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Conference call excerpts: Ashok Leyland - Views on News from Equitymaster
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Conference call excerpts: Ashok Leyland
May 9, 2005

Ashok Leyland Limited (ALL), one of the leading players in the commercial vehicles segment, announced its results for FY05 and 4QFY05 on 28th April 2005. To give more information on its performance and future outlook, the company held a conference call, the excerpts of which are as follows: Demand outstripping supply:  The management was of the view that the demand for commercial vehicles (CVs) is outstripping the supply. For the first half of FY05, the company‘s performance was poor in light of strike at one of its plants, thereby significantly affecting its ability to meet demand. This is evident from the fact that there has been 33% increase in sales of the company in second half of FY05 as compared to 1HFY05. Further, if one considers the CV segment in totality, the company has managed to grow its volumes by 11% as against the industry growth of 25% in FY05. The management expects the commercial vehicle industry to grow in the range of 7%-8%

On the exports front, the performance was aided by an order of 3,322 units for CVs from Iraq, which it had won last year. The management has clarified that orders of such magnitude are not sustainable in near future.

About the possibility of the industry slowing down:  The management opined that the nature of current upsurge in demand is different from the previous one in 1996 that resulted in overcapacity and thereby, slowdown. In 1996, there was almost 100% debt financing and very little equity investment.

Spare parts business:  In FY05, the contribution from the spare parts business was more or less at the same level as last year. As per the management, with improving quality of the spare parts, the life of the products have improved and hence, the replacement cycle period is increasing. However, the company has made efforts to cover the entire nation to increase the share of revenue from spare parts business.

Capex plans:  The company expects the production capacity to increase from current levels of 65,000 units to 77,000 units by July 2005. It has outlined an Rs 4 bn capex plan. Though the break-up is not available, on a broader basis, the plans are in three areas. One, debottlenecking of existing facility to increase volumes. Two, investment for development of engine and transmission. Three, to set up a new complex for product development. The company plans to increase its production capacity to 0.1 m units in next 2 to 3 years.

Product mix:  The company’s product mix mainly consists of multi-axles, tippers and ‘Ecomet’ (LCV). As per management, the profitability is lower in ‘Ecomet’ as compared to MDV (medium delivery vehicles). However, the same will be compensated by orders from defense and exports where margins are higher. The product mix is diluted, mainly, to reach out to small freight owners.

New norms for automobile industry:  Upgradation to new norms will not only require higher capital expenditure but also the cost to the consumer. This in turn, may result in postponement of purchases and impact the replacement cycle of CVs. However, the management is the opinion that easy availability of finance, low interest regime coupled with goods freight rates could help mitigate the rise in the costs. As per management, the incremental cost of upgrading vehicles from E II norms to E III ranges between Rs 40,000 to Rs 50,000 per vehicle, which it hopes to pass on the consumers.

Iveco technology:  Ashok Leyland had entered into an agreement with IVECO Motors of Italy, the commercial vehicle unit of FIAT of Italy in early 2005. On queries regarding the nature of the same, the management specified that Ashok Leyland had the first option for introduction of new technology in India from IVECO stable. At the same time, there are no restrictions on ALL to buy only from IVECO.

Competitors:  The management viewed the competitors’ strategy of reducing prices by offering discounts may not be the right strategy. While the company believes that profitability is more important that market share, competitors like Tata Motors and Eicher are offering discount to increase market share in the southern region where Ashok Leyland is dominant.

Bus markets:  The management expects the bus industry to grow at 7% to 8%. The company enjoys a healthy 80% to 85% in government contracts. ALL expects to maintain that share. Also, government undertakings are in process of floating tenders during the current period, which was long overdue. Infact, STU and MSRTC have already floated tenders this year.

Steel:  The management plans to continue with its policy to enter into long-term contracts for its steel requirements, keeping the remaining portion for the spot market to take advantage of weakening steel prices. The management expects a slowdown in the steel sector from 2QFY06.

What is our view?
The stock currently trades at Rs 23 implying a price to earnings multiple of 10.1 times FY05 earnings. The company has set a target of selling 70,000 units in FY06, which represents a 28% increase as compared to FY05. With the management outlook on exports side being at the same level as in FY05, the target seems to be optimistic. Having said that, with the launch ‘EMECO’ the company expects to perform better in the LCV segment, in which it has a negligible presence.

However, we will have to monitor the company’s performance in the next two quarters to see the ability of the management of achieve such a high target, especially when 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. Further, 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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