S&P: U. K.-Based Jaguar Land Rover Ratings Raised To 'BB+' On Stronger Competitive Position Due To New Models; Outlook Stable
At the same time, we raised our issue ratings on the senior unsecured debt instruments issued by JLR to 'BB+' from 'BB', in line with the corporate credit rating. The '3' recovery rating on these debt instruments is unchanged, reflecting our expectation of average recovery for debtholders (higher end of the 50%-70% range) in the event of a payment default.
Furthermore, we have withdrawn the 'BB' issue and '3' recovery ratings on ?500 million 8.25% notes due 2020 and $410 million 8.125% notes due 2021 as these debt instruments have been fully redeemed.
The upgrade reflects our view that JLR continues to strengthen its competitive position and business profile by demonstrating successful new model launches, including expanding into new market segments, and extending existing models. Notably, the Jaguar brand is being refreshed with new products such as the XE sedan, launched in May 2015, and more recently the F-Pace crossover available since April 2016. Land Rover is also benefiting from the new Discovery Sport, launched in February 2015.
In fiscal 2016 (year to March 31, 2016), JLR's volumes were up 13% to about 522,000 due mainly to the XE and Discovery Sport. During the first four months of fiscal 2017 (year to July 30, 2016), these new models and the F-Pace drove volumes up 20% year-on-year, with Jaguar's volumes ahead by 80%. Volume growth has also been broadly spread by region, including China, which has seen a 28% increase so far this fiscal year. Further new and updated models are in the pipeline, including a Range Rover Evoque convertible (launched in June 2016) and a long-wheel base version of the Jaguar XF in China.
Following the U. K.'s recent vote to leave the EU (Brexit), there are no immediate signs that JLR's U. K. volumes (which accounted for 21% of volumes and revenues during fiscal 2016) have been adversely affected. Record retail volumes in July, up 34% year-on-year (including the U. K. up 38%), also highlight the success of the new models. However, we do see a risk that U. K. car volumes could be lower than they otherwise would be, due to our expectations of slower macroeconomic growth and weaker consumer confidence. We still expect volume growth to continue overall, driven by new models.
We see potential benefits to JLR's margins following the Brexit vote if a weaker pound sterling exchange rate against the U. S. dollar and euro is sustained, given significant export volumes being partly offset by historical hedges and potentially higher costs of imported components. However, we do not anticipate these benefits to fully offset the potential effect of weaker U. K. volumes. JLR's profit margins were lower in fiscal 2016, primarily due to weaker market conditions, model mix, and higher costs, and we expect this to remain the case. However, the S&P Global Ratings-adjusted EBITDA margin of 9.0% for fiscal 2016 remained ahead of many peers.
We expect JLR's cash flow to remain strong, albeit with high capital expenditures (capex) leading to modestly negative free operating cash flow (FOCF). With zero adjusted debt as of fiscal 2016, JLR has significant financial flexibility in its stand-alone credit profile (SACP), which we have raised to 'bbb-' from 'bb+'.
Our base-case scenario for JLR for fiscal 2017 and 2018 assumes: Global GDP growth of about 3% per year, with the U. K. at about 1%, the EU at 1%-2%, the U. S. at about 2%, and China at about 6%. We lowered our growth forecasts for the U. K. and EU following the Brexit vote, though these still show positive growth. We expect global light vehicle volumes to show continued growth of 2%-3% per year, with Asia-Pacific remaining the main growth market, and with the EU also ahead, while growth in the U. S. is slowing and Latin America continues to decline. For JLR, we forecast stronger volume growth of 10%-20% per year, due to the success of new model launches. Stable reported EBITDA margins of about 14%-15%.Sizable capex in fiscal 2017 of ?3.75 billion as guided by JLR, with continued heavy spending in following years. Potentially modestly negative FOCF. Limited annual dividend payments to Tata Motors, consistent with the ?150 million paid in fiscal 2016.Based on these assumptions, we expect leverage metrics to be stronger than our previous expectations. We forecast the following credit measures for JLR in fiscal 2017 and 2018:Stronger adjusted EBITDA and FFO in both years compared to fiscal 2016, with zero adjusted debt maintained in fiscal 2017 and only a very low level of adjusted debt in fiscal 2018.Leverage metrics for fiscal 2018 are below 0.5x adjusted debt to EBITDA and above 100% FFO to adjusted debt. Please see our press release on Tata Motors for our assumptions for the consolidated group ("Tata Motors Rating Raised To 'BB+' On Stronger Competitive Position Due To Success Of New JLR Models; Outlook Stable," published on Aug. 16, 2016 on RatingsDirect). Based on these assumptions, we arrive at the following credit measures in fiscal 2017 and 2018 for Tata Motors:Stronger operating performance to offset negative FOCF, resulting in FFO to debt of about 40%.We expect debt to EBITDA of about 1.7x. Our assessment of JLR's business risk profile is supported by the group's well-established and improving market position as a global premium auto manufacturer, with well-recognized brands, particularly Range Rover, but increasingly Jaguar as well. JLR has a lengthening track record of successful product extension and development, which includes expanding into new market segments, and continues to improve its competitive position. These strengths are partly offset by JLR's still-modest size and more limited product range compared with larger global peers. JLR is ramping up its joint-venture production in China. Cyclical demand for premium and luxury cars is also a constraining factor in our assessment.
Our assessment of JLR's financial risk profile is supported by our expectation of zero or very low adjusted debt and strong leverage metrics during the next two years. JLR also has sizable retained cash balances, which represent a source of financing and support strong liquidity. Dividend payments to Tata Motors are low, which enables JLR to retain cash flows for its own investment needs. Offsetting factors include heavy capex in areas such as vehicle programs and new capacity, which we expect to lead to modestly negative FOCF. We factor in the possibility of higher cash flow volatility in the event of stress.
As of fiscal 2016, adjusted debt was zero. We make analytical adjustments to reported gross debt of ?2.5 billion, mainly by subtracting ?4.4 billion for surplus cash (after deducting a haircut of ?0.3 billion), and adding ?0.6 billion for pensions and operating leases.
JLR's SACP of 'bbb-' reflects a revised satisfactory business risk and unchanged intermediate financial risk profiles. Our liquidity assessment was raised to strong from adequate.
JLR is a wholly-owned subsidiary of India-based Tata Motors Ltd., and accounts for more than 90% of the group's EBITDA, while accounting for about 45% of the group's reported industrial debt. We continue to regard JLR as a highly strategic entity of Tata Motors, reflecting our view that JLR is unlikely to be sold, has a long-term commitment from its parent, and constitutes a significant proportion of the consolidated group. However, JLR is operationally separate and does not serve the same customer base.
The rating on JLR is constrained by the 'BB+' rating on Tata Motors, as we see a risk that Tata Motors could draw support from JLR in a credit-stress scenario.
JLR is a U. K.-based leading automotive manufacturer focused on the premium segment, across Jaguar (sports saloon, sports cars, and luxury sports utility vehicles [SUVs]) and Land Rover (premium/luxury SUVs) brands. Fiscal 2016 revenues were ?22.2 billion.
The stable outlook reflects our expectation that JLR will maintain steady profitability, and that Tata Motors will demonstrate a ratio of FFO to adjusted debt of about 40% over the next one-to-two years.
We may raise our rating on JLR if we raise the rating on Tata Motors. This could occur if JLR's strong operating performance partly offsets higher capex, such that we expect Tata Motors to sustain its ratio of FFO to debt above 45%. Strong operating performance could be supported by further strengthening of JLR's product portfolio.
We may lower the rating on JLR if we lower the rating on Tata Motors. This could occur if operating performance weakens and capex is high, likely resulting in a ratio of FFO to debt below 30% on a sustained basis. A weaker operating performance could be a reflection of lower-than-expected success in new models or a more challenging operating environment, such as a larger than expected adverse impact from Brexit.
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