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Fitch Affirms Jaguar Land Rover at 'BB+'; Outlook Stable
August 30, 2017 / 4:40 PM / 3 months ago

Fitch Affirms Jaguar Land Rover at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) BARCELONA/LONDON, August 30 (Fitch) Fitch Ratings has affirmed Jaguar Land Rover Automotive plc's (JLR) Long-Term Issuer Default Rating (IDR) and senior unsecured ratings at 'BB+'. The Outlook is Stable. The ratings reflect JLR's strong positioning in the premium segment and successful track record in expanding the group's product portfolio in recent years. However, the ratings also reflect the group's limited scale compared with larger peers in the sector, notably in the premium segment. Profitability has fallen materially as a result of high levels of investments in recent years, as well as increased marketing costs. Nevertheless profitability remains robust for the ratings, and cash generation is among the strongest in the industry. JLR's capital structure and liquidity remain strong, with a net cash position even after Fitch's adjustments for operating leases and working capital movements. KEY RATING DRIVERS Operating Margin Recovery Expected: Fitch expects JLR's operating margin to recover towards 8% as the group benefits from a renewed product line-up and improved production cost footprint as the Slovakian plant ramps up. Underlying cash generation has also declined but the funds from operations (FFO) margin remains among the strongest in the industry (13% in FY17). JLR's operating margin fell to 4.8% in financial year to 31 March 2017 from 12.4% in FY15 due to a significant increase in depreciation and amortisation from higher investment, as well as competitive pricing. Strong Demand Drives Volumes: Fitch expects JLR's Land Rover products - mainly luxury SUV's - to continue to benefit from relentless demand in both developed and developing markets. JLR's successful launch of the Jaguar XE and F-PACE have helped fill important segments where the group was previously absent and Fitch expects the E-PACE to benefit from substantial demand in the popular small SUV segment. Fitch projects sales growth will slow in FY18 due to lower UK demand, followed by high-single-digit unit sales growth from 2019 on product line-up and production capacity expansion. Capex to Remain High: Fitch expects JLR's investments in capacity expansion, engine manufacturing, vehicle architecture and new technologies, to contribute to negative free cash flow (FCF) of up to GBP1 billion in FY18 despite strong cash flows from operations. In particular, investments include a new manufacturing facility in Slovakia with an initial capacity of 150,000 units that is targeted for completion in 2018. Fitch expects positive FCF to return from 2019 as capex normalises and recent investments drive additional volumes. Over the longer term, Fitch expects further R&D investments, notably to develop new powertrains and meet multiple emission requirements, and to participate in new sector and mobility trends, will continue to constrain earnings and cash generation. Robust Financial Profile: Fitch expects JLR to maintain a healthy financial profile and ample liquidity. Fitch forecasts FFO-adjusted gross leverage of around 1.0x at FYE18 and FFO-adjusted net leverage around breakeven (FY17: 1.2x and -0.2x respectively). Fitch adds GBP600 million to JLR's gross debt to adjust for operating leases and treats GBP487 million as restricted cash. Total reported debt was GBP3.5 million at end-1QFY18, of which GBP159 million were short-term maturities. Limited Scale and Product Diversity: JLR's scale and range of products are smaller than the group's premium-segment peers, which raise the risk of volatility in earnings and cash flow, and constrain the business profile. However, recent heavy investments are increasing JLR's product breadth and volume, thereby helping to diminish this business risk. The group also benefits from its brands' solid reputation and history and, notably, Land Rover's undisputed positioning in the booming SUV segment. Geographic Diversification Improving: JLR's efforts over the last five years have helped the group to achieve a more balanced geographic mix, with over half of retail sales volumes outside of UK and Europe. In particular, despite the group's high production exposure to the UK, Fitch does not expect any major impact from Brexit. JLR's growth in China has been rapid and the group is the fourth-largest automaker in the premium segment by volumes after Audi, BMW and Mercedes. More Challenging Emissions Regulation: Tightening emission requirements in both developed and developing countries remain a challenge for JLR, as its product portfolio is currently weighted towards larger, less fuel-efficient SUVs. However, a further broadening of its product line to include more compact, fuel-efficient models would reduce its exposure to the risk of evolving environmental legislation. In the longer term, market success of its upcoming electric I-Pace as well as hydrid electric vehicles - which are under development - would demonstrate an ability to transition to non-conventional drivetrains, though given limited initial volumes the impact of total fleet emissions would likely be limited in the near term. DERIVATION SUMMARY JLR is positioned in the profitable premium segment but lacks the scale of its much larger German competitors Daimler AG (A-/Stable) and BMW AG, and the multi-brand Volkswagen AG (BBB+/Stable). The group's limited product portfolio and lower diversification are a constraint on the ratings, but an expanding product portfolio and a longer positive track record will be positive for the group. In recent years both profitability and cash generation have been stronger than its mass market peers Fiat Chrysler Automobiles N.V. (BB-/Positive), Peugeot S.A. (BB+/Stable) and Renault SA (BBB-/Positive), and in line with German premium manufacturers'. The cost of recent investments has reduced this advantage; however, Fitch believes the positive impact of these investments (both in new products and lower cost production footprint) will help JLR regain some ground. JLR is currently undergoing a period of significant expansion, both with respect to capacity and product range, resulting in temporarily negative FCF, though through the cycle strong operational cash flow has resulted in industry- leading FCF levels. JLR's capital structure is solid with consistently FFO adjusted gross and net leverage of around 1x and breakeven respectively in recent years, comparable to Daimler's and VW's. Renault's and PSA's leverage have declined to similar levels as JLR's, after significant debt increases following the 2008-2009 industry crisis and 2010-2012 recession. However, Fitch believes JLR's capital structure has been more stable and consistent through the cycle. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low single-digit revenue growth in 2018 and 2019 because of weakening demand in the UK, pricing pressure and increasing entry level sales, offset by North American and Chinese growth; - EBIT margin remaining depressed at around 5%-6% due to increased D&A from large investments, as well as continued pricing pressure; - FFO margin of 14% in 2018, increasing to 15% thereafter, with improvements driven by increasing production in low- cost countries as Slovakian operations ramp up; - Capex of GBP4.2 billion in 2018 as the Slovakian plant is built, and falling back moderately thereafter; - Dividends remain at GBP150 million. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Further product diversification and an increase in scale towards GBP30 billion-GBP40 billion sales, combined with additional positive track record in maintaining robust profitability, including an operating margin consistently above 6% and a positive FCF margin of around 1.5%, and a strong financial profile, including FFO-adjusted net leverage below 0.5x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Deterioration in key credit metrics including FFO-adjusted net leverage to above 1.5x on a sustained basis; -Material weakening of JLR's liquidity position; -Problems with implementation of new product introduction and production footprint expansion or decreasing market share; -Sustained negative FCF. LIQUIDITY Robust Liquidity, Net Cash Positive: At end-1QFY18, JLR had reported cash and cash equivalents of GBP1.6 billion, short-term liquidity deposits of GBP2.5 billion, and committed undrawn facilities of GBP1.9 billion maturing in 2022. Total reported debt was GBP3.5 million at end-1QFY18, of which GBP159 million were short-term maturities. When calculating leverage and liquidity, Fitch includes short-term deposits, and deducts 2% of sales (equivalent to around GBP0.5 billion) to account for cash needed for intra-year working capital volatility. Contact: Principal Analyst Emmanuel Bulle Senior Director +34 9 3323 8411 Supervisory Analyst Thomas Corcoran Associate Director +44 20 3530 1231 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Summary of Financial Statement Adjustments - Fitch adds an 8x multiple of lease payments to debt, resulting in a GBP600 million debt adjustment in FY17; -Fitch has treated GBP0.5 billion (equivalent to 2% of sales) as restricted for intra-year working capital volatility. Short-term deposits (GBP2.6 billion at FYE17) are treated as readily available cash; -Tianjin Port explosion recoveries of GBP151 million in FY17 are treated as non-recurring and non-operating. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com. 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