Ashok Leyland's strong market share, BS-IV tech give it long-term earning push

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Nitin Agrawal Moneyconotrol Research

Ashok Leyland (AL), the second largest commercial vehicle manufacturer, reported an optically weak quarter marred by decline in the top line and profit led by a decline in volumes, increase in operating costs, foreign exchange losses, and one-time losses. However, we recognise numerous tailwinds for the company like an increase in its market share, strong exports, strategy on defense, the GST opportunity and last but not the least, the focus on BS-VI and EVs. Any weakness in the stock should be an opportunity for long-term investors.

Quarter at a glance

Topline - BS-IV and GST to blame
In the first quarter of the fiscal, net revenue from operations saw a decline of 0.5 percent (y-o-y) and 36 percent (q-o-q). The decline was mainly because of the headwinds industry faced on account of BS-IV led pre-buying and GST rollout. The same resulted in destocking and postponement of purchase by customers. The company witnessed volume decline of 8.6 percent (y-o-y) and 40 percent (q-o-q).

Margin headwinds – pricing power might shield the impact
AL’s EBITDA margin shrunk by 410 basis points (y-o-y) in 1Q18, which was led by a rise in raw materials cost (76bps), employee costs (192bps) and other operating costs (142bps) as a percentage of sales.

The management said that raw material costs continue to go up and feels confident to pass on the same as it plans to hike prices of its products starting August 2017. The company indicated that it is the only player who has been taking steady price hikes.

On employee cost increase, the lower denominator (sales) played its part and employee cost as a percentage of sales will even out as sales pick up.

Profit Decline – Partially Optical
The company’s profit after tax fell significantly by 61.7 percent from last year. This decline was mainly caused by foreign exchange losses of Rs 2.7 crores recorded in Q1 of FY18 as against the gain of Rs 49.7 crore in the same quarter previous year. Additionally, one-time loss on loans to subsidiaries of Rs 12.5 crore dented profit. As per management, all material impairments on subsidiaries have been taken care of.

Hinduja Foundries to be EBITDA Accretive
Commenting on Hinduja Foundries, the management indicated that it is not yet EBITDA positive. It has, however, got cash profit for the month of June and is going to be EBITDA accretive, going forward.

Looking beyond the current quarter numbers, the company did sound positive, riding on multiple tailwinds.

Highest-ever Market Share
While the company continued to face industry-related headwinds, it achieved the highest ever market share of 34.7 percent in the current quarter. On the back of the company’s technological prowess and smooth riding over the past many quarters, it has been able to gain year-on-year market share in 12 out of the past 13 quarters.

The market share gain was not only in a particular product or a region, but it was well-rounded across all products and regions. This was driven by its innovative BS-IV compliant iEGR technology, which was launched in April after the government banned the use of BS-III vehicles in the country. The management is very confident about the technology as is evident from the increase in warranty for its products.

Volumes Recovery
With many of the headwinds largely behind, volume pick-up is only a matter of time riding on the positive impact of GST rollout, and the government’s increased focus on infrastructure spending. While recognising the competitive intensity, the management is confident about its products and its position in the market.

The management, in the conference call, indicated that international markets such as Saudi Arabia and Qatar have started to recover and the company undertook good exports in the quarter gone by, especially in Bangladesh. On the back of this, the company has guided to 25 percent growth in MHCV exports.

Focus on BS-VI and EV
AL has earmarked Rs 500 crore towards R&D to prepare itself for BS-VI and electric vehicles. As per the government’s timeline, the auto companies have to be BS-VI compliant by 2020 and the company is gearing itself for the same.

Recently, AL announced its strategic alliance with SUN Mobility to take a step further in developing EVs. However, the management indicated that it will have a positive impact on the company only after 18-24 months.

Strong position in Defense
The company has sold 1,500 units to Indian Arm Forces and the management is very confident and excited about the long-term opportunity in the defense sector.

In sum, we are positive on the medium to long-term outlook on Ashok Leyland. The company has bolstered its position in the market and looks set to gain from GST, infrastructure spending and market’s return to normalcy post BS-IV implementation.

We also like AL’s long-term growth drivers including opportunities in defense, preparedness for BS-VI and foray into EVs. At the current price, the stock trades at a reasonable valuation of 18.7 FY18 projected earnings and 14.5x FY19 projected earnings, which makes it an ideal candidate for accumulation on any weakness.

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