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Ashok Leyland: Investor Meet extracts - Views on News from Equitymaster
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Ashok Leyland: Investor Meet extracts
Feb 20, 2006

On February 18th 2006, in the Equitymaster Investor Meet, Mr. Hariharan, DGM Finance, Ashok Leyland (ASOK) presented his outlook on the commercial vehicle sector (CV) and Ashok Leyland. Following are the key excerpts of the same. Overloading: Recently, Supreme Court (SC) passed an order banning overloading of trucks. Post that, the marketing team of ASOK has given the feedback that the state governments are serious about implementing the ban. The recent increase in the freight rates (around 30% in some pockets) is a precursor to the same. Currently, the overloading is in the range of 20% to 40% of the rated capacity. If the ban is implemented, there could an additional demand of around 10% over the next year (in terms of tonnage accretion, it could be higher).

Middle East venture: As per the management, ASOK is amongst the leading players in the Middle East region. To capitalise on the same, it is setting up an assembly unit in this region with the initial capacity of around 5,000 units per annum. The rationale of setting up assembly units is primarily to get the tax and other incentives that are available to domestic players.

Inorganic growth strategy: Traditionally, ASOK has had a weak presence in the light commercial vehicle segment (LCV). To increase its presence, the company is looking out for suitable acquisitions. Currently, the company has identified two such opportunities, one in China and other in European region. That said, the benefit from the acquisition, if it materlialises, is not likely to be immediate.

Segmental demand: In the M&HCVs, the company expects the bus segment to witness strong demand. Currently, demand for buses from the private players and the state transport undertakings (STUs) is around 40:60. The management believes that the potential demand from the private sector is significantly higher and therefore, their share can increase to 60% as against the current 40%.

As far as M&HCVs is concerned, the management expects the industry demand to increase by around 10% YoY in FY07. However, we have factored in a 7% YoY growth in domestic demand. Having said that, we expect the company to outperform the industry growth. We expect the company to grow by 9% to 10% in FY07.

Cost reduction strategy: Ashok aims to bring down its material cost (as a percentage of sales to around 69%) from the current levels, assuming stable steel prices. A part of the savings would come from its e-sourcing strategy, which will become fully operational by 1HFY07. The e-sourcing program, when fully implemented, could result in 5% savings in procurement costs. Similarly, it aims to bring down its staff cost to around 6% of sales from the current levels (marginally over 7% in FY05). The management aims to achieve the above targets in about two years time frame.

Rising interest rates: As per the management, a 100 basis points increase in the interest rate would not have any significant impact on margins of the freight operators, assuming tonnage demand grows by 10%. As against interest rates, fuel prices are a major threat to the CV industry going forward (considering the fact that it accounts for more than 50% of total cost for freight operators in general).

Entry of international players: The entry of international players should not pose any threat to the existing players for two reasons i.e. scale of operations and competitive cost structures. As per the management, the real threat is from the Chinese players who are expected to enter the Indian market in next two to three years. We expect the industry to fragment at the higher tonnage segment in the long-term (beyond three years).

Competition from the railways: Recent media reports suggest that the Railway Minister could lower freight rates by as much as 20% in the forthcoming budget. As per the management, while the reduction, if happens, will be good for consumers. In our opinion, as has been the case in international markets (where railways have a free-hand when it comes to pricing), roadways will gain in strength and the share of railways will come down in the non-bulk commodity transport sector.

What to expect?
At the current price of Rs 36, the stock is trading at a price to cash flow multiple of 6.7 times our FY08 estimates. Though Ashok Leyland has been the second largest player in the commercial vehicle segment, it has been losing market share. This was primarily due to labour disputes, which have been sorted out. Secondly, the company lost its market share due to production constraints. With company raising its production capacity to 100,000 units by FY07, we believe that even this issue has been sorted out.

Having said that, the limited playground of the company is one of its biggest disadvantages. Secondly, though the company is expanding capacity based on expected demand, if the demand fails to materialise, there could be significant pressure on net margins. It should be noted that CV industry is cyclical in nature and currently, it is at the peak of the cycle (in terms of volumes). Considering these factors, at the current price, the risk to reward ratio is equally poised and to that extent, investors have to be cautious.

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