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~ Action
After a nearly 20% correction in stock price in past three months, AL shares are
trading at 9x FY13F EPS, well below lower our coverage universe average of
10.9x. Ramp up in a new plant in the tax-free zone should lead to improvement in
margins in FY12F, we expect. While our volume growth estimate for FY12F at 8%
is below management guidance of 18%, we believe the stock still offers an
attractive 21% return to our revised price target of INR74. BUY.
aCatalysts
Expected improved volumes in 4Q FY11F and margin improvement in FY12F are
the key catalysts.
Anchor themes
Nomura’s India economy team forecasts 7.8% IIP growth for FY12F. We have built
in volume growth of 8% in FY12F, in line with that forecast.
Strong pick up in volumes ahead
c Volumes to improve significantly from 3Q FY11 levels
AL management indicated that volume momentum remains strong.
Volumes in 3Q FY11 were plagued by logistics issues and component
shortages. The company expects to sell 30,000 units in 4Q FY11F,
implying a 62% q-q increase in volumes. We have been conservative
in building in 27,000 units expected for the same quarter.
d Earnings growth likely to remain strong on ramp up of
new plant
We are building in EPS growth of 31% in FY11F and 27% in FY12F.
While earnings growth in FY11F should be driven by strong volume
growth (estimated at 43%), in our view, earnings growth in FY12F will
likely be driven by the ramp up of a new plant in the tax-free zone,
leading to margin improvement.
e Valuations look attractive despite our outlook for low
industry growth
AL’s stock has corrected by nearly 20% in the last three months,
(underperforming the BSE Sensex by 12%), likely reflecting concerns
over a slowdown. We have been conservative in building in 99,000
units in FY12F (11% below management guidance). The stock now
trades at 9x FY13F EPS, at the lower end of the range for our
coverage universe (10.9x FY13F). Given the likelihood of a margin
improvement backed by tax breaks at the new plant, we believe that
the current price offers an attractive entry point.
f Maintain BUY rating with revised price target of INR74
We value Ashok Leyland based on DCF. For this purpose, we build in
volume growth of 43% in FY11F and 8% in FY12F. Our new PT
reflects our revised earnings estimates and implies 21% upside.
Drilling down
Slow but steady growth ahead
Ashok Leyland’s volumes in 3Q FY11 slowed significantly as the company faced
logistics issues related to the launch of its U-truck platform and the ramping up of its
new plant. The company continues to see strong demand in volumes and has guided
for a 62% q-q improvement in 4Q FY11 to 30,000 units. We note that recent industry
SAAR has not indicated any softness in demand, and this has been corroborated by
our channel checks with dealers. Nonetheless, we believe that growth in FY11F and
FY12F will remain slower than guidance. We have thus been conservative in building
in 91,000 units in FY11F and 99,000 units in FY12F, compared with management
guidance of 95,000 units in FY11F and 112,000 units in FY12F
New plant will provide significant tax benefits
AL is in the process of ramping up its new plant, which will enjoy a 100% income tax
benefit for five years and 100% excise duty benefits for ten years. The volume
contribution from this plant is likely to improve from 16% in FY11F to 35% in FY12F,
based on our estimates, thus likely boosting operating margins y-y, as shown below.
Key assumptions – building in volume growth of 8% in FY12F
We have increased our volume estimates by ~10% in FY11F and FY12F to factor in a
higher-than-previously estimated volume run rate; however, given the sharp increases
in material costs and lower volume guidance at the new plant in FY12F (35,000
compared to 40,000 earlier), we have lowered our margin forecasts. We also now
assume better working capital management, resulting in lower interest cost leading to
4.5% increase in FY11F EPS and 10% increase in FY12F.
We have been conservative in building in volume assumptions lower than
management guidance of 95,000 in FY11F and 18% growth in FY13F. Our FY12F
volume growth estimate is in-line with our truck industry growth estimate of 8%
DCF based valuation of INR74/share
We value Ashok Leyland based on DCF at INR74/share. Our methodology is
unchanged. We value the standalone business at INR68.7/share and the investments
at INR5.7/share (see discussion below). Our key assumptions for DCF are 4% terminal
growth and 13% cost of equity (ke). We have built in 8% volume growth in FY12F and
10% growth in FY13F.
Key risks
a) Slower-than-expected ramp up of new plant – In case AL is not able to
produce 35,000 units from the new plant by FY12F, our margin estimates
would be at risk.
b) Slowdown in industrial growth – In case there is a sharp slowdown in
industrial growth, our volume estimates would be at risk.
c) New competition – New competition from players like Mahindra and
Mahindra could be a risk to our volume estimates for FY12F.
Valuing new ventures at book value of investments INR5.7/share
Over the next two years (FY11-12), AL is likely to invest INR6bn per year in the
standalone business, we expect. In addition, we look for the company to invest INR4bn
per year for other ventures including the LCV venture with Nissan and construction
equipment business with John Deere. While the investment in these two new ventures
will depress earnings and return ratios, they should start contributing significantly from
FY13F, in our view. Therefore, we value these investments (INR8bn) at 1x discounted
book value at INR5.7/share.
3Q FY11 results below estimates
Ashok Leyland’s 3Q FY11 results came in well below estimates. PAT was INR433mn,
well below our estimate of INR869mn.
z The key surprise was higher-than-expected employee costs due to a bonus payout
of INR260mn for the quarter. The company had conducted wage negotiations in 3Q
FY11 and its provisioning was lower by INR260m for FY10. This cost is
nonrecurring.
z Other expenses / sales at 8.4% of sales also were higher than our estimate of 7.7%.
z OPM thus came in at 7.5%, below our estimate of 9.8%.
z The company implemented a price increase of 2% from 10 Jan 2011 and should be
able to maintain gross margins, we expect.
z Operating margins should improve with an expected increase in volumes in 4Q
FY11F.
z The company is targeting sales of 30,000 units in 4Q FY11.
z The quarter had higher interest costs as inventory increased by 800 vehicles q-q
and 3,500 vehicles were sold to State Transport Units, where dues are outstanding.
These vehicles have a lower contribution margin.
Cost ratios – staff costs surprise
AL’s staff cost-to-sales ratio came in at 11% in 3Q FY11. However, the company has
been able to pass on steep cost increases related to headwinds such as 1) change in
emission norms; and 2) increases in other costs like rubber, and as a result, it has
marginally improved the raw material (RM) /sales ratio. With a 2% price hike from 10
January 2011, the company, in our view, should be able to maintain its RM/sales or
marginally improve it as well.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
~ Action
After a nearly 20% correction in stock price in past three months, AL shares are
trading at 9x FY13F EPS, well below lower our coverage universe average of
10.9x. Ramp up in a new plant in the tax-free zone should lead to improvement in
margins in FY12F, we expect. While our volume growth estimate for FY12F at 8%
is below management guidance of 18%, we believe the stock still offers an
attractive 21% return to our revised price target of INR74. BUY.
aCatalysts
Expected improved volumes in 4Q FY11F and margin improvement in FY12F are
the key catalysts.
Anchor themes
Nomura’s India economy team forecasts 7.8% IIP growth for FY12F. We have built
in volume growth of 8% in FY12F, in line with that forecast.
Strong pick up in volumes ahead
c Volumes to improve significantly from 3Q FY11 levels
AL management indicated that volume momentum remains strong.
Volumes in 3Q FY11 were plagued by logistics issues and component
shortages. The company expects to sell 30,000 units in 4Q FY11F,
implying a 62% q-q increase in volumes. We have been conservative
in building in 27,000 units expected for the same quarter.
d Earnings growth likely to remain strong on ramp up of
new plant
We are building in EPS growth of 31% in FY11F and 27% in FY12F.
While earnings growth in FY11F should be driven by strong volume
growth (estimated at 43%), in our view, earnings growth in FY12F will
likely be driven by the ramp up of a new plant in the tax-free zone,
leading to margin improvement.
e Valuations look attractive despite our outlook for low
industry growth
AL’s stock has corrected by nearly 20% in the last three months,
(underperforming the BSE Sensex by 12%), likely reflecting concerns
over a slowdown. We have been conservative in building in 99,000
units in FY12F (11% below management guidance). The stock now
trades at 9x FY13F EPS, at the lower end of the range for our
coverage universe (10.9x FY13F). Given the likelihood of a margin
improvement backed by tax breaks at the new plant, we believe that
the current price offers an attractive entry point.
f Maintain BUY rating with revised price target of INR74
We value Ashok Leyland based on DCF. For this purpose, we build in
volume growth of 43% in FY11F and 8% in FY12F. Our new PT
reflects our revised earnings estimates and implies 21% upside.
Drilling down
Slow but steady growth ahead
Ashok Leyland’s volumes in 3Q FY11 slowed significantly as the company faced
logistics issues related to the launch of its U-truck platform and the ramping up of its
new plant. The company continues to see strong demand in volumes and has guided
for a 62% q-q improvement in 4Q FY11 to 30,000 units. We note that recent industry
SAAR has not indicated any softness in demand, and this has been corroborated by
our channel checks with dealers. Nonetheless, we believe that growth in FY11F and
FY12F will remain slower than guidance. We have thus been conservative in building
in 91,000 units in FY11F and 99,000 units in FY12F, compared with management
guidance of 95,000 units in FY11F and 112,000 units in FY12F
New plant will provide significant tax benefits
AL is in the process of ramping up its new plant, which will enjoy a 100% income tax
benefit for five years and 100% excise duty benefits for ten years. The volume
contribution from this plant is likely to improve from 16% in FY11F to 35% in FY12F,
based on our estimates, thus likely boosting operating margins y-y, as shown below.
Key assumptions – building in volume growth of 8% in FY12F
We have increased our volume estimates by ~10% in FY11F and FY12F to factor in a
higher-than-previously estimated volume run rate; however, given the sharp increases
in material costs and lower volume guidance at the new plant in FY12F (35,000
compared to 40,000 earlier), we have lowered our margin forecasts. We also now
assume better working capital management, resulting in lower interest cost leading to
4.5% increase in FY11F EPS and 10% increase in FY12F.
We have been conservative in building in volume assumptions lower than
management guidance of 95,000 in FY11F and 18% growth in FY13F. Our FY12F
volume growth estimate is in-line with our truck industry growth estimate of 8%
DCF based valuation of INR74/share
We value Ashok Leyland based on DCF at INR74/share. Our methodology is
unchanged. We value the standalone business at INR68.7/share and the investments
at INR5.7/share (see discussion below). Our key assumptions for DCF are 4% terminal
growth and 13% cost of equity (ke). We have built in 8% volume growth in FY12F and
10% growth in FY13F.
Key risks
a) Slower-than-expected ramp up of new plant – In case AL is not able to
produce 35,000 units from the new plant by FY12F, our margin estimates
would be at risk.
b) Slowdown in industrial growth – In case there is a sharp slowdown in
industrial growth, our volume estimates would be at risk.
c) New competition – New competition from players like Mahindra and
Mahindra could be a risk to our volume estimates for FY12F.
Valuing new ventures at book value of investments INR5.7/share
Over the next two years (FY11-12), AL is likely to invest INR6bn per year in the
standalone business, we expect. In addition, we look for the company to invest INR4bn
per year for other ventures including the LCV venture with Nissan and construction
equipment business with John Deere. While the investment in these two new ventures
will depress earnings and return ratios, they should start contributing significantly from
FY13F, in our view. Therefore, we value these investments (INR8bn) at 1x discounted
book value at INR5.7/share.
3Q FY11 results below estimates
Ashok Leyland’s 3Q FY11 results came in well below estimates. PAT was INR433mn,
well below our estimate of INR869mn.
z The key surprise was higher-than-expected employee costs due to a bonus payout
of INR260mn for the quarter. The company had conducted wage negotiations in 3Q
FY11 and its provisioning was lower by INR260m for FY10. This cost is
nonrecurring.
z Other expenses / sales at 8.4% of sales also were higher than our estimate of 7.7%.
z OPM thus came in at 7.5%, below our estimate of 9.8%.
z The company implemented a price increase of 2% from 10 Jan 2011 and should be
able to maintain gross margins, we expect.
z Operating margins should improve with an expected increase in volumes in 4Q
FY11F.
z The company is targeting sales of 30,000 units in 4Q FY11.
z The quarter had higher interest costs as inventory increased by 800 vehicles q-q
and 3,500 vehicles were sold to State Transport Units, where dues are outstanding.
These vehicles have a lower contribution margin.
Cost ratios – staff costs surprise
AL’s staff cost-to-sales ratio came in at 11% in 3Q FY11. However, the company has
been able to pass on steep cost increases related to headwinds such as 1) change in
emission norms; and 2) increases in other costs like rubber, and as a result, it has
marginally improved the raw material (RM) /sales ratio. With a 2% price hike from 10
January 2011, the company, in our view, should be able to maintain its RM/sales or
marginally improve it as well.
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