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Ashok Leyland: Approaching a mid-cycle growth phase; maintain Hold
Maintaining Hold with an 8% increase in target price to Rs65
We are raising our FY11E and 12E EPS estimates by around 14% to Rs4.3 and
Rs4.9. We have increased our target price by 8% to Rs65 and maintain our Hold
recommendation. We note that Ashok Leyland’s market share gains have tapered
after reaching the long-term trend level of 27%. While production scale-up at its
tax-advantaged Uttaranchal plant would be margin accretive, we believe it would
be offset by rising competitive intensity in the domestic CV market.
Commercial vehicle growth likely to decelerate to 12% in FY12E
We expect FY12E to be a mid-cycle phase for commercial vehicles and for AL’s
volume growth to decelerate from 41% in FY11E to 12% and 10% in FY12E and
FY13E. The entry of Mahindra & Mahindra could also impact competitive intensity
and likely offset the positive margin impact of incremental production from AL’s
new plant in Uttaranchal. We forecast EBITDA margin to remain flat at around
10.6% for next two years (FY12-13E).
3QFY11 forecast: price increases unlikely to offset input costs
We forecast revenue of Rs21.1bn (17% YoY), EBITDA of Rs2.2bn (4.5% YoY) and
EBITDA margin of 10.2% (-110bps QoQ). We expect EBITDA per truck to be
around Rs116,875. We intend to focus on management commentary around
production scale-up at the Uttranchal plant and the level of local sourcing. We also
await an update on the JV with Nissan for LCVs.
Two-year EPS CAGR (FY11-13E) of 13%, trading at 12x FY12E EPS
Our DCF-based target price for AL is Rs65/share, implying 13x FY12E EPS and 9x
EV/EBITDA, in line with mid-cycle valuation. Our DCF assumptions are RFR of
6.4%, risk premium of 7.2%, CoE at 14.3%, Kd of 10%, WACC of 12.3% and
terminal growth rate of 4%. Upside risks include higher-than-expected volume
growth. A higher-than-expected increase in input prices is a key downside risk.
Financial analysis
Revenues – Two-year CAGR (FY11E – 13E) of 15%
We forecast AL’s volumes to grow at a CAGR (FY11E-13E) of 11%, in line with our industry
growth forecast. We expect realisations to grow at 3.5% p.a. as we expect CV
manufacturers to pass on at least part of the increase in input costs to customers. Overall,
we expect revenues to grow at 15% p.a. over the next two years.
EBITDA margins expected to stabilise at current levels
AL’s profitability should improve as it ramps up production at its tax-advantaged plant in
Uttaranchal. We estimate AL will likely produce c.40% of its vehicles at Uttaranchal by FY13E
compared with 16% in FY11E. However, we believe these gains would be offset by
increases in input costs and higher competitive intensity on account of M&M’s entry into this
segment. We forecast AL’s FY13E EBITDA margin at 10.4% vs 10.6% in FY11E. We expect
an EBITDA CAGR (FY11-13E) of 13.5%.
Two-year EPS CAGR (FY11E–13E) of 13% assumes benefits from tax exemption
We forecast AL’s net profit to grow in line with EBITDA despite the income tax exemption
available at the Uttaranchal plant on account of a higher burden of depreciation and interest
costs.
We expect Ashok Leyland to turn free cash positive in FY13E
AL generated free cashflows of Rs3.7bn in FY10. We expect an increase in capex and
investments over FY11E and FY12E, which would be higher than its cashflow generation. We
expect investments to taper by FY13E, resulting in free cashflow of Rs3.1bn.
DCF – Assumptions and valuations
We continue to value Ashok Leyland using a DCF analysis. We have used a 15-year
timeframe for our DCF forecasts. We have assumed revenue growth to trend downwards
from 16% in FY12E. We expect capex/sales to stabilise at around 4.5% and EBIT margin to
rise initially and then trend down to 6.5% by FY26E. Our DCF assumptions are as follows:
risk-free rate (6.4%), risk premium (7.2%), beta (1.1) and terminal growth rate of cash flows
(4%). Our cost of debt is 10% and the resultant WACC is 12.3%. Our terminal growth rate is
in line with our expectation for long-term GDP growth in India. The resultant DCF value of
Rs65/share implies a P/E of 13x FY12E EPS and FY12E EV/EBITDA of 8.5x.
Risks
Upside risks
Upside risks include better-than-expected growth in commercial vehicles and an increase in
AL’s market share. A lower-than-expected increase in raw material costs would also
positively impact margins and earnings.
Downside risks
Downside risks include loss of market share in the CV market. A higher-than-expected
increase in commodity prices would also pose a downside risk to our earnings estimates.
The entry of Mahindra & Mahindra could impact competitive intensity and offset the positive
margin impact of incremental production from AL’s new plant in Uttaranchal.
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