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Ashok Leyland: Bottomline matters!

May 2, 2006

PERFORMANCE SUMMARY
Ashok Leyland announced its 4QFY06 and FY06 results last weekend. In 4QFY06, while the topline grew at a healthy pace of 19%, an efficient cost control enabled the company to expand its operating margins. However, the operating performance failed to trickle down into the bottomline on account of a double whammy i.e. higher interest charges and lower other income. For FY06, the topline growth was robust; the bottomline performance (excluding extraordinary income) failed to match the topline performance.

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales 14,593 17348.1 18.9% 41,824 52,477 25.5%
Expenditure 12,882 15,161 17.7% 37,595 47,076 25.2%
Operating profit (EBDITA) 1,711 2,187 27.8% 4,228 5,401 27.7%
EBDITA margin (%) 11.7% 12.6% 10.1% 10.3%
Other income 327 110.22 -66.2% 538 330 -38.7%
Interest (net) (11) 98.3 28 165 488.0%
Depreciation 339 330.28 -2.5% 1,092 1,260 15.4%
Profit before tax 1,709 1,869 9.3% 3,646 4,306 18.1%
Extraordinary item (25) (21) -15.5% (96) 217
Tax 257 513.3 99.6% 836 1,250 49.5%
Profit after tax/(loss) 1,428 1,334 -6.5% 2,714 3,273 20.6%
Net profit margin (%) 9.8% 7.7% 6.5% 6.2%
No. of shares (m) 1,222 1,222 1,222 1,222
Diluted earnings per share (Rs) 2.7
Price to earnings ratio (x) 19.0

WHAT IS THE COMPANY'S BUSINESS?
Ashok Leyland is the second largest manufacturer of medium and heavy commercial vehicles (M&HCV) in India. In FY06, it had a 27% market share in the M&HCV segment and a marginal presence of 1% in the LCV segment (light commercial vehicles). Apart from CVs, it is also a key player in the passenger bus segment with almost 50% to 55% market share. Land Rover Leyland Investment Holdings (LRLIH) has 51% in the company.

WHAT HAS DRIVEN THE PERFORMANCE IN 4QFY06?
Topline – A good show: For 4QFY06 and FY06, Ashok Leyland reported strong topline growth. Infact, the topline has outpaced the volume growth (see table below).This is partly due to improved product mix (higher 'tipper' and multi-axle vehicles) and also on account of price hikes during the third quarter in range of 1% to 2.5%. However, Ashok Leyland has not been able to implement the price hikes as originally envisaged due to competitive pressures.

On the volumes front, exports were a disappointment. Infact, the YoY decline in exports overshadowed the company's efforts on the domestic front. For FY06, the poor performance on the export front is partly due to the high base effect of FY05. It should be noted that Ashok Leyland received an one-time order of 3,322 units in FY05 (46% of FY05 sales).

Segmental break up...
Domestic Exports Total
Segment 4QFY05 4QFY06 % change 4QFY05 4QFY06 % change 4QFY05 4QFY06 % change
MDV Passenger 3,223 3,382 4.9% 659 649 -1.5% 3,882 4,031 3.8%
MDV Goods 12,326 15,629 26.8% 1,956 511 -73.9% 14,282 16,140 13.0%
LCV Goods 132 142 7.6% 33 - -100.0% 165 142 -13.9%
Total 15,681 19,153 22.1% 2,648 1,160 -56.2% 18,329 20,313 10.8%
Segment FY05 FY06 % change FY05 FY06 % change FY05 FY06 % change
MDV Passenger 10,469 13,409 28.1% 2,052 2,291 11.6% 12,521 15,700 25.4%
MDV Goods 37,137 42,577 14.6% 4,667 2,580 -44.7% 41,804 45,157 8.0%
LCV Goods 322 721 123.9% 93 18 -80.6% 415 739 78.1%
Total 47,928 56,707 18.3% 6,812 4,889 -28.2% 54,740 61,596 12.5%

Improving operating margins: Despite an increase in raw material costs (as a % of sales), operating margins expanded by 90 basis points in 4QFY06. This has been on account of efficient management of other operating expenses. The increase in the raw material costs (as a % of sales) is also on account of increase in the in-house body building activity by the company (margins are negligible) and also on account of higher defence sales.The sharp reduction in staff cost in 4QFY06 is due to one-off adjustment with respect to excess salary provisions made in 3QFY06 as a part of settlement of new wage agreement at its Ennore plant.

For the FY06, but for exchange rate fluctuations, the other expenses (as a % of sales) would have been lower by around 50 basis points (0.5%).

Cost break-up…

(Rs m) 4QFY05 4QFY06 %Change FY05 FY06 %Change
Raw materials 10,525 12,838 22.0% 29,729 37,690 26.8%
% sales 72.1% 74.0% 71.1% 71.8%
Staff cost 948 816 -13.9% 3,540 4,039 14.1%
% sales 6.5% 4.7% 8.5% 7.7%
Other expenses 1,410 1,508 6.9% 4,326 5,347 23.6%
% sales 9.7% 8.7% 10.3% 10.2%

Bottomline – Cash crunch impact: Benefits of sound operating performance failed to trickle down at the net profit level. This was because of significant increase in interest charges and lower other income. The rise in interest expense is on account of higher working capital borrowings. To give a perspective, the inventory levels stood at 5,000 units as on 31st March 2006 as compared to 2,300 units last year (at the factory level).

The reduction in other income should be viewed in light off higher surplus funds last year on account of US$ 100 m FCCB issue in April 2004. As on 31st March 2006, a significant part of the funds have been invested by the company in a variety of activities (including debt repayment).

WHAT TO EXPECT?
At Rs 51, the stock is trading at a price to cash flow of 9.5 times of our FY08 estimates. The company has outperformed our volumes estimates by 3%, largely due to improved performance in the domestic arena. What is also heartening is the fact that operating margin expanded, as against our estimates of a marginal contraction.

Excluding the impact the extraordinary income, the company has outperformed our net profit estimates by 8% (at the PBT level). We had factored in an additional income on account of sale of shares in IndusInd Bank, as per the RBI guidelines. However, the company is still in process of obtaining an extension. While we will have to revise our estimates, with an upward bias, we do not foresee any significant changes. We shall update the investors at the earliest.

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