Stock Note : Ashok Leyland – Contrarian Trade

Cmp-93 | Market Cap- 27,535 | Potential Return- 30% | Industry- Automobiles

Company Overview

Ashok Leyland (AL), flagship of the Hinduja Group, is the 2nd largest manufacturer of commercial vehicle (CV) in India and 12th largest manufacturer of trucks globally. It is headquartered in Chennai and has 9 manufacturing facilities, out of which 7 are based out of India and the rest provide AL international exposure – a Bus manufacturing facility in RAK, UAE and one at Leeds, United Kingdom. The Co. has pioneered many disruptive technologies owing to the strong focus on R&D which has made it the first Indian company to receive OBD – II (on board diagnostic) certification for BS IV compliant engines, SCR (selective catalytic reduction), iGER (intelligent exhaust gas recirculation) and CNG technologies.  Apart from CVs, AL is also present in other businesses like Power solutions, defence etc. to reduce the impact of the cyclical nature of its core business.

Investment Thesis

Robust industry outlook

Indian commercial vehicle space is likely to experience strong growth momentum going forward and being a second largest player in the Indian market, AL with wide array of product offerings is perfectly poised to take up the opportunity. Implementation of GST has benefitted the CV industry by revolutionizing the logistics sector. Reduced effective cost of ownership under the GST regime is also aiding the demand.

Focus on building non-cyclical business

AL is scaling up its non-truck businesses to mitigate the impact ofbusiness cyclicality and earnings volatility. These businesses includespare parts, exports, LCV, defence and power solutions. Currently thesebusinesses contribute approximately 12% of the standalone revenue and the target is to increase this to 50% going forward. AL haslaunched ‘Service Mandi’ app in Aug 17 to improve the after salesservice business and generated revenue of INR100 crore in FY18 andexpect this revenue can go up to INR500 crore in FY19. But considering the increasing CV sales significant contribution from non-cyclical business is not likely in near future.

Leadership in high tonnage segment

AL has 50% market share in the high tonnage segment whereas it has32% market share in the overall M&HCV segment. The growth in thehigh tonnage segment is outpacing the whole CV industry mainly due tothe implementation of GST. On the other hand, pick up in miningactivity is also aiding to the demand. Over FY12-18, HCV (>26 ton) segment grew at a CAGR of 20% whereas MCV segment reported a de growth of 2% and currently HCV contributes 25% of the M&HCV segment. We believe in the M&HCV space the share of HCV will continue to rise due to warehouse consolidation under GST (“Hub & Spoke Model”) and AL as a leader in that segment is likely to benefit.

LCV Business to abode well

Post GST and its relatively successful implementation & E-Commerce growth, will aid ‘HUB & SPOKE’ MODEL which will in turn witness structural growth in LCV space. Efforts by AL into LCV space is commendable, with multiple launches lined up in the next 12-18 months will aid the company tackle volatility in CV space. Growth in e –commerce space is also aiding growth to a large extent for the LCV segment.

Improvement in Market Share despite a slowdown

Total CV units sold by AL in FY19 are 1,94,254 a growth of 10%. AL increased its market share to 36.7% from 35.6% in FY18, an improvement of 110 bps.  Total industry volumes stood at 5,29,300.

Strong earnings growth from Non CV business:  

Operating leverage, favourable product mix (high tonnage), consolidation of LCV business and scale up of high margin/non-cyclical defence and spare parts business will drive the margin expansion and earnings for the Company going forward. But non-implementation of scrappage policy is expected to dent the earnings growth going forward.

Key Negatives – Factored in Steep Price Fall

Volume De Growth

FY18 witnessed 19% volume growth in MHCV & 28% in LCVs, however pace of volume growth has slowed to 10% to 1,94,254 total units.

Second half of FY19 witnessed 10-12% de growth in volumes mainly due to slowdown in infrastructure growth & NBFC liquidity crisis.

CV CYCLE at 5year Peak

Market fears of cyclical peak in CVs is factored in price. An average CV cycle lasts for 5-6 years, the current cycle is in its 6 year already. But during the same period, stock has fallen more than 50%.

CV Cycle

New Emission Norms & Anti Scrappage Policy to expand the CV Cycle

Bharat Standard-VI

Pollution has become a major concern in India and automobile contributes a significant portion of it. So, Government has mandated to roll out BS VI compliant vehicles by April, 2020. Management has guided for 8-10% price increase (INR1.5-2 lakhs per vehicle on average) on transition to BS VI regulation. This anticipated price hike is significantly higher than those of the previous transitions which is likely to drive up pre-buying ahead of the roll out in H2 FY20.

Anti-Scrappage Policy

This is something that the market is not factoring in, apart from implementing BS VI emission standard to curb pollution, a major decision has been made to take out CVs which are more than 20 years old from the road (Scrappage Policy) which has got all the pertinent approvals and only left with approval from GST council. If this gets implemented it will create an additional demand of 300,000 vehicles per year from FY21 onwards. According to the management, BSV1 cannot be successfully implemented without an effective scrappage policy of government.

Attractive Financials

AL is poised at a very attractive juncture at CMP. As explained in the revenue model, at cmp AL is at the bottom of the valuation band.

If you compare AL on valuations, the company during its worst cycle of FY12-14 traded at a band of 12.5 times at peak and 8.5 times at the bottom.

During the same period the company had a leveraged balance sheet too, debt to equity of 1-1.5 times vs 0.2 times in FY19.

AL at cmp is trading at a very attractive valuation of trailing 8.5 times FY19 EV/EBIDTA.

We assign a target of 120, implying a return of 30%

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