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Ashok Leyland: Above par… - Views on News from Equitymaster

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Ashok Leyland: Above par…

May 7, 2007

Performance summary
Ashok Leyland, India’s second largest manufacturer of commercial vehicles (CVs) announced its 4QFY07 and FY07 results late last Friday. Riding on the boom in the CV industry, the company has reported a 37% YoY rise in topline in FY07 and a marginally lower 35% YoY growth in bottomline. Operating margins have also shrunk by 50 basis points. However, a more than two fold jump in other income and lower finance charges has helped suppress this slight decline in operating margins. Furthermore, if one excludes the extraordinary items, the bottomline vaults by 49%, reflecting the buoyancy in its core operations. Margin pressure has also been faced by the company during 4QFY07, as the bottomline has been able to grow at a slower rate of 29% YoY over a 32% YoY growth in topline. Here again, higher other income and lower finance charges have lent the bottomline some support.

(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Units sold 20,402 26,140 28.1% 61,655 83,094 34.8%
Net sales 17,348 22,910 32.1% 52,477 71,682 36.6%
Expenditure 15,161 20,261 33.6% 47,076 64,655 37.3%
Operating profit (EBDITA) 2,187 2,649 21.1% 5,401 7,027 30.1%
EBDITA margin (%) 12.6% 11.6%   10.3% 9.8%  
Other income 85 169 98.1% 330 708 114.7%
Interest (net) 73 19 -74.3% 165 53 -67.6%
Depreciation 330 481 45.7% 1,260 1,506 19.5%
Profit before tax 1,869 2,318 24.1% 4,306 6,176 43.4%
Extraordinary income/(expense) (21) (30)   217 (131)  
Tax 513 573 11.6% 1,250 1,632 30.6%
Profit after tax/(loss) 1,335 1,715 28.5% 3,273 4,413 34.8%
Net profit margin (%) 7.7% 7.5%   6.2% 6.2%  
No. of shares (m) 1,221.6 1,323.9   1,221.6 1,323.9  
Diluted earnings per share (Rs)* 4.0 5.2   2.5 3.3  
Price to earnings ratio (x)**         11.7  
(* annualised, ** on trailing twelve months earnings)

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, the company 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% stake in the company.

What has driven performance in 4QFY07?
Medium & Heavy CVs (M&HCVs) – Doing the heavy lifting: The company sold 28% more vehicles during 4QFY07 than it managed during same quarter last year. Although still impressive, it was a lot lower than 3QFY07, when Ashok Leyland managed to sell 54% more vehicles over corresponding previous quarter. It was thus able to close the year with a 35% growth in overall volumes, a little less than was being expected before the start of 4QFY07. Hardening of interest rates towards the latter part of the fiscal seems to have made a certain section of buyers shy away from buying trucks. The performance for the full year was nonetheless impressive and was brought about mainly by its biggest segment, the M&HCV goods segment.

Here (M&HCV goods segment), the domestic volumes of the company grew by an impressive 53% YoY, higher than the industry growth rate of 38%, thus enabling it to consolidate its market share further. It should be borne in mind that this segment is Ashok Leyland’s forte and with the truck operators increasing replacing their fleet with high-end vehicles, owing to its superior profitability, the company has been able to reap the benefit of the same.

The overall domestic growth has however come in at a much lower rate of 36%, mainly because the company has not been able to take advantage of the equally buoyant growth in the LCV market. Here, the industry volumes grew 34% YoY, while Ashok Leyland performed disastrously as its volumes declined by 62% YoY. With the sales shifting more towards the sub 2 tonne vehicles in this category such as highly successful ‘Tata Ace’, the company has suffered on account of a lack of any model in this category.

On the exports front, Ashok Leyland has registered a good jump in exports, where volume were higher by 24% YoY in FY07, driven mainly by the 68% growth in M&HCV passenger segment.

Sales Break up
  4QFY06 4QFY07 Change (%) FY06 FY07 Change (%)
M&HCVs Passenger        
Domestic 3,383 4,035 19.3% 13,410 11,717 -12.6%
Exports 649 1,057 62.9% 2,255 3,778 67.5%
M&HCVs Goods        
Domestic 15,658 20,324 29.8% 42,613 65,063 52.7%
Exports 511 677 32.5% 2,580 2,233 -13.4%
Total M&HCVs        
Domestic 19,041 24,359 27.9% 56,023 76,780 37.1%
Exports 1,160 1,734 49.5% 4,835 6,011 24.3%
Domestic 181 36 -80.1% 753 289 -61.6%
Exports 20 11 -45.0% 44 14 -68.2%
Domestic 19,222 24,395 26.9% 56,776 77,069 35.7%
Exports 1,180 1,745 47.9% 4,879 6,025 23.5%
Grand Total 20,402 26,140 28.1% 61,655 83,094 34.8%

Input cost pressures: On account of continuous pressure on raw materials expenses, the company has faced a squeeze on operating margins, both during 4QFY07 as well as for the full year. However, for the quarter, rising wage costs and other expenditure have put further pressure on the margins, thus leading to a drop of 100 basis points. For the full year though, these cost heads have actually declined as a percentage of sales, thus restricting the margin fall to 50 basis points.

Cost Break up
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Raw materials 12,838 17,059 32.9% 37,690 53,391 41.7%
% sales 74.0% 74.5%   71.8% 74.5%  
Staff cost 816 1,163 42.6% 4,039 4,807 19.0%
% sales 4.7% 5.1%   7.7% 6.7%  
Other expenditure 1,508 2,038 35.2% 5,347 6,457 20.8%
% sales 8.7% 8.9%   10.2% 9.0%  

Other income on the other hand, has increased sharply, both for the quarter as well as for the full year and this has been able to nullify some of the negative impact of the fall in operating margins. Interest costs too have come to the rescue of the bottomline, as they have dropped by a significant 68% YoY for FY07. The company has attributed this to savings on the working capital front. Thus, these two factors combined have enabled the bottomline to grow at an impressive 35% YoY, despite the contraction in operating margins.

What to expect?
At the current price of Rs 39, the stock is trading at a P/E multiple of 12 times its FY07 earnings. With the rise in interest rates, we do not expect the volumes to grow at the rate witnessed in the recent past and in view of the current inflationary environment, any scope for margin expansion also looks dim. Thus, we believe the stock is adequately valued from a medium term perspective. The long-term prospects though, look promising, as its acquisitions should also start adding to its bottomline growth, in addition to its robust domestic expansion plans.

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