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Ashok Leyland: Good, but not enough - Views on News from Equitymaster

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Ashok Leyland: Good, but not enough
Jul 31, 2006

Performance Summary
Riding on the growth of the CV (commercial vehicle) industry, Ashok Leyland, India’s second largest CV player has put up an impressive show during 1QFY07. Buoyed by a 34% YoY growth in topline, operating profits have grown at a marginally lower rate of 33% while profit before tax and extraordinary items have improved 56% YoY. The bottomline growth has however come in at 8% owing to an extraordinary profit of over Rs 300 m during same quarter last year. If one excludes the extraordinary income, net profits more than double over 1QFY06.

Financial performance: Standalone snapshot
(Rs m) 1QFY06 1QFY07 Change
Net sales 10,624 14,239 34.0%
Expenditure 9,734 13,052 34.1%
Operating profit (EBDITA) 890 1,187 33.3%
EBDITA margin (%) 8.4% 8.3%  
Other income 42 139 233.8%
Interest (net) 3 (5) -249.9%
Depreciation 297 328 10.2%
Profit before tax 638 993 55.6%
Extraordinary income/(expense) 277 (38)  
Tax 271 262 -3.2%
Profit after tax/(loss) 644 692 7.5%
Net profit margin (%) 6.1% 4.9%  
No. of shares (m) 1,189 1,310  
Diluted earnings per share (Rs)* 2.0 2.1  
Price to earnings ratio (x)**   12.7  
(* 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, 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 performance in 1QFY07?
Topline performance - Volume growth good but lags industry: Overall volumes have improved by 28% over 1QFY06. This was powered by a 43% jump in domestic sales of goods carrying medium and heavy commercial vehicles (M&HCVs). Passenger carrying M&HCVs have however witnessed a decline of 40% in sales, thus reducing the overall domestic sales of M&HCVs (both goods as well as passenger carrying) to 28%. This is significantly lower than the industry growth rate of 52% during the same period thus leading to a loss in market share. On the exports front, total volumes have seen a rise of 36%, mainly driven by a huge 152% jump in passenger M&HCVs. Exports have also underperformed the industry growth rate of 38%, albeit not to as big an extent as domestic sales.

The 34% YoY growth in topline, higher than the growth in volume terms could be attributed to a couple of factors. First, the company undertook some price hikes during 1QFY07 and secondly, the sales mix has become more favorable as company sold more number of multi-axle vehicles and tractor-trailers, vehicles which are high value products.

Segment wise break up of sales…
  1QFY06 1QFY07 Change (%)
M&HCVs Passenger
Domestic 2,287 1,373 -40.0%
Exports 321 808 151.7%
M&HCVs Goods
Domestic 10,023 14,328 43.0%
Exports 572 434 -24.1%
Total M&HCVs
Domestic 12,310 15,701 27.5%
Exports 893 1,242 39.1%
LCVs  
Domestic 96 95 -1.0%
Exports 21 2 -90.5%
Total
Domestic 12,406 15,796 27.3%
Exports 914 1,244 36.1%
Grand Total 13,320 17,040 27.9%

Operating margins – Status quo: Operating profits during 1QFY07have almost grown in line with the topline thus leaving the margins at 1QFY06 levels. Although the company has witnessed some pressure on the raw material costs front, in particular from high rubber prices, lower staff costs and other expenditure as a percentage of sales have been able to offset the effect of the same. With no signs of raw material pricing pressure abating, it remains interesting to be seen how much will the company be able to pass on to the consumers especially when its market share has declined in 1QFY07.

Cost break-up…
(Rs m) 1QFY06 1QFY07 Change
Raw materials 7,528 10,445 38.7%
% sales 70.9% 73.4%  
Staff cost 1,047 1,291 23.4%
% sales 9.9% 9.1%  
Other expenditure 1,159 1,316 13.5%
% sales 10.9% 9.2%  

The other income kicker: Other income during the quarter more than tripled over 1QFY06 and this further helped the company shore up its bottomline performance. It should be noted that during 1QFY06, company had posted an extraordinary income of Rs 301 m towards profit from sale of its castings business. As a consequence, the bottomline growth in this quarter has been a rather muted 8%. However, if one excludes this one time effect, the bottomline shows a sharp jump of 102%.

What to expect?
At the current price of Rs 35, the stock is trading at a price to cash flow multiple of 9 times our estimated FY08 cash flow per share. At current valuations, growth in the near term seems to be fully factored in. Unless growth dramatically improves in the next couple of quarters or the company makes some big announcements, we do not see a reason to revisit our numbers.

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