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Ashok Leyland (AL)
Automobiles
Earnings momentum to slow down. We believe commercial vehicle volume growth
will likely moderate in FY2012E as increase in truck freight rates will not be able to
completely offset increase in cost of ownership of the truck. We expect earnings
downgrades to follow as consensus moderates volume growth and EBITDA margin
assumptions. Hence, we reinitiate the stock with a SELL rating and target price of Rs60
based on 13X PE mid-cycle multiple on our FY2012E EPS.
CV cycle growth to moderate in FY2012E
Leading indicators (likely increase in interest rates, sharp rise in diesel and vehicle prices) coupled
with not much improvement in freight rates point to moderating growth in truck volumes despite
robust outlook of IIP growth. We believe truck operators’ profitability is deteriorating given sharp
rise in input costs. Hence, we believe domestic truck industry volume growth is likely to moderate
to 12% yoy after a sharp rise in FY2010 and FY2011E.
Earnings downgrades likely on slower volume growth and input cost pressures
Our earnings estimates for FY2011-2012E are 17-21% below consensus due to lower volume
growth and lower EBITDA margins (on account of rise in tyre and steel prices). Our volume
estimates (89,586 units in FY2011E) are below management guidance of 95,000-100,000 units
while we factor in only 0.5% yoy improvement in EBITDA margins in FY2012E despite increase in
production at Pantnagar plant as we believe management will pass on the excise benefit to protect
its market share.
Reinitiate with a SELL rating
We reinitiate on the stock with a SELL rating and a target price of Rs60 based on 13X PE mid-cycle
multiple on our FY2012E earnings estimate. Key upside risks to our call include (1) higher-thanforecast increase in truck industry volume growth, (2) increase in share of heavier tonnage vehicles
in overall industry volumes, and (3) fall in commodity costs, especially steel and tyre prices.
Reinitiate the stock with sell rating
We reinitiate on Ashok Leyland with a SELL rating as we believe certain indicators point to
moderating growth of commercial vehicle cycle. Increase in interest rates and cost of
ownership of vehicle (rise in vehicle and diesel prices) coupled with strong base effect after a
two-year strong run of the CV cycle with not much improvement in freight rates indicate
that commercial vehicle volume growth is likely to moderate in FY2012E despite robust
outlook on IIP growth, in our view. We expect earnings downgrade cycle to kick in for
Ashok Leyland as volume growth moderates. Our earnings are 17-21% below consensus
over FY2011-12E. We reinitiate with a target price of Rs60 based on 13X PE mid-cycle
multiple on our FY2012E earnings forecast.
CV volume growth likely to moderate in FY2012E
Past trends in the commercial vehicle cycle indicate that after a sharp fall in volumes,
commercial vehicle cycle shows robust growth for a period of 3-4 years. However, given the
sharp increase in cost of ownership of vehicle due to rise in prices after the emission
changeover from BS2 to BS3, likely increase in interest rates, escalating input costs,
especially tyre and diesel prices without any significant improvement in truck freight rates
could lead to a slowdown in commercial vehicle volume growth in FY2012E, in our view.
Average truck freight rates across major Indian cities have increased by 9% since Jan 2010
while the diesel prices have risen by 15% during this period, indicating supply of trucks have
grown at a faster rate than demand. We are concerned about rising tyre prices and likely
increase in interest rates due to high inflation, which could put further pressure on truck
operators’ profitability. Hence, we believe truck operators will delay their purchases until
freight volumes increase significantly to cover their costs. Truck prices have been increased
by 10% since April 2010 by Ashok Leyland which is likely to moderate demand, in our view.
We forecast domestic industry truck volumes to grow at 12% yoy in FY2012E after a twoyear strong run. We expect Ashok Leyland to maintain its market share in FY2012E.
Earnings downgrades to follow, we are 17-21% below consensus over FY2011-
12E
We believe consensus has not revised their earnings downwards to factor in slowing volume
growth and escalating material cost pressures. Consensus margins for FY2011E are 0.5%
higher than management guidance as well and we believe earnings downgrades are likely to
follow post 3QFY11 results.
Ramp-up at Pantnagar plant has been slower than expectations
The company has produced around 3,750 units from Pantnagar till November 2010 and it
plans to ramp up production to 14,500 units by end of FY2011E (vs earlier guidance of
~20,000 units) and 30,000 units by end of FY2012E. Management has guided to
Rs35,000/vehicle excise benefit from Pantnagar plant at 50% localization. We believe the
company’s EBITDA margins will improve by 1% if they manage to produce 30,000 units in
FY2012E and retain the entire benefit.
However, we believe the company will not be able to retain the entire benefit in light of
slowing industry growth. We factor in 25,000 units of production at Pantnagar plant in
FY2012E and 0.5% yoy improvement in EBITDA margins in FY2012E.
Ashok Leyland has started to lose market share to Tata Motors
Ashok Leyland lost significant market share to Tata Motors in Oct-Nov 2010 due to (1)
higher inventory build-up, and (2) Tata Motors faced supply constraints in 1HFY11 which led
to fall in market share. We believe Ashok Leyland will increase its market share as heavy
truck volumes pick up in 4QFY11E but it won’t be enough to meet its annual guidance of
95,000-100,000 units. Tractor trailer and tipper segments also fell sharply after the
implementation of new emission norms in October 2010. Higher tonnage segments (>16
tons) have fallen more than the lower tonnage segments due to higher increase in prices in
the higher tonnage category and slowdown in mining activity. >16 ton segment forms
~62% of its domestic truck volumes vs 50% for the industry; hence, slowdown in higher
tonnage segment will impact Ashok Leyland’s volumes as well as profitability.
Bus demand to moderate as JNNRUM orders expire
Bus demand has been robust in this fiscal driven by new orders from JNNRUM in 1HFY11.
Both Tata Motors and Ashok Leyland have been beneficiary of these orders and have
delivered most of the orders to the State transport undertakings. We believe bus demand is
likely to moderate to 10% yoy in FY2012E as private operators may defer replacing vehicles
due to rise in bus prices. However, orders from State transport undertakings is likely to
continue but given these orders are lower margins than private bus orders we expect bus
segment operating margins to decline in FY2012E.
New JVs not to contribute meaningfully to earnings
New ventures like Nissan LCV JV, John Deere JV are likely to start selling their products from
mid-CY2011E. However, management is not too focused on these ventures as of now and
committing minimal investments to these ventures. In the Nissan LCV joint venture, Ashok
Leyland will do contract manufacturing for Nissan and will use its existing Hosur facility in
the initial phases. We have not included any volume numbers from the LCV joint venture
due to lack of clarity on new product launches and contract manufacturing fees. Ashok
Leyland will invest Rs8 bn over FY2011-12E in the joint ventures.
Progress on Hinduja Leyland finance has been quite encouraging. The company has financed
2,400 vehicles till October 2010 and has disbursed Rs3.1 bn till now. Management plans to
increase distribution reach and disburse Rs5 bn by end of FY2011E.
Gearing at comfortable levels
Ashok Leyland plans to invest Rs20 bn over FY2011-12E in product development,
investment in Pantnagar plant and investments in joint ventures. The company has invested
Rs2.5 bn in 1HFY11 in capex and plans to invest another Rs4.5 bn in 2HFY11E which is likely
to increase interest expenses. However, gearing levels are comfortable and we do not see
any major stress on the balance sheet to finance the ongoing capex.
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