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Ashok Leyland: The missing zing-thing

Apr 29, 2005

Introduction to results
Ashok Leyland, one of the leading players in the Commercial Vehicles (CVs) in India, announced its FY05 and 4QFY05 results. While the topline growth for FY05 and 4QFY05 was at 23% and 31% respectively, the bottomline grew at a much faster clip of 40% and 64% for respective periods. But for a sharp spurt in other income and lower tax outgo, net profits could have been significantly lower.

Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 11,187 14,593 30.5% 33,939 41,824 23.2%
Expenditure 9,656 12,882 33.4% 29,993 37,595 25.3%
Operating profit (EBDITA) 1,530 1,711 11.8% 3,946 4,228 7.1%
EBDITA margin (%) 13.7% 11.7% 11.6% 10.1%
Other income 57 327 472.8% 186 538 189.0%
Interest (net) (18) (11) -39.4% 208 28 -86.5%
Depreciation 251 339 34.9% 965 1,092 13.2%
Profit before tax 1,354 1,709 26.2% 2,960 3,646 23.2%
Extraordinary income/(expense) (54) (25) -54.3% (95) (96) 0.9%
Tax 427 257 -39.8% 929 836 -10.0%
Profit after tax/(loss) 873 1,428 63.5% 1,936 2,714 40.2%
Net profit margin (%) 7.8% 9.8% 5.7% 6.5%
No. of shares (m) 1,189 1,189 1,189 1,189
Diluted earnings per share (Rs)* 2.9 4.8 1.6 2.3
Price to earnings ratio (x) 10.1
(* annualised)

What is company's business?
Ashok Leyland (ASOK) is the second largest manufacturer of medium and heavy commercial vehicles (M/HCV) in India. It has a 28% market share in the domestic CV segment and a marginal presence of 1% in LCV's (light commercial vehicles). Apart from CVs, ASOK is also a key player in the passenger bus segment with almost 50% to 55% market share. CVs and passenger vehicles contributed to 91% of revenues in FY05 while engines, sale of CKD units, castings and spare parts contributed the balance. Land Rover Leyland Investment Holdings (LRLIH) owns 51% of ASOK.

What has driven the performance in FY05?
FY05 in snapshot...
(Units) FY04 FY05 Change
MDV Passenger
Domestic 11,047 10,469 -5.2%
Exports 1,580 2,052 29.9%
Total 12,627 12,521 -0.8%
MDV Goods
Domestic 33,443 37,137 11.0%
Exports 1,915 4,667 143.7%
Total 35,358 41,804 18.2%
LCV Goods
Domestic 376 322 -14.4%
Exports 287 93 -67.6%
Total 663 415 -37.4%
Total 48,648 54,740 12.5%
Exports - the real performer: As evident from the adjecent table, total volumes in FY05 grew by a modest 13% YoY. While total domestic sales was higher by 7%, exports grew by 80% YoY aided by the export order of 3,322 units from Iraq that the company won last year. However for FY06, the management expects to atleast maintain export volumes like in FY05. It should be noted that during the first half of the year, the company was plagued with strike at one of its plants, which severely affected its capacity utilisation. As compared to 1HFY05, the domestic volumes in the 2HFY05 were up by 33%. If one were to consider the performance of the company on the CV side, domestic volumes are higher only by 11% in FY05 as against almost 25% rise in industry sales in the same period. While strike and supply related constraints impacted Ashok Leyland's performance in FY05, the fact that the company has underperformed cannot be ignored.

Other income - a significant contributor: During the quarter, the company sold 3% stake in IndusInd Bank in order to comply with RBI regulation of maximum permissible holding in a bank. (It should be noted that the company acquired 16% stake in IndusInd Bank by virtue of merger of Ashok Leyland Finance Ltd with IndusInd bank.) While the profit from this sale is not available with us, the significant rise in other income during the year is primarily on account of the same. (473% rise in 4QFY05 YoY). Further, the management has clarified its intention to offload another 3% in FY06, in order to bring the holding in line with RBI directives. Apart from this, the reduction in tax expense YoY is on account of change in corporate tax rate for FY06 as a result of which, its deferred tax liabilities are accounted at a lower tax rate as compared to last year.

Operating margins under pressure: Though the margins at net profit level have improved (owing to higher other income), there is pressure on margins at the operating level. For 4QFY05, the company managed well to reduce its material costs mainly through various value-engineering efforts. But a 60% increase in other expenses has had a negative effect on margins. For the full year, the value engineering efforts enabled company to cut down the impact of rising input cost. The management expects the cost of steel prices to decelerate starting 2QFY06. Further, over the last few quarters (see chart), the company's performance has been volatile, which is a cause of concern.

What to expect?
The stock currently trades at Rs 23 implying a price to earnings multiple of 10.1 times FY05 earnings. The company hopes to increase production capacity to 77,000 units in the second half of FY06, which will provide economies of scale in operations (and has set a sales target of 70,000 units for FY06). This combined with any softening of steel prices from 2HFY06 can significantly improve its margins.

However, the CV industry has been on a higher growth trajectory in the last three years (including FY05). Though there doesn't seem to be a slackening of demand, having regards to the cyclical nature of the CV industry, some amount of caution is required. With more players expected to enter the Indian markets in the higher end of the CV chain, market will fragment, which will impact regional players like Ashok Leyland. Given these factors, the risk-reward equation is equally poised and to that extent, investors have to exercise caution.

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