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Ashok Leyland: Northbound?

Feb 25, 2002

Auto stocks have been in the limelight over the last few days. After two years of sluggishness, higher agricultural output in the current fiscal seems to have brought some respite to the auto majors. Though two-wheeler majors have been on the rise in light of robust volumes, commercial vehicle (CV) demand also has picked up. The No. 2 in CV sector is Ashok Leyland (ASOK). We take a closer look at the performance of the company in the current fiscal and future prospects.While turnover for the first nine months of the current fiscal increased by 5%, sales fell sharply in 3QFY02. The company secured fresh export orders from various state transport undertakings for supply of vehicles in completely knocked down (CKD) form in 1QFY02. This benefited the company in terms of higher volume growth. Besides, it commenced delivery of light recovery vehicles (LRVs) to the Indian army. The order for around 500 LRVs was delivered by 2QFY02. Consequently, despite a marginal 4% growth in HCV volumes in the first half of the current fiscal, the company managed to post higher volume growth. But with the CV industry on the path to recovery (industry volumes are expected to grow at 6% in FY03), ASOK would benefit from any upturn in volumes. Also, given the existing ageing fleet profile, replacement demand could also be a stimulant, going forward.

A big positive for Ashok Leyland is its venture into defense vehicle manufacturing. This bodes well for the company in the long run as it would, to a certain extent, insulate the company from cyclicality. Sale of vehicles through CKDs (which include both Stallion and passenger vehicle segment) that contributed to 11% of turnover in FY01 will also increase progressively. Meanwhile, ASOK has developed two more specialized defense vehicles: a 6x6 high mobility vehicle (HMV) and a 4x2 truck fire-fighting vehicle (TFF). Both of them have undergone the evaluation of the Ministry of Defense and have been approved for induction into the Army.

At the operating level, the company is expected to perform well. Over the last four years, the company has managed to reduce workforce by 1,785 to 13,489 in FY01 and it hopes to reduce it further by 10%. Further, raw material costs that accounted for 64% of operating expenses in FY01 will also decline. This would be partly led by vendor pruning exercise as well as migration to ‘Hino’ based engine platform for its CVs. In FY02 and FY03, the company would also be retiring debts worth Rs 3.4 bn (35% of FY01 debt). This would enable the company to post higher growth in profits in the coming years. Consequently interest coverage, which stood at 1.8x in FY01, will also improve progressively.

However, on the CV front, it has a long way to go. For one, the company has a weaker presence in the Northern market. The northern, eastern and western markets together account for close to 75% of truck demand. Of this, the Northern region alone contributes to 34% of industry sales. While it is increasing its presence in north, its rival, Telco, has a dominant position in this region. Also, it will not take long for Telco to establish and expand its dealer network in the Southern region, which could dent volume growth of Ashok Leyland.

Besides Telco, there is another formidable international giant, which has already made inroads in the higher tonnage vehicle segment. Thanks to the road development initiatives taken by the government coupled with the economies involved with higher tonnage vehicle, demand for such vehicles has been rising at a steadfast pace over the last few years. Though both the domestic majors have stepped up their pedal on above 16 tonne CV manufacturing, they are still lagging behind Volvo in this segment. Besides the truck operators are of the view that maintanence expenses of Volvo are significantly lower when compared to domestic models.

ASOK currently trades at Rs 90 implying a P/E multiple of 13.8x FY02E earnings. It is trading at 0.9x book value and market capitalisation to sales works out to 0.4 times. While the prospects look promising for the industry, growth prospects are highly dependent on expansion of its presence in the Northern markets. This coupled with the promoters background have been the key reasons for the stock to trade at a comparatively lower P/E multiple over the years.

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