The UK passed its EU referendum last week with a majority supporting the leave camp. The economic uncertainties will certainly lead to a weaker business and consumer confidence for manufacturing and import/export names and this will certainly be a negative for car demand in the UK which could negatively impact JLR (NYSE:TTM). By backing out of the EU, the UK's trade agreement with the union blocks will face many uncertainties as there could be restriction in movements of skilled workers, a negative to JLR's R&D effort. On the other hand, JLR may benefit from the depreciating sterling. However, I see more negatives than positives and I am turning cautious on JLR in the medium-term.
After the referendum result was published, the sterling fell 8% against the USD and 5% against the euro. With 80% of its cars manufactured in the UK going to North America, China, Europe and the rest of the world, JLR could see higher revenue and EBITDA on lower sterling against the other currencies. One way to take advantage of the lower sterling is to increase sales by offering higher incentives (JLR has one of the lowest incentives amongst the automakers in the US and globally) and/or enhance its margins. However, I believe that investors should not overlook the economic uncertainties and the impact on the demand for JLR given that the UK and the EU accounts for roughly 45% of JLR's volume in FY16.
There are also several economic uncertainties involving the UK leaving the EU. First, movements of human capital may be hindered in the wake of the UK exist, thereby negatively impacting JLR's R&D effort as I have mentioned previously. The UK and the EU have an integrated automotive industry with the UK exporting 80% of its auto production and imports 90% of its light vehicles (80% of which comes from the EU). Additionally, cost are dominated in Euros with half of the components used in the UK coming from the continent. Brexit could also force JLR to pay higher tariff to selling cars in the EU and pay higher tariff on components imported from the EU compared with the free movements of goods that it is currently enjoying more. This will mean higher cost on the UK manufacturers and higher cost for the EU buyers of UK-made goods. With the UK relying on the EU for capital goods, components and human capital, this will exert considerable pressure on UK-based manufacturers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.