to adjusted debt of not less than 50% by fiscal 2016.

We continue to assess JLR’s financial risk profile “intermediate,” supported by the currently very strong leverage metrics due to very low adjusted debt, as well as significant operating cash flow generation. JLR also has sizable
retained cash balances, which provide a potential source of financing and ongoing limited dividend payments to Tata Motors. We also factor in the possibility of higher cash flow volatility in the event of stress. An upgrade
would likely require a revision of our financial risk profile assessment on JLR to “modest.”

As of March 31, 2014, adjusted debt was negligible at only £65 million. We make analytical adjustments to reported gross debt of £2.0 billion, mainly by subtracting £2.6 billion for surplus cash (after applying a 25% haircut) and adding £0.6 billion for pensions.

Our assessment of JLR’s business risk profile remains “fair,” supported by the group’s well-established market position as a global premium auto manufacturer with well-recognized brands, particularly Range Rover. JLR also benefits from above-average growth rates in the premium segment, supported by demand in emerging markets–notably China, which is the group’s largest market by volume. The company has also shown improving profitability during fiscal 2014 and first-quarter fiscal 2015. JLR has a lengthening track-record of successful product extension and development, which continues to improve its competitive position.

These strengths are partly offset by JLR’s still-modest size and limited product range and scope compared with larger global peers. While we expect the Jaguar brand to continue to be supported by the roll-out of new products, (including the imminent launch of the new Jaguar XE), we see the potential for execution risks in the roll-out of new models, and consider that the range of cars remains limited. Cyclical demand for premium and luxury cars is also a constraining factor in our business risk profile assessment.

Our base case assumes:

  • Volume growth to continue in fiscal 2015 and 2016, assisted by growth in the premium segment ahead of the overall auto market, and supported by new product launches.
  • Generally stable reported EBITDA margins in the range of 16%-17%.
  • Sizable capex in fiscal 2015 of £3.5 billion-£3.7 billion, with continued heavy spending the following year.
  • Negative free operating cash flows during fiscal 2015 and 2016.
  • Limited annual dividend payments to Tata Motors, consistent with the £150 million paid for financial 2014.

Based on these assumptions, we arrive at the following credit measures for
fiscal 2015 and 2016:

  • Adjusted debt to EBITDA of no more than 1x.
  • FFO to adjusted debt of no less than 50%.

JLR is a wholly owned subsidiary of India-based Tata Motors, and we apply our group rating methodology in our rating analysis. JLR is a significant part of the consolidated Tata Motors group, representing an increased 90% of group EBITDA for fiscal 2014 and we now classify JLR as a “highly strategic” group entity, rather than “strategically important.” This reflects our view that JLR is unlikely to be sold, has a long-term commitment from Tata Motors, constitutes a significant proportion of the consolidated group, and shares a reputation with the parent. We also note, however, that JLR is operationally separate from Tata Motors, and does not serve the same customer base.

JLR’s stand-alone credit profile is ‘bb+’. The rating is one notch lower at ‘BB’, in line with the rating on Tata Motors. This reflects our view of the risk that in a credit-stress scenario, Tata Motors could draw support from
JLR.

The positive outlook reflects that on JLR’s parent company Tata Motors, and our expectation that JLR’s strong operating cash flow generation, if sustained, can result in stronger leverage metrics than we expect. This would lead to Tata Motors sustaining a ratio of FFO to debt above 30%, despite a significant increase in capex.

We would raise our rating on JLR if we raise the rating on Tata Motors. We may raise our rating on Tata Motors if the strong operating cash flows of JLR partly offset the increased capex, such that the ratio of FFO to debt for Tata Motors is sustained above 30%. We may also upgrade Tata Motors if the successful positioning of the Jaguar range of vehicles improves the business risk profile.

We may revise the outlook on JLR to stable if we do the same on Tata Motors. We may revise the outlook to stable on Tata Motors if the ratio of FFO to debt declines toward 25%. This may happen if operating performance weakens, for example due to lower demand for JLR’s products in key markets like China, or due to new product launches, or if capex is higher than expected.

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