Fitch downgrades Tata Motors, cites cash flow issues due to coronavirus

Citing severe free cash flow issues, international rating agency Fitch has downgraded the ratings of Tata Motors to 'B' and also revised down the outlook on the company that owns the marquee British brands JLR to negative from stable.

The company had a 'BB-' rating on its long-term issuer default ratings till this, but is now down to B, Fitch said in a note on Thursday. Both 'BB' and 'B' are below investment grade or junk status.

This move will have negative consequence for the company's debt profile which will spike its borrowing cost.

Below investment grade issuers of debt have to pay higher interest rate to investors as junk bonds are considered speculative.

"The downgrade reflects our significantly lower expectation for the company's profitability and cash flow over the next few years due to the effect of the coronavirus pandemic on demand and disruption to its domestic operations as well as to key auto markets globally that are served through Jaguar Land Rover," Fitch said in the note.

On the impact of the pandemic on its free cash flow, the agency estimates it could be a negative ₹40,000 crore in Q1 of FY21 due to lower earnings and working capital mismatch caused by lower sales receipts, while payments continue to suppliers for past supplies. This is against ₹63,000 core of free cash flow in the same time in FY19.

The agency sees Tata Motors' consolidated revenue to decline by 12 per cent in FY21 due to the effect of the pandemic-related shutdown, which may rise by 8 per cent in FY22.

Consolidated EBITDA margin will decline to 5.5 per cent in FY21 from9 per centin FY20 due to negative operating leverage and may recover to around 9 per cent in FY22, it said. Capex/revenue will fall to 12 per cent in FY21, in line with a prudent approach, but remain above 15 per cent in FY22, it said.

In FY19, the company had ₹8,700 crore in cash and ₹1,500 crore in undrawn credit lines that mature in 2022, compared to ₹3,580 crore and ₹3,130 crore in scheduled maturities of long-term debt over 2020 and 2021, respectively. It also had ₹7,720 crore in short-term debt which may be rolled over.

The agency estimates consolidated EBITDA generation will drop nearly 50 per cent in FY21 and will remain below FY19 levels in FY22 even with a recovery.

"We expect sharp deterioration in free-cash generation and leverage, as the company will have limited flexibility to lower heavy investment, despite lower profitability, particularly at JLR, as it needs to bolster its long-term competitiveness in view of emerging industry trends," the note said.

The negative outlook reflects risks to Tata Motors' financial profile from a prolonged pandemic that can result in further deterioration in its profitability and exert greater pressure on its liquidity than we currently envisage, it said.

Listing out the key reasons for the rating action, it cited sharply weaker profitability and substantially negative free cash flow as the major concerns. Covid-19 mitigation measures, including shutdowns, have affected its operations globally.

As the global economy is set to plunge into the worst recession since the 1930s, this will cause double-digit fall in new auto sales, hurting the company's profitability due to lower absorption of fixed costs, despite some flexibility.

"We expect recovery only in FY22, from a low in FY21, but volume is likely to remain lower than in FY20 in absolute terms," it said. This will see consolidated FY22 EBITDA remaining nearly 40 per cent lower than previously estimated.

Domestic industry conditions remain weak, PV and CV volumes declining over 15 per cent and 25 per cent, respectively in FY20, while the same for Tata Motors has been sharper at 35 per cent. The pandemic will further weaken demand in FY21, as it will compound higher ownership costs following the BS-VI emission norms.

JLR, which accounts for majority of consolidated EBITDA, has significant exposure to Europe and North America, two heavily affected regions, which together made up over 60 per cent of its FY19 volume.