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Settling into a normalized growth phase
We initiate coverage on the commercial vehicle (CV)
industry with a BUY rating on Tata Motors (TAMO) and
HOLD on Ashok Leyland (ALL). An analysis of CV cycles over
the last 39 years indicates that CV industry is currently in an
upturn. However, we believe volume growth would
moderate for M&HCV goods segment to 10%-11% over
FY12E-13E from 36% in FY11. In such a scenario, we prefer
TAMO, which is more driven by JLR’s performance
compared to ALL, which still is a pure CV play.
Growth rates to moderate over FY11-13E; however, CV
cycle on an up-trend: We expect growth rates for the
M&HCV goods segment to moderate to 10-11% over FY12-
13E from 36% in FY11. Our hypothesis of moderation in
growth is based on continued pressure seen on fleet
operators’ profitability, lack of external factors (stimulus
package, pent-up demand and pre-buying due to emission
change) and our economist’s view of the expected
moderation in GDP/IIP growth and gross capital formation
over the forecasted period. However, our analysis of past
CV cycles for last 39 years indicates that the CV industry is
currently on an up-trend.
LCVs gaining strong ground: We remain more confident
about the LCV growth story with the hub-and-spoke
model fast gaining ground. Our confidence is based on the
fact that India’s LCV-to-CV ratio currently stands at 48%
compared to average 88% for emerging and developed
countries. New product launches and huge scope of
further growth is likely to drive strong volume growth
ahead. We forecast volume growth of 17%/16% for
FY12E/FY13E compared to 23% in FY11.
Pricing power to weaken for OEMs: Aggressive round of
price increases in FY11 helped OEMs offset most of input
cost pressures. This was supported by strong volume
growth. However, going forward, given our expectation of
moderation in growth, we foresee limited pricing power in
hands of OEMs. This, coupled with continued pressure on
input cost, would keep margins under check.
Prefer TAMO over ALL: We prefer TAMO (BUY, Target
Price Rs1,557 based on our SOTP of Rs499 for the
standalone business, Rs942 for JLR and Rs116 for
subsidiaries) driven by strong momentum for LCV growth
coupled with the positive outlook for JLR, both in terms of
volumes and profitability. ALL (Hold, Target Price Rs61,
based on 7.4x FY13E EV/EBITDA + Rs4.3/share as value of
investments in JVs) is still largely exposed to the CV cycle.
Industry Outlook
M&HCV growth to moderate, but LCV segment to remain strong
According to Centrum Research’s economist, Dhananjay Sinha, India’s GDP and IIP growth are likely to moderate to 7.6% and
7.5%, respectively, in FY12E from 8.6% and 8.8% in FY11E. Given the high sensitivity of M&HCV demand to IIP growth, coupled
with benign GDP outlook, moderation in M&HCV demand is likely.
Anecdotal checks with truckers and fleet operators suggest that the underlying freight market continues to remain weak.
External factors like the economic stimulus package, pent-up demand and pre-buying ahead of deadline for emission norms
supported strong 26% YoY growth for the CV industry in FY11. These factors are unlikely to prop growth in FY12E-13E.
Based on our “Econometric model for demand forecasting” and base case, we estimate long-term CV growth at 12-13% based
on long-term independent variables assumptions – IIP at 6.2%, PLR at 11%, freight ratio at 5x and WPI inflation at 5%. However,
we estimate higher growth of 14% each in FY12E and FY13E factoring in stronger growth expectations for LCVs.
Conclusion: We expect the M&HCV (Goods) segment to register 10% and 11% YoY volume growth in FY12E and FY13E,
respectively, compared to 36% in FY11. However, we remain more confident about the LCV growth story with the hub-andspoke
model fast gaining ground. Our confidence is based on the fact that India’s LCV to CV ratio currently stands at 48%
compared to average 88% for emerging and developed countries. New product launches and the huge scope of growth is likely
to drive strong volume growth ahead. We forecast volume growth of 17%/16% for FY12E/FY13E compared to 23% in FY11E.
Pricing power to weaken both for OEMs and fleet operators
Freight rate data indicates the moderation in pricing power is pervasive across routes. Also, the freight-fuel ratio (an indicator
reflecting pricing power of fleet operators) is displaying signs of pressure indicating stress on fleet operator’s profitability.
Aggregate operating margin for service providers has declined YoY in 11 out of past 17 quarters.
Aggressive round of price increases in FY11 helped OEMs offset most of input cost pressures. This was supported by strong
volume growth. However, going forward, given our expectation of moderation in growth, we foresee limited pricing power in
hands of OEMs. This, coupled with continued pressure on input cost, would keep margins under check.
Conclusion: We expect margin contraction of 100-110bps combined for Ashok Leyland and Tata Motors (standalone) in
FY12E/FY13E compared to FY11E
Impact on earnings and valuations to mirror volume growth
Moderation in volume growth and margin pressures would result in muted PAT growth for TAMO (standalone) and Ashok
Leyland.
The PE multiples in any cyclical industry tend to mirror volume growth. Based on our estimate of moderation in CV growth, we
believe that valuations of pure CV players would mirror volume growth. As a result, we would be comfortable assigning midcycle
multiple.
Where is the opportunity? We prefer TAMO to ALL
Positive on TAMO (BUY, CMP Rs.1,250, Target Price Rs.1,557)
TAMO’s overall business is now dominated by JLR which accounts for 56% of consolidated revenues and 63% of consolidated
EBITDA. Hence, the company’s business is expected to be less vulnerable to moderation in M&HCV growth. Also TAMO’s is best
positioned to capture the potential opportunity in the LCV space as it has strongest product range (nearly 58% of its CV sales
from the LCV segment which is expected to grow at 17% in FY12E and 16% in FY13E).
Evoque to drive overall volumes for JLR. Land Rover, which accounts for 78% of overall JLR volumes, is foraying into the entrylevel
luxury SUV segment with the launch of Evoque in Sept 2011 (priced at UK£ 27,955) and will compete with BMW X1 (priced
at UK£27,065) and Audi Q5 (priced at UK£28,000). Both BMW X1 and Audi Q5 have attained significant volumes post their
launches. The X1 (launched in late 2009) now accounts for 31% of BMW’s global SUV sales and globally sells 100k units. Similarly
the Q5 (launched in late 2008) accounts for 77% of Audis SUV sales and sell 147k units globally.
Ashok Leyland less preferred ( Hold, CMP Rs.55, Target Price Rs.61)
Still a pure CV play. The M&HCV segment accounts for more than 67% of its overall revenues. Moderation in volume growth
would limit operating leverage and working capital would continue to put pressure on interest costs.
Current CV cycle in an upturn, but growth rates to moderate
Our analysis of CV sales cycles indicates the industry is
currently in an upturn
The M&HCV goods industry registered a strong re-bound in
FY11 clocking 36% YoY volume growth compared to the
long-term average growth of 9% (FY1971-FY2010). The
deviation in FY11 trend is on positive side and the rebound
has translated into a cyclical upturn for the industry after
signs of negative deviation. However, even with a re-bound,
the average growth of 12% over the last 3 years is lower than
compared to average growth rate of 23% witnessed during
expansion cycle of 2003-08.
Pressure on fleet operators’ profitability continues
Our channel checks indicate that operators’ profitability and
cash flows have been impacted significantly, especially in the
past few months (this is in tune with other data points that
indicate a slowing economy)
The confluence of three factors: (1) increase in base vehicle
prices; (2) rising diesel prices (diesel accounts for 55-60% of
operating costs); and (3) hardening lending rates have
resulted in a significant increase in the cost of ownership. On
the other hand, the freight-fuel ratio (an indicator reflecting
pricing power of fleet operators) is displaying signs of
pressure, indicating stress on fleet operators’ profitability.
LCV growth story to continue
The CV market in India is set to experience significant changes
with the hub-and-spoke model of transportation. With
increased road infrastructure development, CV sales would be
driven by focus on application-specific vehicles such as
M&HCVs for long-distances and LCVs, typically sub-3.5 tonne
vehicles for short distances.
Over the last 3 years, the ratio of LCV goods to overall CV’s
has increased to 1.27x compared to the average of 0.65x over
the last 7 years.
Our confidence is based on the fact that LCV-to-CV ratio in
India currently stands at 48% compared to average 88% for
emerging and developed countries.
Global market size for premium segment estimated at
8.5mn units in 2022 vs 5mn units in 2009
Based on BMW’s March 2011 investors presentation, the
global luxury segment is expected to register a CAGR volume
growth of 4% over 2009 to 2022 , translating into overall
market size of 8.5mn units compared to 5mn units in 2009.
After registering a strong YoY growth of 12% in 2010, global
luxury car giants are expecting YoY volume growth of 4-5% in
2011 compared to 12% in 2010 for luxury car segment.
Sector valuations
We initiate coverage on the commercial vehicle (CV) industry with a BUY rating on Tata Motors
(TAMO) and HOLD on Ashok Leyland (ALL). An analysis of CV cycles over the last 39 years indicates
that the CV industry is currently in an upturn. However, we believe volume growth would
moderate for M&HCV goods segment to 10%-11% over FY12-13E from 36% in FY11. In such a
scenario, we prefer TAMO, which is more driven by JLR’s performance compared to ALL, which still
is a pure CV play.
We find valuations for pure CV players are highly correlated to volume growth and return
trajectory, which we believe is set to moderate over FY12E-13E for both Ashok Leyland and Tata
Motors (standalone) compared to FY10-11E. As discussed in sector outlook, we expect the M&HCV
segment’s volume growth to moderate to 10-11% over FY12-13E from 36% in FY11.
While, the transformation of TAMO’s business model makes it less vulnerable to the moderation in
M&HCV business, ALL still a remains pure CV play (the cyclical M&HCV goods segment accounts
for 67% of its revenues). As a result, valuations would tend to mirror the volume and earnings
growth. Given the moderation expected in volume growth (volume growth of 10% over FY12E-
13E v/s 32% in FY10-11 ) and earning growth (earnings growth of 10% over FY12-13E vs 86% in
FY10-11E ) for ALL, we believe the higher than historical valuation for the stock is unjustified and
expect valuations to trade at historical valuations. We have valued ALL at 7.4x FY13E EV/EBITDA
assigning historical multiple . Similarly for TAMO’s standalone business, we assign historical
EV/EBITDA for valuing standalone business.
Recommendations
Tata Motors ( BUY, CMP Rs.1,250, Target Price Rs.1,557, upside 24%)
At the CMP of Rs1,250, the stock is currently trading at 8.3x FY12E consolidated EPS of Rs150 and
7.0x FY13E consolidated EPS of Rs180. We initiate coverage with a BUY and a SOTP-based target
price of Rs1,557 (Rs499 for the standalone business, Rs942 for JLR business and Rs116 for
subsidiaries).
Ashok Leyland (Hold, CMP Rs.55, Target Price Rs.61, upside 11%)
At the CMP of Rs55, the stock trades at 10.7x FY12E EPS of Rs.5.1 and 9.8x FY13E EPS of Rs5.5. We
initiate coverage with a Hold rating and a target price of Rs61 (based on 7.4x FY13E EV/EBITDA,
inline with its historical average multiple and Rs4.3 per share as value of investments in JVs).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Settling into a normalized growth phase
We initiate coverage on the commercial vehicle (CV)
industry with a BUY rating on Tata Motors (TAMO) and
HOLD on Ashok Leyland (ALL). An analysis of CV cycles over
the last 39 years indicates that CV industry is currently in an
upturn. However, we believe volume growth would
moderate for M&HCV goods segment to 10%-11% over
FY12E-13E from 36% in FY11. In such a scenario, we prefer
TAMO, which is more driven by JLR’s performance
compared to ALL, which still is a pure CV play.
Growth rates to moderate over FY11-13E; however, CV
cycle on an up-trend: We expect growth rates for the
M&HCV goods segment to moderate to 10-11% over FY12-
13E from 36% in FY11. Our hypothesis of moderation in
growth is based on continued pressure seen on fleet
operators’ profitability, lack of external factors (stimulus
package, pent-up demand and pre-buying due to emission
change) and our economist’s view of the expected
moderation in GDP/IIP growth and gross capital formation
over the forecasted period. However, our analysis of past
CV cycles for last 39 years indicates that the CV industry is
currently on an up-trend.
LCVs gaining strong ground: We remain more confident
about the LCV growth story with the hub-and-spoke
model fast gaining ground. Our confidence is based on the
fact that India’s LCV-to-CV ratio currently stands at 48%
compared to average 88% for emerging and developed
countries. New product launches and huge scope of
further growth is likely to drive strong volume growth
ahead. We forecast volume growth of 17%/16% for
FY12E/FY13E compared to 23% in FY11.
Pricing power to weaken for OEMs: Aggressive round of
price increases in FY11 helped OEMs offset most of input
cost pressures. This was supported by strong volume
growth. However, going forward, given our expectation of
moderation in growth, we foresee limited pricing power in
hands of OEMs. This, coupled with continued pressure on
input cost, would keep margins under check.
Prefer TAMO over ALL: We prefer TAMO (BUY, Target
Price Rs1,557 based on our SOTP of Rs499 for the
standalone business, Rs942 for JLR and Rs116 for
subsidiaries) driven by strong momentum for LCV growth
coupled with the positive outlook for JLR, both in terms of
volumes and profitability. ALL (Hold, Target Price Rs61,
based on 7.4x FY13E EV/EBITDA + Rs4.3/share as value of
investments in JVs) is still largely exposed to the CV cycle.
Industry Outlook
M&HCV growth to moderate, but LCV segment to remain strong
According to Centrum Research’s economist, Dhananjay Sinha, India’s GDP and IIP growth are likely to moderate to 7.6% and
7.5%, respectively, in FY12E from 8.6% and 8.8% in FY11E. Given the high sensitivity of M&HCV demand to IIP growth, coupled
with benign GDP outlook, moderation in M&HCV demand is likely.
Anecdotal checks with truckers and fleet operators suggest that the underlying freight market continues to remain weak.
External factors like the economic stimulus package, pent-up demand and pre-buying ahead of deadline for emission norms
supported strong 26% YoY growth for the CV industry in FY11. These factors are unlikely to prop growth in FY12E-13E.
Based on our “Econometric model for demand forecasting” and base case, we estimate long-term CV growth at 12-13% based
on long-term independent variables assumptions – IIP at 6.2%, PLR at 11%, freight ratio at 5x and WPI inflation at 5%. However,
we estimate higher growth of 14% each in FY12E and FY13E factoring in stronger growth expectations for LCVs.
Conclusion: We expect the M&HCV (Goods) segment to register 10% and 11% YoY volume growth in FY12E and FY13E,
respectively, compared to 36% in FY11. However, we remain more confident about the LCV growth story with the hub-andspoke
model fast gaining ground. Our confidence is based on the fact that India’s LCV to CV ratio currently stands at 48%
compared to average 88% for emerging and developed countries. New product launches and the huge scope of growth is likely
to drive strong volume growth ahead. We forecast volume growth of 17%/16% for FY12E/FY13E compared to 23% in FY11E.
Pricing power to weaken both for OEMs and fleet operators
Freight rate data indicates the moderation in pricing power is pervasive across routes. Also, the freight-fuel ratio (an indicator
reflecting pricing power of fleet operators) is displaying signs of pressure indicating stress on fleet operator’s profitability.
Aggregate operating margin for service providers has declined YoY in 11 out of past 17 quarters.
Aggressive round of price increases in FY11 helped OEMs offset most of input cost pressures. This was supported by strong
volume growth. However, going forward, given our expectation of moderation in growth, we foresee limited pricing power in
hands of OEMs. This, coupled with continued pressure on input cost, would keep margins under check.
Conclusion: We expect margin contraction of 100-110bps combined for Ashok Leyland and Tata Motors (standalone) in
FY12E/FY13E compared to FY11E
Impact on earnings and valuations to mirror volume growth
Moderation in volume growth and margin pressures would result in muted PAT growth for TAMO (standalone) and Ashok
Leyland.
The PE multiples in any cyclical industry tend to mirror volume growth. Based on our estimate of moderation in CV growth, we
believe that valuations of pure CV players would mirror volume growth. As a result, we would be comfortable assigning midcycle
multiple.
Where is the opportunity? We prefer TAMO to ALL
Positive on TAMO (BUY, CMP Rs.1,250, Target Price Rs.1,557)
TAMO’s overall business is now dominated by JLR which accounts for 56% of consolidated revenues and 63% of consolidated
EBITDA. Hence, the company’s business is expected to be less vulnerable to moderation in M&HCV growth. Also TAMO’s is best
positioned to capture the potential opportunity in the LCV space as it has strongest product range (nearly 58% of its CV sales
from the LCV segment which is expected to grow at 17% in FY12E and 16% in FY13E).
Evoque to drive overall volumes for JLR. Land Rover, which accounts for 78% of overall JLR volumes, is foraying into the entrylevel
luxury SUV segment with the launch of Evoque in Sept 2011 (priced at UK£ 27,955) and will compete with BMW X1 (priced
at UK£27,065) and Audi Q5 (priced at UK£28,000). Both BMW X1 and Audi Q5 have attained significant volumes post their
launches. The X1 (launched in late 2009) now accounts for 31% of BMW’s global SUV sales and globally sells 100k units. Similarly
the Q5 (launched in late 2008) accounts for 77% of Audis SUV sales and sell 147k units globally.
Ashok Leyland less preferred ( Hold, CMP Rs.55, Target Price Rs.61)
Still a pure CV play. The M&HCV segment accounts for more than 67% of its overall revenues. Moderation in volume growth
would limit operating leverage and working capital would continue to put pressure on interest costs.
Current CV cycle in an upturn, but growth rates to moderate
Our analysis of CV sales cycles indicates the industry is
currently in an upturn
The M&HCV goods industry registered a strong re-bound in
FY11 clocking 36% YoY volume growth compared to the
long-term average growth of 9% (FY1971-FY2010). The
deviation in FY11 trend is on positive side and the rebound
has translated into a cyclical upturn for the industry after
signs of negative deviation. However, even with a re-bound,
the average growth of 12% over the last 3 years is lower than
compared to average growth rate of 23% witnessed during
expansion cycle of 2003-08.
Pressure on fleet operators’ profitability continues
Our channel checks indicate that operators’ profitability and
cash flows have been impacted significantly, especially in the
past few months (this is in tune with other data points that
indicate a slowing economy)
The confluence of three factors: (1) increase in base vehicle
prices; (2) rising diesel prices (diesel accounts for 55-60% of
operating costs); and (3) hardening lending rates have
resulted in a significant increase in the cost of ownership. On
the other hand, the freight-fuel ratio (an indicator reflecting
pricing power of fleet operators) is displaying signs of
pressure, indicating stress on fleet operators’ profitability.
LCV growth story to continue
The CV market in India is set to experience significant changes
with the hub-and-spoke model of transportation. With
increased road infrastructure development, CV sales would be
driven by focus on application-specific vehicles such as
M&HCVs for long-distances and LCVs, typically sub-3.5 tonne
vehicles for short distances.
Over the last 3 years, the ratio of LCV goods to overall CV’s
has increased to 1.27x compared to the average of 0.65x over
the last 7 years.
Our confidence is based on the fact that LCV-to-CV ratio in
India currently stands at 48% compared to average 88% for
emerging and developed countries.
Global market size for premium segment estimated at
8.5mn units in 2022 vs 5mn units in 2009
Based on BMW’s March 2011 investors presentation, the
global luxury segment is expected to register a CAGR volume
growth of 4% over 2009 to 2022 , translating into overall
market size of 8.5mn units compared to 5mn units in 2009.
After registering a strong YoY growth of 12% in 2010, global
luxury car giants are expecting YoY volume growth of 4-5% in
2011 compared to 12% in 2010 for luxury car segment.
Sector valuations
We initiate coverage on the commercial vehicle (CV) industry with a BUY rating on Tata Motors
(TAMO) and HOLD on Ashok Leyland (ALL). An analysis of CV cycles over the last 39 years indicates
that the CV industry is currently in an upturn. However, we believe volume growth would
moderate for M&HCV goods segment to 10%-11% over FY12-13E from 36% in FY11. In such a
scenario, we prefer TAMO, which is more driven by JLR’s performance compared to ALL, which still
is a pure CV play.
We find valuations for pure CV players are highly correlated to volume growth and return
trajectory, which we believe is set to moderate over FY12E-13E for both Ashok Leyland and Tata
Motors (standalone) compared to FY10-11E. As discussed in sector outlook, we expect the M&HCV
segment’s volume growth to moderate to 10-11% over FY12-13E from 36% in FY11.
While, the transformation of TAMO’s business model makes it less vulnerable to the moderation in
M&HCV business, ALL still a remains pure CV play (the cyclical M&HCV goods segment accounts
for 67% of its revenues). As a result, valuations would tend to mirror the volume and earnings
growth. Given the moderation expected in volume growth (volume growth of 10% over FY12E-
13E v/s 32% in FY10-11 ) and earning growth (earnings growth of 10% over FY12-13E vs 86% in
FY10-11E ) for ALL, we believe the higher than historical valuation for the stock is unjustified and
expect valuations to trade at historical valuations. We have valued ALL at 7.4x FY13E EV/EBITDA
assigning historical multiple . Similarly for TAMO’s standalone business, we assign historical
EV/EBITDA for valuing standalone business.
Recommendations
Tata Motors ( BUY, CMP Rs.1,250, Target Price Rs.1,557, upside 24%)
At the CMP of Rs1,250, the stock is currently trading at 8.3x FY12E consolidated EPS of Rs150 and
7.0x FY13E consolidated EPS of Rs180. We initiate coverage with a BUY and a SOTP-based target
price of Rs1,557 (Rs499 for the standalone business, Rs942 for JLR business and Rs116 for
subsidiaries).
Ashok Leyland (Hold, CMP Rs.55, Target Price Rs.61, upside 11%)
At the CMP of Rs55, the stock trades at 10.7x FY12E EPS of Rs.5.1 and 9.8x FY13E EPS of Rs5.5. We
initiate coverage with a Hold rating and a target price of Rs61 (based on 7.4x FY13E EV/EBITDA,
inline with its historical average multiple and Rs4.3 per share as value of investments in JVs).
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