HDFC Sec: Ashok Leyland: 2HFY11 volume growth rates set to come off 1H highs

Since the bottom of the CV cycle in Jan-Mar’09, AL’s stock price has risen 4x

(cf. 5x for Tata Motors), sharply outperforming the Sensex. In the last one year

as well, the stock has returned a strong 88%. Stock currently trades at 13.2x

FY12E earnings (cf. 25x Tata Motors parent and 8.9x Tata Motors consolidated

earnings), in line with historic averages. As base effect catches up, we expect

AL’s headline volume and earnings growth rates to moderate. PE multiples for

the stock expanded as the CV cycle surprised street expectations positively.

However, with growth rates set to moderate, we see limited scope for further

multiple re-rating and expect stock price to move in line with earnings growth.

2HFY11 volume growth rates set to come off 1H highs

Ashok Leyland (AL) expects 20% volume growth for M&HCVs in FY11, driven by

strong demand for freight as goods movements picks up led by the uptick in industrial

demand. The company also expects food-grain movement to accelerate led by the

strength in agri demand. However, given YTD growth of 66%, the company expects

growth to moderate in 2HFY11 as base effect sets in. Overall, AL expects FY11

volumes at 80,000 (domestic) and an additional 10,000 from exports (9,000) and its

new LCV line (1,000). Outlook on bus segment remains robust, driven by uptick in

orders from State Transport Undertakings (STUs). However, AL scaled back its FY11

target volume for its new Uttarakhand plant from 20,000 to 15,000 mainly due to

delays in vendor scaling up and power supply shortages.

Upgrades to BSIII and IV – no major impact, FY11 margins expected at 10%+

AL estimates the impact of upgrading its vehicles to BSIII at Rs40,000/vehicle and

BSIV at Rs100,000/vehicle. AL has also built up dealer inventory of around 10,000

BSII vehicles to meet higher truck demand ahead of the deadline. While consensus

estimates on AL’s FY11 Ebitda are at 11%, management guided to margins of

“10%+”. While overall pricing power remains intact (company has raised truck prices

by 4% so far in Apr-Jun’10), management does not expect major scope of margin

expansion, especially in BSIV trucks where room to hike prices beyond actual

quantum of cost was limited. AL’s new Uttarakhand plant will scale up production

from current levels of 1,000/month to 3,000/month in FY12 – by when AL expects the

plant to produce 30,000/year.