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Ashok Leyland: Riding the wave! - Views on News from Equitymaster

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Ashok Leyland: Riding the wave!

Oct 31, 2006

Performance summary
Ashok Leyland, India’s second largest CV (commercial vehicle) manufacturer has benefited from the continued robustness in the industry but not without margin pressure. On the back of a strong 33% YoY growth in volumes, the topline of the company has improved by a similar rate of 34% YoY for the quarter ended September 30, 2006. However, higher outgo towards key raw materials has shaved off a good 120 basis points from corresponding previous quarter’s operating margins. The bottomline growth at 27% YoY however, has come in slightly higher than the growth in operating profits, thanks mainly to the almost doubling of other income. For the half year, the growth in topline and bottomline on a YoY basis stood at 34% and 20% respectively.

Financial performance: Standalone snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net sales 12,501 16,757 34.0% 23,133 30,996 34.0%
Expenditure 11,338 15,407 35.9% 21,080 28,459 35.0%
Operating profit (EBDITA) 1,162 1,350 16.2% 2,053 2,537 23.6%
EBDITA margin (%) 9.3% 8.1%   8.9% 8.2%  
Other income 170 337 98.1% 203 475 133.7%
Interest (net) 7 4 -48.9% 19 9 -52.7%
Depreciation 342 365 6.5% 640 692 8.2%
Profit before tax 983 1,319 34.2% 1,598 2,311 44.7%
Extraordinary income/(expense) (18) (31)   259 (69)  
Tax 215 334 55.4% 486 597 22.7%
Profit after tax/(loss) 750 954 27.1% 1,371 1,645 20.1%
Net profit margin (%) 6.0% 5.7%   5.9% 5.3%  
No. of shares (m) 1,189.2 1,310.0   1,189.2 1,310.0  
Diluted earnings per share (Rs)* 2.3 2.9   2.1 2.5  
Price to earnings ratio (x)**         16.2  
(* 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 2QFY07?

Segment wise break up of sales…
  2QFY06 2QFY07 Change (%)
M&HCVs Passenger  
Domestic 4,263 2,924 -31.4%
Exports 559 846 51.3%
M&HCVs Goods  
Domestic 9,032 15,251 68.9%
Exports 806 753 -6.6%
Total M&HCVs  
Domestic 13,295 18,175 36.7%
Exports 1,365 1,599 17.1%
Domestic 232 89 -61.6%
Exports 3 0 -100.0%
Domestic 13,527 18,264 35.0%
Exports 1,368 1,599 16.9%
Grand Total 14,895 19,863 33.4%

Riding the CV industry wave: The domestic CV industry has continued with its positive growth for the fifth year in a row and Ashok Leyland, by virtue of being the second largest player, has benefited from such a trend. Strong economic numbers coupled with a significant demand in the replacement market has been driving the double-digit growth rate in the industry. While the company has recorded a huge 69% YoY growth in the goods segment of M&HCV, thus benefiting from a structural shift towards multi-axle vehicles, the 31% YoY decline in passenger segment has pulled the overall growth in this segment down to 37%. Further, with LCVs witnessing a drop of 62% in volumes, the domestic CV portfolio of the company has managed to grow in line with the industry growth rate of 35%. Consequently, the market share of the company during 1HFY07 has remained virtually unchanged at 17% on a YoY basis. Exports have improved by 17%, driven primarily by the 51% rise in exports of M&HCV (passenger).

Rise in input costs hurt margins: Raw material cost as a percentage of sales have increased by as much as 500 basis points over corresponding previous quarter. Our interaction with the management of other auto companies has led us to believe that certain raw material suppliers have come together to form a cartel and have been demanding higher prices from OEMs. Ashok Leyland seems to have been affected by the same trend, as is evident from the jump in raw material costs as a percentage of sales. Although the company has tried to mitigate the impact of the same through control on wages and other expenditure, operating margins have still suffered a decline of 120 basis points.

Cost break-up…
(Rs m) 2QFY06 2QFY07 Change
Raw materials 8,838 12,661 43.3%
% sales 70.7% 75.6%  
Staff cost 1,175 1,203 2.4%
% sales 9.4% 7.2%  
Other expenditure 1,326 1,542 16.3%
% sales 10.6% 9.2%  

The other income kicker: With other income almost doubling and with depreciation charges remaining benign, the net profit growth at 27% YoY has come in higher than the operating profit growth of 16%. However, with more of the FCCNs getting converted into shares, it has resulted into a 10% dilution in earnings for shareholders who have not bought into the FCCNs.

What to expect?
At the current price of Rs 47, the stock is trading at a price to earnings multiple of 16 times trailing twelve months earnings. Although the company’s plans of setting up a new plant in Uttaranchal is indeed positive, we believe competition seems to be doing much more than Ashok Leyland in order to capitalise on the industry growth story. Besides its relative size and inferior efficiency parameters vis-à-vis competition does not inspire much confidence. As such, we advise investors to exercise caution.

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