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Ashok Leyland: Low base effect - Views on News from Equitymaster
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Ashok Leyland: Low base effect
Aug 5, 2005

Introduction to results
Ashok Leyland, the second largest commercial vehicles (CV) player in the country had recently announced its results for 1QFY06. While the company has reported a strong growth in topline, the bottomline has grown at a much greater pace, mainly due to an extraordinary income on sale of its foundry unit. If one were to exclude this extraordinary effect, the bottomline growth has almost kept pace with the growth in topline.

(Rs m) 1QFY05 1QFY06 Change
Net sales 8,212 10,632 29.5%
Expenditure 7,462 9,742 30.6%
Operating profit (EBDITA) 750 890 18.7%
Operating profit margin (%) 9.1% 8.4%  
Other income 30 34 11.7%
Interest 30 (12) -138.4%
Depreciation 240 297 23.9%
Profit before tax 510 638 25.1%
Extraordinary items (23) 277 -
Tax 167 271 61.9%
Profit after tax/(loss) 319 644 101.6%
Net profit margin (%) 3.9% 6.1%  
No. of shares (m) 1,189 1,189  
Diluted earnings per share (Rs)* 1.1 2.2  
P/E (x)   13.95  
(* annualised)      

Company background
Ashok Leyland is the second largest manufacturer of medium and heavy commercial vehicles (M&HCV) in India. In FY05, it had a 28% market share in the domestic 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. 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) has 51% in the company.

What has driven the performance in 1QFY06?
Volumes grow on a low base:  As can be seen from the table below, Ashok Leyland managed to report an all round performance in the domestic industry. However, one should view the performance in light of the fact that the company was facing labour problems in 1QFY05 at one of its plants. The management had estimated the loss due to strike to 5,000 units in 1QFY05. Infact, based on the adjusted volumes, the company has witnessed a decline to the tune of 17% YoY. On the export fronts, it should be noted that in FY04, Ashok Leyland had won an order of 3,322 units (46% of exports in FY05) from Iraq for delivery in FY05. This had aided the export performance in 1QFY05. For FY06, while orders of such magnitude are not in pipeline, the management has aimed to achieve the same level of volumes as in FY05.

Segmental break up...
  Domestic Exports Total
Segment 1QFY05 1QFY06 % change 1QFY05 1QFY06 % change 1QFY05 1QFY06 % change
MDV Passenger 1,837 2,287 24.5% 466 327 -29.8% 2,303 2,614 13.5%
MDV Goods 7,830 10,016 27.9% 923 572 -38.0% 8,753 10,588 21.0%
LCV Goods 67 103 53.7% 13 15 15.4% 80 118 47.5%
Total 9,734 12,406 27.5% 1,402 914 -34.8% 11,136 13,320 19.6%

Operating margins continues to be under pressure:  As can be seen from the table below, while the company has managed to control staff costs, rising input costs together with increasing administrative and advertising expenses have dented the operating margins. It should be noted that while price of steel (accounting for around 45% to 50% of the operating costs) have receded from their peak, they are still ruling at significantly high levels. Going forward, we believe that there is further room for correction in steel prices. This will benefit the company much faster as compared to its peers as the management has adopted a policy of procuring around 65% of its requirement on spot basis against industry standard of 35%.

Cost break-up...
(Rs m) 1QFY05 1QFY06 Change
Raw materials 5,705 7,528 32.0%
% sales 69.5% 70.8%  
Staff cost 874 1,047 19.7%
% sales 10.6% 9.8%  
Other expenses 883 1,167 32.2%
% sales 10.8% 11.0%  

Extra ordinary effect on bottomline:  In FY05, the company had transferred its foundry and casting division to one of its group company, the financial effect of which has been reflected in 1QFY06. While this news is not a surprise, it is a positive move by the company as this will not only enable it to concentrate on its main business but will also improve the return and utilisation ratios as casting unit had been hampering the overall performance. We have already factored this income in our projected earnings for FY06.

What to expect?
At the current price of Rs 30, the stock is trading at a price to earnings multiple of 11 times our estimated FY06 earnings. While the phenomenal growth witnessed in the past 8 to 9 quarters is not sustainable, we believe that in the next two to three years, the growth in demand for CVs will be in the range of 6% to 8% with a bias towards higher tonnage vehicles. To that extent, Ashok will be benefited as it has presence largely in M&HCV segments. Having said that, we also expect the LCV segment to grow at 4% to 5% per annum in next two to three years. This will hamper the overall growth of the company as it has a marginal presence in this segment.

Further, traditionally, the company has been an under performer when compared to Tata Motors, which is the market leader. This is also a cause of concern as Tata Motors has been able to eat into the market of Ashok Leyland. We prefer Tata Motors in this segment.

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